Fiscal Policy Flashcards
Expansionary fiscal policy
Aims to increase AD. Governments increase spending or reduce taxes to
do this. It leads to a worsening of the government budget deficit, and it may
mean governments have to borrow more to finance this.
Contractionary fiscal policy
Aims to increase AD. Governments increase spending or reduce taxes to
do this. It leads to a worsening of the government budget deficit, and it may
mean governments have to borrow more to finance this.
How fiscal policy can be used to influence AS:
The government could reduce income and corporation tax to encourage spending
and investment.
The government could subsidise training or spend more on education. This lowers
costs for firms, since they will have to train fewer workers. Spending more on
healthcare helps improve the quality of the labour force, and contributes towards
higher productivity.
Governments could spend more on infrastructure, such as improving roads and
schools.
Budget Deficit
When expenditure exceeds tax receipts in a
financial year
Budget surplus
When tax receipts exceed expenditure.
Limitations of fiscal policy
There is a significant time lag involved with employing fiscal policy. It could
take months or years to have an effect
If the government borrows from the private sector, there are fewer funds
available for the private sector, which could lead to crowding out.
If** interest rates are high, fiscal policy might not be effective** for increasing
demand.
Capital government expenditure
Spent on assets, which can be used multiple
times. For example, it could be government expenditure on roads or building a school
Current government expenditure
Spending which recurs. This is on goods and
services which are consumed and last for a short period of time. For example, it could be on drugs for the health service.
Transfer payments
Welfare payments from the government. They aim to provide
a minimum standard of living for those on low incomes. No goods or services are exchanged for transfer payments.
eg. JSA
Problems with large budget deficits
In the short run its fine
However, excessive borrowing will cause demand-pull inflation, as it causes inflation it can cause a rise in interest rates, which will discourage firms from investment, and make a currency rise in value which will make exports less competitive
Increase national debt
Less attractive to FDI
National debt problems
May cause firms and foreign countries to stop lending to that government, limiting growth in the future.
Crowding out -
however, if gov spending boosts the economy there may be “crowding in” instead.
Budget surplus problems
Might suggest taxes are too high or that governement arent spending enough which could contrain economic growth
Fiscal rules to avoid overspending
Governement can borrow to invest into infrastructure but not to fund current expenditure (wages).
Created Office for Budget Responsibility to analyse public spending
