Fiscal Policy

Question 1

What is fiscal policy?

Answer 1

Involves changes in government spending, taxation and the level of government borrowing to help achieve some of the micro and macroeconomic objectives of the government.

Question 2

The tools of fiscal policy

Answer 2

• An increase in government spending can have multiplier effects, enhancing the impacts of aggregate demand
• Reducing the level of taxation can also affect aggregate demand
• The overall impact of fiscal changes depends on the balance between government expenditure and revenue
• If government expenditure > revenue, the government runs a budget deficit

Question 3

Fiscal policy

Answer 3

Involves changes in government spending, taxation and the level of government borrowing to help achieve the macroeconomic objectives of the government.

• State sector spending is also known as public sector spending

Question 4

Main instruments of fiscal policy

Answer 4

• Government spending
• Taxation
• Fiscal balance (deficit or surplus)

Question 5

Instruments of fiscal policy

Answer 5

Question 6

Government spending

Answer 6

Also known as the public expenditure, refers to the money that a government allocates to fund various state provided programmes and public services. These expenditures are typically financed through taxes and government borrowing (such as issuing bonds)

Question 7

The main types of government spending

Answer 7

• Capital (day to day) spending - on public services such as education - short run
• Capital (investment) spending - (infrastructure) - long run
• Transfer payments - welfare benefits

Question 8

Difference between current and capital spending

Answer 8

Current government spending - on providing public services. - e.g. salaries of NHS employees, Army logistic supplies, Road management budget

Capital spending - new public infrastructure - e.g. Construction of new motorways and bridges, Flood defence schemes, Defence schemes

Question 9

Significance of government spending

Answer 9

• Is a key component of aggregate demand
• Helps to stabilise demand in a recession
• Has a regional economic impact
• Important in providing public & merit goods
• Driver of long run growth
• Can help achiever greater equity in society

Question 10

Taxation

Answer 10

Taxation is the process by which governments collect revenue form individuals, businesses, and other entities to finance public services, infrastructure, and various government functions

Question 11

What are the main reasons for taxation?

Answer 11

Question 12

Balanced budget

Answer 12

Government spending = taxation (G = T)

• AD stays the same

Question 13

Budget deficit (good thing)

Answer 13

Government spending > taxation (G > T)

• Greater injections (G) than withdrawals (T)
• AD increases
• = Economic growth + unemployment decreases

Question 14

Budget surplus (bad thing)

Answer 14

Government spending < Taxation (G < T)

• Greater withdrawals than injections
• AD decreases
• Decrease in RNO

Question 15

How does a budget deficit occur?

Answer 15

• Occurs when public sector spending exceeds revenue
• The budget deficit is financed by public sector borrowing

Question 16

Expansionary fiscal policy

Answer 16

Question 17

Types of government spending

Answer 17

Current (SR) - day to day
Capital (LR) - infrastructure
Transfers - reduce inequality

Question 18

Key roles of fiscal policy

Answer 18

Question 19

Contractionary fiscal policy

Answer 19

Is implemented through increases in taxes, decreases in government spending and purchases.

Question 20

Expansionary fiscal policy - chain of reasoning

Answer 20

Expansionary fiscal policy involves increasing government spending or cutting taxes to increase aggregate demand.
This reduces the risk of a recession occurring. Assuming ceteris paribus, a cut in income tax, will increase household disposable incomes, thus consumer confidence will increase, leading to an increase in consumption. C is part of AD so AD will increase which increases economic growth and reduces negative output gap.

Question 21

What are the 3 categories of government expenditure

Answer 21

• Transfer payments
• Current/ capital (investment payments)
• Reccuring payments

Question 22

2 problems of a persistent budget deficit

Answer 22

• Crowding out
• Decline in economic growth