Fiscal Policy Flashcards
What’s fiscal policy?
Fiscal policy is the use of government spending and taxation in order to reach the government’s goals of equity, funding (debt) and stability. It’s also used to stimulate aggregate demand and to smooth out the economic cycle.
When would a country use expansionary/contractionary fiscal policy?
They’d use expansionary fiscal policy in a negative output gap and use contractionary fiscal policy in a positive output gap.
What do the keynesian school say about fiscal policy?
They argue that fiscal policy can have powerful effects on AD, output, and employment, particularly when the economy is operating well below full capacity national output.
What are automatic stabilisers and how do they work?
Automatic stabilisers help to reduce the volatility of the economic cycle. They’re built into the economy through the tax and benefit system. A fast-growing economy tends to lead to a net outflow of money from the circular flow. During a recession, tax revenues fall and the government automatically injects extra welfare spending into the economy and runs a larger budget deficit. According to the OECD, automatic stabilisers can reduce the amplitude of the economic cycle by over 20%.
What are the cons of using fiscal policy to manage AD?
Time lags
It’s difficult to measure the govt. spending multiplier
There could be unintended circumstances e.g, eat out to help out brought a second wave of COVID.
What are discretionary fiscal changes?
Deliberate changes in indirect and direct taxation and government spending.
What are non-discretionary fiscal changes?
Current spending - commitments that the government needs to honour e.g, NHS, education.
What are the reasons for government spending?
Provision of public and merit goods
Redistribution of income and wealth
Influencing regional resource allocation and industrial efficiency.
Influencing the level of economic activity.
What’s fiscal discipline?
The growth and stability pact, fiscal compact, which governments must maintain.
What’s the growth and stability pact - fiscal compact?
A budget deficit should be no more than 3% of GDP. The national debt should be no more than 40% of GDP. Every year, the budget deficit is added to the national debt. The UK’s national debt is equivalent to the size of its GDP.
What’s the golden investment rule?
It states that any government borrowing must be used for investment, not for current spending.
What are the reasons for taxation?
Meeting the benefit principle
Changing the level and pattern of demand
Influencing the distribution of income and wealth
Helping to correct for market failure
What’s direct taxation?
Direct taxation is tax that’s levied on income, wealth and profit.
They include income tax, national insurance contributions, capital gains tax and corporation tax.
AKA progressive tax - the more you earn, the more you pay.
What’s the laffer curve effect?
It states that at a certain point, increasing taxes will disincentivise productive behaviour. Households and individuals will hide their income, leading to the shadow economy growing and the brain drain, where skilled workers leave to places with lower tax.
Liz Trust reduced the top band rate from 45% to 40% and quoted the laffer curve.
What’s fiscal drag?
If your income increases in nominal terms, you’re dragged from one tax band to another because tax bands don’t increase in line with inflation.
Some estimate that the government have collected £40billion more tax revenue because of fiscal drag in the last year.
What’s corporation tax and its consequences?
Corporation tax is paid by firms and in the UK it’s about 19%
If you raise corporation tax, it can result in PAP, shedding labour, inflation, reduced R+D, reduced FDI.
