Fiscal Policy

Question 1

What does tight/deflationary fiscal policy involve?

Answer 1

Reducing government spending / increasing taxation

Question 2

What does loose/expansionary fiscal policy involve?

Answer 2

Increase government spending / reduce taxation

Question 3

What are automatic stabilisers? (inclu examples)

Answer 3

Fiscal policy that automatically dampens the business cycle - e.g. when economy grows, people automatically pay more taxes and the government spends less on unemployment benefits

Question 4

What are 2 government expenditures that don’t tend to change with the business cycle?

Answer 4

Health and education

Question 5

What effect does stabilizing fiscal policy have?

Answer 5

Decreases autonomous consumption, and increases government spending

Question 6

What is the paradox of thrift?

Answer 6

Individuals reduce spending and increase savings, which economy wide can decrease income by more than the reduction in spending (deepen recession), a reduction in aggregate spending can lead to a reduction in aggregate savings

Question 7

What is the fallacy of composition?

Answer 7

Strategies that are optimal for individuals are not necessarily optimal for economies as a whole

Question 8

When is the government budget balance in surplus, deficit and balance?

Answer 8

Surplus - G < T
Deficit - G > T
Balance - G = T

Question 9

How is govt budget surplus/deficit calculated?

Answer 9

Expenditure + interest payment - revenue raised

Question 10

All else equal what will will slow the growth of the debt-GDP ratio? (2 things)

Answer 10

1. higher GDP growth
2. lower real interest rates (either from low nominal r/i or high inflation)

Question 11

During a global recession what can we think of the decision to use fiscal policy as?

Answer 11

Prisonners’ dillemma

Question 12

What is the optimal outcome of the fiscal stimulus/austerity prisonners’ dilemma?

Answer 12

Both countries engage in fiscal stimulus

Question 13

What is the problem with the stimulus-austerity prisonners’ dilemma?

Answer 13

Both countries have an incentive to free ride if others are enacting stimulus

Question 14

What happens to employment when aggregate demand increases?

Answer 14

Employment is above the equilibrium level

Question 15

What are the criticisms of fiscal policy?

Answer 15

1. Govt have poor information and may make wrong choice
2. Time lags - can take several months to filter through to AD and then it may be too late
3. Crowding out as govt has to borrow from private sector which leave them with lower funds for investment
4. Govt spending is inefficient
5. Higher borrowing costs (expansionary fiscal policy can increase bond yields thus increasing debt repayments)

Question 16

What is crowding out?

Answer 16

When government spending fails to increase overall aggregate demand because higher government spending causes an equivalent fall in private sector spending and investment

Question 17

What are the benefits of fiscal policy?

Answer 17

1. Taxes can be targeted specifically e.g. polluter taxes
2. Tax can stable macro-economy through fiscal drag and boots
3. Discretionary changes in direct tax can regulate AD
4. Tax and welfare spending can be used to promote equity/reduce income inequality

Question 18

How can budget deficits be financed?

Answer 18

1. Cutting deficit (lower G increase T)
2. Money creation (risk of hyperinflation)
3. Default

Question 19

What does it mean for a price or wage to be sticky?

Answer 19

Resistant/slow to respond to a change

Question 20

What is Ricardian Equivalence?

Answer 20

Impossibility of using fiscal policy to change aggregate demand

Question 21

What is the Lucas Critique?

Answer 21

Impossibility of the policy maker to anticipate of forecast private agents’ actions