Fiscal Policy Flashcards
1
Q
the concept of fiscal policy.
A
- Fiscal policy is based on the principles of Keynesian economics
- The means of which a government can vary the amount of revenue and spending within the economy in order to stabilise economic activity;
- Which can impact the trends of macroeconomic objectives such as economic growth, unemployment and also inflation.
2
Q
Commonwealth Government’s Budget
A
- A budget is simply an estimate of income and expenditure for a set period of time.
- statement made on an annual basis (May) which outlines the revenue and expenditure projections for the following financial year
3
Q
The Fiscal policy works to fulfil three important roles
A
- Firstly, it decides how revenue will be raised, and allocates funds to areas of need
- The government raises funds through the presence of a progressive taxation system in the Australian economy which provides the fair majority of government revenue
- Secondly, it redistributes income from the wealthy to the less-wealthy
- Thirdly (perhaps most important), the government can use the budget to influence the level of macroeconomic activity (stabilise fluctuations in the business cycle)
4
Q
Identify the components of government revenue and expenditure in the budget
A
- The components of government revenue consist of three primary categories
- Revenue:
- > refers to the direct forms that the government body receives income from both sources of income in the circular flow model; households and firms.
- Indirect:
- > a tax levied on goods or services rather than on persons or organizations.
- Excise:
- > tax on certain types of goods produced or manufactured in Australia, including alcohol, tobacco, fuel and petroleum products.
Expenditure:
- Defence: funds military organisations such as the Australian Defence Force (ADF), the Royal Australian Navy (RAN) and also the Royal Australian Air Force (RAAF).
- Education: this funding goes towards public schools and improving the working conditions of teachers Australia-wide.
- Social Security and Welfare: is the largest component of government spending as it focuses heavily on achieving an equal distribution of income as this form of spending funds pensions, unemployment benefits and also welfare payments.
- General Public Services: these include general government spending such as police and ambulance services and other emergency services.
5
Q
. Outline different budget outcomes (i.e. balanced, surplus and deficit budgets)
A
- The primary aim of the fiscal policy is to achieve a balanced budget over the course of the oscillations of economy, on average.
- Budget Surplus where the total government revenue (T) becomes greater than the total government spending (G) i.e. T > G.
- Budget Deficit where the total government revenue (T) becomes less than the total government spending (G) i.e. T
6
Q
Account for differences between planned and actual budget outcomes.
A
- Can change from the planned outcome (to the actual outcome)
- due to changing economic conditions (cyclical or Non-discretionary changes)
- and changes in fiscal policy (structural or discretionary factors).
Cyclical or Non-discretionary changes:
- Unexpected Negative Events:
- > these events all worsen the budget outcome which can either decrease an existing surplus or increase an existing budget deficit
- > e.g. GFC, natural Disasters
- Unexpected Positive Events:
- > these events all improve the budget outcome which can either decrease an existing deficit or increase an existing budget surplus
- > e.g. Mining Boom, Technological breakthrough
Structural or Discretionary changes:
- If economic growth exceeds the expectations of the government body, then this will cause tax revenue to increase as there is more income in the economy. This will either decrease the existing deficit or change the deficit into a budget surplus.
- On the other hand, if economic growth falls short of the expectations of the government body, there is less income in the economy and hence tax revenue decreases. This will either decrease an existing surplus or change the surplus into a budget deficit.
7
Q
Explain the methods of financing a budget deficit and the uses of a budget surplus.
A
- A budget deficit will most likely occur in phases of a recession
- must draw funds from other sources to account for the difference between taxation and government spending.
- Borrowing from other sectors of the economy:
This involves selling new Commonwealth Government Securities (CGS) such as treasury bonds. ( Loan to the Government)
-> preferred government method of raising funds because it does not add to net foreign debt
-> when the Federal Government sells CGS, it competes with the private sector for domestic savings, creating what is referred to as a “crowding out effect”.
- Borrowing from other sectors of the economy:
- Borrowing from the Reserve Bank:
- Commonwealth Government to sell CGS to the Reserve Bank.
- RBA prints money to finance Government needs
- is highly inflationary.
- When the government spends this printed money, there is an increase in the money supply.
- But if the economy is near full employment, demand inflation occurs rapidly, as there is too much money chasing a finite supply of goods. - Borrowing from overseas:
- the Reserve Bank sells new CGS to overseas buyers, and receives foreign funds that are converted into Australian dollars (AUD).
- This method of financing the budget deficit adds to foreign debt when interest is paid on the securities
- The government may decide to borrow funds from overseas to reduce the “crowding out effect”. - Selling government assets:
- reduces the “crowding out effect” caused by the sale of government bonds.
- can create a headline budget surplus
- not sustainable as it can only be used on a “one-off” basis.
- It can also reduce the net worth of the government over time
8
Q
Explain Crowding Out Effect
A
- A shortage of funds in the domestic market can result in domestic investors needing to borrow funds from overseas.
- Shortage of Funds when Government borrows from private sector
- Government borrowing has then, effectively “crowded out” private investment. Private investment short-lived as interest rates and the cost of credits begin to increase.
9
Q
Using Budget Surplus
A
- Using surplus to repay prior debt within sectors of the economy:
- > buying back CGS to fund for previous deficits from the private sector
- > reduces the “crowding out effect “and relieves the pressure on interest rates - Repay debt to overseas:
- > - Used to fund government expenditure and/or depositing it with the RBA:
- Used to fund tax cuts:
10
Q
Distinguish between automatic fiscal stabilisers and discretionary fiscal policy.
A
- Cyclical or non discretionary changes – called automatic fiscal stabilisers.
- Structural changes in fiscal policy – called discretionary fiscal policy.
- Non discretionary fiscal changes in fiscal policy are changes in the level of economic activity
- Automatic stabilisers can be defined as those changes in the level of government revenue and expenditure that occur as a result of changes in the level of economic activity
11
Q
types of automatic stabilisers
A
- Impact:
- > provide a counter-cyclical role.
- > Automatic stabilisers on their own are not prominent enough to counter the oscillations of the economic cycle.
- > Because they are not powerful enough to change economic conditions,
- > it may improve a trough and/or curb a boom.
- Progressive Taxation System
- > during a boom, employment opportunities are decreasing and incomes are falling.
- > Falling incomes moves workers into lower income taxation brackets which means that they pay less income tax.
- > This will lead to a decrease in government taxation revenue and the same applies for when in a boom, incomes are rising, hence individuals are paying more income tax and government taxation revenue increases.
- Unemployment benefits
- > when the economy moves into a recession, the level of economic activity falls,
- > causing a rise in unemployment levels.
- > An increase in unemployment leads to greater government expenditure on unemployment benefits.
- > Therefore, a decline in the level of economic activity automatically leads to an increase in government expenditure
12
Q
Stances of fiscal policy
A
- refers to the overall effect of the budget outcome on economic activity.
- Expansionary (Fiscal) Stance
- > Government increases net expenditure compared to the previous year
- > Can be through lower taxation, higher government spending or both – results in larger deficit or a smaller surplus
- > Expansionary stance effectively acts as an injection – multiplier effect still applies
- > Thus this increase the level economic activity, this stance is used to boost aggregate demand to close a deflationary gap
- Contractionary (fiscal) stance
- > Government decreases net expenditure compared to the previous year
- > Can be through higher taxes, lower government spending or both – results in a smaller deficit or a larger surplus
- > Contractionary spending effectively acts as a leakage – multiplier effect still applies
- > Thus this decreases the level of economic activity, this stance is used to reduce aggregate demand and close an inflationary gap
- Neutral (fiscal) stance
- > Government maintains the same level of net expenditure as in the previous year
- > Effectively, this is neither a leakage nor an injection since the net spending is the same as the previous year
- > This budget would have no effect on the economy
13
Q
Effects of budgetary changes on resource use and economic activity
A
Economic activity
- Changes in the stance of fiscal policy can impact on the level of economic activity through changes in the budget outcome
- Effects on the economic activity are based on stances
Resource Allocation
- Fiscal policy can influence the allocation of resources either directly or indirectly
- Direct measures
-> Direct influence is through selective government spending. E.g. direct spending
on infrastructure
-> Governments are more likely to use direct measure if they expect that markets will not provide the resources quickly enough without government intervention
oMay also provide public goods, which private sectors don’t provide. E.g. national defense, environmental protection - Indirect measures
- > Indirect influence is through tax and spending policies, which influence the prices of goods, which affects levels of consumption and the amount of resources allocated into the sector. E.g. lower tax on ethanol to encourage its use
- > Indirect measures are used to influence spending patterns. E.g. higher tax on tobacco to discourage smoking, which reduces the costs on health care in the longer term
14
Q
Effects of budgetary changes on income distribution
A
- The fiscal policy plays the most important role in influencing the distribution of income.
- Income distribution is affected by the budget through changes to the taxation, social security and welfare systems.
- Through the commitment to the progressive tax system, income is redistributed from high income earners to low income earners through transfer payments (family allowance, pensions, dole etc.)
- Tax arrangements:
- > A reduction in tax rates at the upper end of the income scale would make the tax system less progressive and create more inequality.
- > An increase of regressive tax (GST) would further create more inequality
- Budgetary spending
- > Reductions in spending on government services would affect lower income earners more since they tend to be more reliant on government services
-> This would create more inequality as low income earners would need to spend more on services that were previously free
15
Q
Weaknesses of Fiscal Policy
A
- Political bias:
- > The party in power will use the structural component of the budget to make political statements
- Political structure:
- > for a budget to be adopted, both houses of parliament must agree to it.
- > Close election results have meant that the party handing down the budget will not necessarily have the majority in the Upper House and this may require some negotiation.
Social and political constraints:
- > large changes to allocations and distributions made in previous budgets cannot generally be made because of the patterns which have been established over time.
- > For example, to suddenly cut subsidies to non-government schools could cause either economic hardship in that particular sector or a rapid overcrowding of the government school system.
Time lags:
• Recognition lag – data about the economy’s economic performance may only become apparent after the event or trend analysis.
• Implementation lag – it may take some time for economic policy makers, politicians and pressure groups to come to an agreement on appropriate action once they have recognised trends in economic activity.
• Impact lag – the budget is generally only handed down once a year. Therefore any new projects can take a long time to get started.
-> e.g reforms to infrastructure
Competing objectives:
- > For example, the government might want to provide extra payments to low income earners so that equity is improved.
- > possible that this will place extra pressure on productive capacity, and inflation might result.
- > The government must therefore choose which of these objectives is “more important”.
Impact on the private sector:
- > crowding out and crowding in can limit the effectiveness of fiscal policy,
- > increasing economic globalisation has enabled firms to borrow funds from overseas more easily, limiting the impact of government borrowing.
Competing goals of state and local governments:
-> contractionary policy, for instance, will not be as effective if state governments are increasing spending.
