Fiscal Policy Flashcards
Fiscal Policy
Government expenditure and taxation
Reasons for fiscal policy
Prevent disequilibrium
Prevent fluctuations
Increase potential output
Budget deficit
Spending > Taxation
Budget surplus
Spending < Taxation
General government
Combination of central and local government
National debt
Accumulated deficits of central government, domestically and internationally
Public-sector net borrowing
Difference between spending and taxation
Public-sector net cash requirements
The amount the government needs to borrow
Current expenditure
Recurrent spending on goods and factor payments
Capital expenditure
Expenditure on investment and assets
Final expenditure
Expenditure on goods and services, included in GDP
Transfer
Payments to recipients, not injections by negative taxation
Net borrowing
Relative flow receipts in comparison to expenditure
Net debt
Accumulated debt stock
Current budget deficit
Current expenditure minus public sector receipts
Primary deficit
The sum of public sector expenditure minus interest < receipts
Relationship between primary surplus and debt to GDP ratio
PS/Y=D/Y * (r-G)
PS/Y: Primary surplus to GDP
D/Y: Debt to GDP
r: Interest rate
G: Real growth rate
Structural deficit/Surplus
Public sector deficit or surplus if the economy were operating at the potential level of national income
Fiscal stance
How expansionary or contractionary a budget is
Automatic stabilisers
Changes in government spending and taxation without a change in policy
Reduce fluctuations in the economy via counter-cyclical response
Problems of automatic stabilisers
Adverse supply side effects
- A higher progressive tax system may led to the substitution of work with leisure
- Unemployment benefits may decrease the incentive to work, shifting Philips curve to the right
- Steeper income curve may create a poverty trap
Fiscal drag
- Can prevent an economy from recovering as additional income generated is absorbed into higher taxation
Fiscal stabilisers cannot completely eliminate fluctuations in national income
Discretionary fiscal policy
Deliberate changes in the governments tax rates or level of government expenditure
Used to alter AD, AS, and the distribution of income
Fiscal impulse
Non-cyclical fiscal stance arising from discretionary fiscal policy changes
Influences on the effectiveness of discretionary fiscal policy
Predicting the effects of changes in government expenditure
- Crowding out: if the government employs the pure fiscal policy then the government will need to borrow the funds, leading to higher interest rates
Predicting the effects of changes in taxes
- A cut in tax will not only increase consumption not savings too
- Lower taxation may not alter income is the substitution effect > income effect
Predicting the resulting multiplier effect on national income
- Multiplier effect can fluctuate based on expectations
- Induced investment via the accelerator is based on sustained confidence
- Credit conditions may be pro-cyclical
- Small differences in predictions can lead to large divergences
Random shocks
- Forecasts cannot take into account unpredictable events
Problems of timing
- Time to recognition
- Time to action
- Time to effect taking place
- Time to changes in government spending and taxation
- Time to changes in consumption
Pure fiscal policy
Fiscal policy which does not alter the money supply
Crowding out
The increase in interest rates, preventing private sector investment, from an increase in government borrowing
Factors influencing the size of crowding out
The shape of the L curve; Flatter, the lower change in interest rates
Whether the money supply is exogenous; If an increase in money demand increases the money supply then the curve will slope upwards
The responsiveness of investment to a change in real interest rates
