Fiscal Policy

Question 1

Define fiscal policy

Answer 1

Fiscal policy involves the use of government spending, taxation and borrowing to influence the level of economic activity.

Question 2

Government spending can be split up into 3 different categories

Answer 2

Current: day to day expenditure on wages, books for schools etc
Capital: adding to the capital stock
Transfer payments: benefits paid for which no goods services are received in return, e.g pensions and unemployment benefits

Question 3

Where does government revenue come from?

Answer 3

Taxes

Profits of state owned enterprises and the selling/rent of them

Question 4

What is the budget surplus, budget deficit and national debt?

Answer 4

If gov. revenues exceeds total expenditure = surplus
If gov. total expenditure exceeds revenues = deficit
National debt = total of all debt/borrowing

Question 5

What are discretionary fiscal changes?

Answer 5

Deliberate changes in direct and indirect taxation and gov. spending.

Question 6

What are automatic fiscal changes?

Answer 6

Changes in tax revenues and gov. spending arising automatically as the economy moves through the different stages of the business cycle.

Question 7

What are automatic stabilisers?

Answer 7

They will try and limit the fluctuations in the business cycle, and can reduce the volatility of the cycle by 20%.
E.g unemployment and low income become eligible for transfer payments; the economy doesn’t go as deep into recession.

Question 8

What type of fiscal policy is needed to close a recessionary gap?

Answer 8

Expansionary/reflationary fiscal policy:
Increase gov. spending 
Reduce tax rates 
This is to reduce unemployment, and increase the rate of economic growth. 
Increase AD via the multiplier effect.

Question 9

What type of fiscal policy is needed to close a inflationary gap?

Answer 9

Contractionary/deflationary fiscal policy
Decrease gov. spending
Increase tax rates
This is to reduce inflation and slow the rate of economic growth
Decrease AD

Question 10

Evaluation of fiscal policy - time lags

Answer 10

Recognition lag: slow recognition that AD is growing either too quickly or too slowly and the policies need to be out in place.
Administration lag: takes time to implement the appropriate policy.
Impact lag: take time for the policy to work

Question 11

Evaluation of fiscal policy: complete crowding out

Answer 11

An increase of government spending which has been financed using bonds and has resulted in higher interest rates, and it will lead to a decrease in C and I, which completely offsets the G and AD1 will will decrease back to the original AD.

Question 12

Evaluation of Fiscal policy - incomplete crowding out

Answer 12

Incomplete crowding occurs due to G being greater than the decrease in C and I, and therefore the overall impact on real output is positive. This is the most realistic in a real life situation.

Question 13

Evaluation of fiscal policy - no crowding out.

Answer 13

There is no reduction in C or I and therefore no crowding out.

Question 14

Evaluation of fiscal policy - advantages

Answer 14

Ability to pull economy out of deep recession
Target specific sectors of the economy
Direct impact of Gov. spending on AD

Question 15

Evaluation of fiscal policy - weakness

Answer 15

Time lags
Gov. spending has a much bigger impact on the economy than a cut in taxes, as some of the additional income gained from a cut in taxes will be withdrawn from the circular flow in the form of T, S, and M
Crowding out
Political interests - the policies are made by politicians which may not have the best interests for the economy as a whole
Opportunity cost - what the money could of been spent on