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Economics ATAR > Fiscal policy > Flashcards

Fiscal policy Flashcards

1
Q

What is the federal budget?

A

Delivered in May of each year, and estimates government revenue and the costs of current and capital expenditure plans for the coming year

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2
Q

2014-15

A
  • Revenue = $391.4b
  • Expenditure = $414.9b
  • Budget deficit = $23.5b
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3
Q

Major sources of revenue

A
  • Income tax
  • Company tax
  • Sales tax
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4
Q

Major areas of exppenditure

A
  • Social security and welfare
  • Health
  • Education
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5
Q

Budget surplus

A

Revenue is greater than expenditure

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6
Q

Budget deficit

A

Spending exceeds revenue

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7
Q

Balanced budget

A

Spending is equal to revenue

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8
Q

Comparing the budget in relation to the previous year

A
  • In 2013-14, the actual budget balance was a deficit of $50b
  • The 2014-15 forecast deficit of $23.5b could be considered contractionary because the deficit has been reduced
  • Therefore, the outcome of the budget really depends, not on its absolute value, but on its value relative to the actual outcome last year
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9
Q

Exogenous factors

A
  • E.G. exchange rate movements, rapid changes in the terms of trade or non-economic events
  • May cause the actual outcome to differ from the predicted result
  • For example, the decline in iron ore prices in 2014 had an impact on the level of tax revenue
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10
Q

First purpose of the budget

A
  1. Decides how revenue will be raised, and allocated funds to areas of need. Allocations don’t change much from year to year, as they are determined by on-going funding needs. They are also driven by the political process
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11
Q

Second purpose of the budget

A
  1. The budget redistributes income from the wealthy to the less-wealthy. The wealthy pay higher rates of income tax than the poor, and the poor receive more government support (both directly and indirectly) than the wealthy
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12
Q

Third purpose of the budget

A
  1. The government can use the budget to influence the level of macroeconomic activity
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13
Q

Why did Keynes argue that a balanced budget was destabilizing?

A
  • Because government expenditure was tied to revenue
  • In a trough, when revenue falls, a balanced budget would result in a fall in government expenditure.
  • This is just the opposite of what the economy needs to boost levels of spending and output
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14
Q

Difference between the structural and cyclical component of the budget

A
  • The cyclical component of the budget refers to how government revenue and expenditure is affected by the current state of the economy and the business cycle
  • The structural component refers to deliberate decisions made by the government when planning expenditure and revenue, and deciding whether the budget will be in deficit or surplus
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15
Q

Automatic stabilisers (during a boom)

A
  • During a boom, and when the economy is stronger, tac revenue rises and welfare payments fall so the budget balance becomes increasingly positive
  • As a result, income taxes and transfer payments act like an economic shock absorber
  • They reduce the aggregate level of spending in a boom
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16
Q

Automatic stabilizers (in a trough)

A
  • If the economy slowed, tax revenue would fall and transfer payments would rise
  • This would push the budget into deficit, but stabilizing the economy because people have more money to spend than would otherwise be the case
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17
Q

Problems with automatic stabilizers

A
  • Cannot prevent fluctuations in the business cycle

- Are not themselves sufficient to completely counteract the peaks and troughs in economic activity

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18
Q

Structural balance

A
  • An estimate of the budget balance, excluding cyclical factors
  • It reveals how governments change revenue and spending settings to achieve longer-term macro-economic policy objectives
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19
Q

Discretionary fiscal policy

A
  • The changes the government actually makes to government expenditure and or/ taxation to achieve their objectives
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20
Q

When should the government run a budget surplus, budget deficit or a balanced budget?

A
  • Surplus: when economic activity is too strong
  • Deficit: economic activity is below potential
  • Balanced: stable economy
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21
Q

Policy to stimulate spending

A
  • Reduce income tax
  • Cut corporate tax
  • Increase government spending on infrastructure
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22
Q

Deflationary gap

A

Describes the output gap that exists between the current level of income and that which could be achieved at full employment

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23
Q

To close the deflationary gap

A

Government stimulates spending so aggregate expenditure rises from Ydef to Yfe

24
Q

Presence of the multiplier

A

Due to the presence of the multiplier, the final effect is larger than the initial stimulus

25
Q

Ways to achieve a contraction

A
  • Increasing income tax rates and company taxes
  • Reducing or postponing government spending
  • Increasing excise tax (E.G. on cars, tobacco and alcohol)
26
Q

Taxation multiplier

A

A change in government spending will not have the same multiplier effect as an equivalent change in taxes

Multiplier (taxes) = mpc/mps or mpc/(1-mpc)

27
Q

Ways the government can finance a budget deficit

A
  • Selling government bonds
  • Borrowing from the central bank
  • Borrowing from overseas
28
Q

What is a bond?

A
  • A financial instrument which raises funds for its issuer (such as the government), in return for a rate of interest payable to the buyer
  • A financial instrument for investors with surplus funds
  • They are very safe because the risk of default is low, but the rate of interest they offer has to be attractive to the buyers
  • Bonds are in competition with other financial products in which people can ‘invest’ their surplus funds
29
Q

Effect of a large bond issue

A

May cause an increase in interest rates across the market, because government borrowing creates higher demand for credit in financial markets

30
Q

Crowding out effect

A
  • Caused by competition for loanable funds
  • The private sector is crowded out of the financial market by government borrowing
  • This causes a policy paradox
    o The government has borrowed to finance a deficit and increase the level of economic activity
    o The competition for loanable funds may increase interest rates
    o Usually would dampen consumption and investment expenditure
  • The expansionary effect of a budget deficit is offset to some degree by the impact of higher rates on private spending
31
Q

Borrowing from the private sector

A
  • Does not increase the money supply
  • The public initially withdraws money from the banking system to pay for purchases of securities
  • When the government spends the borrowed funds, the net effect on the money supply is nil
32
Q

Borrowing from the central bank

A
  • This injects new money into the economy, having an expansionary effect
  • However, the increase in money supply is likely to have an expansionary impact if the growth in money supply exceed the growth in real output
33
Q

Borrowing from overseas

A
  • Does not increase the money supply under Australia’s system of a floating exchange rate
  • The exchange rate will appreciate due to the inflow of money capital
  • Exports become less competitive, and imports become more competitive against domestic goods
  • This would counter the objectives of a budget deficit
34
Q

Ways the government can use budget surplus funds

A
  • Pay off government debt
  • Held over to fund future expenditure
  • Returned to tax payers as tax cuts
35
Q

Crowding in effect

A

Occurs when, for example retiring debt means that bond holders are repaid the capital value of their bonds, giving them extra spending power

36
Q

Lower public debt - question about ‘inter-generational equity’

A
  • The idea that the costs of infrastructure built today should be shared between today’s taxpayers and those who will also benefit from those facilities in the future
37
Q

3 strengths of fiscal policy

A

Fiscal policy is direct

Effect upon the economy in a recession

Fiscal policy measures and automatic stabilizers

38
Q

Fiscal policy is direct

A
  • Revenue and spending measures announced in the budget can be implemented immediately
  • Such decisions impact on revenue and saving patterns as soon as they are enacted
39
Q

Effect upon the economy in a recession

A
  • Open up a ‘spending tap’ to increase the level of AD in the economy

E.G. the Great Depression (1930s)

  • Government funds were used to build infrastructure and employ workers on government projects
  • Provides an immediate boost to employment, spending power and consumption
40
Q

Fiscal policy measures and automatic stabilisers

A
  • Are complementary

- In a boom, both discretionary and automatic stabilizers dampen spending and economic activity

41
Q

Four types of time lags

A
  1. Recognition lag
  2. Decision lag
  3. Implementation lag
  4. Effect lag
42
Q

The recognition lag

A

Occurs because the economic indicators that provide data about economic performance often lag the real trends

43
Q

The decision lag

A

Refers to the time that passes whilst appropriate policy is formulated. This is because the views of many groups must be considered as part of the political process

44
Q

The implementation lag

A

Refers to the time taken to implement the policy decision

45
Q

The effect lag

A

the time it takes for the policy to have an impact on the level of economic activity

46
Q

Inside lags

A

The analysis of data and decision to appropriate action within the government

47
Q

Outside lags

A

The time taken for the policy to take effect

48
Q

Comparison between inside and outside lags

A
  • The inside lag is long because the budget is only handed down once per year
  • Outside lags are comparatively shorter because of the potential direct impact of the budget announcements on the economy
49
Q

Why is fiscal policy is generally inflexible?

A
  • The budget cannot make large changes to the patterns of allocation and distribution established in the past years
  • Social and political constraints
  • For example, it would be impossible to reduce spending in a boom by cutting social security payments
  • Policy makers also have to consider possible costs of compliance due to policy changes
50
Q

Political constraints

A
  • Impact on the budgetary process because governments seek re-election
  • Political business cycle
    o First year of term – tough fiscal measures
    o Year preceding an election – budgetary measures appear easier to ‘buy votes’ from electors
  • Marginal seats have been known to benefit from government projects whereas ‘safe’ seats miss out
51
Q

Impact (unintended) on decisions taken in the private sector

A
  • The budget deficit can make it harder for the private sector to participate in recovery due to the supply of loanable funds becoming tighter
  • Availability of loanable money falls (negative effect on firms), and its price becomes higher (↑ interest rates)
  • Borrowing becomes riskier, and private firms may decide not to go ahead with plans to borrow
  • ↑ government expenditure could be cancelled out by reduced private sector activity
  • Therefore, expansionary fiscal policy would have no effect on the economy
52
Q

Macroeconomic framework of budgets:

A
  • Ensuring adequate public saving
  • A substantial rate of economic growth
  • Raising the economy’s growth capacity over time
53
Q

Structural unemployment

A

Occurs when there is a mismatch between the supply and demand of job skills

54
Q

How has the structure of our economy has changed?

A
  • Unemployment for the past 20 years remained (on average) just above 5%.
  • At face value it would seem expansionary fiscal policy would work well, but this isn’t necessary
  • There is close to 0% cyclical unemployment, and our unemployment is mainly due to structural unemployment
  • Structural unemployment reflects the supply-side problems of the economy, therefore using demand management policies such as traditional fiscal policy is ineffective in achieving economic objectives
  • Our budgets have also been in deficit, even in times of reasonable economic growth. This reflects the structural problems in the economy, which is consistent with our current account deficit and the imbalance between savings and investment
  • These problems cause a shift in government thinking, and a greater emphasis on getting the long term structure of the economy right
55
Q

Monetary policy

A

In recent years, it has been the preferred tool for demand management

Economics ATAR (12 decks)

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