Fiscal Policy Flashcards
How and why
Purpose
Tool to control AD
- correcting a fundamental disequilibrium (e.g.boosting demand during a recession)
- can also be used to control AS (increased spending on infrastructure)
Government finances:
Expansionary fiscal policy v budget deficit and surpluses
Financing a deficit
- gilts and t bills (domestic borrowing )
National debt
Total amount of outstanding borrowing of a central government From internal (national creditors) and external (foreign creditors )
Fiscal policy
Expansionary aims to increase money supply
Increase spending or cut taxes
M
Contractionary is the opposite
Keynesian perspective on gov debt
Governments should run deficits in recessions, and surpluses in booms
Austerity may even worsen the debt burden if it deepens a recession
Growing debt is not a big problem, so long as it grows slower than the sum of inflation and real economic growth
Debt servicing costs
In recessions, even large deficits may not significantly increase interest rates
But large deficits are a much bigger problem for countries without their own currency
Types of expenditure
Current - recurrent spending on goods and factor payments
Capital expenditure- investment expenditure: on assets
Final expenditure - expenditure on goods and services, included in GDP part of AD
Transfers- transfers of money from taxpayers to recipients of benefits and subsidies
Not an injection to the circular flow but basically a negative tax(withdrawal)
Key fiscal indicators
Public sector net borrowing (PSNB)- difference between expenditure in public sector and its receipts from taxation and the revenues from public corps
Public sector net cash requirement (PSNCR)- annual deficit of the public sector , the amount the pub sector has to borrow
Public sector net borrow- gross public sector debt - liquid financial assets
Public sector current budget deficit - the amount by which public sector expenditures classified as current expenditure exceed public sector receipts
Primary surplus or deficit ñ- situation when the sum of public sector expenditure (excluding interest payments on public sector debt ) is less than (greater than public sector receipts
Structural deficit / surplus
Public sector deficit/surplus that would occur if the economy were operating at the potential level of national income I.e. One where there is a zero output gap
Automatic fiscal stabilisers
Tax revenues that rise and government expenditure that falls as national income rises
The more they change with income the bigger the stabilising effect on the economy
Fiscal drag
The tendency for automatic stabilisers to reduce the recovery of an economy from recession
Discretionary fiscal policy
Deliberate changes in tax rates or the level of government expenditure in order to influence the level of AD
Pure fiscal policy
Fiscal policy that does not involve any change in money supply
Predicting the resulting multiplied effect on national income
Size of the multiplier might be hard to predict (MPC and MPW may fluctuate)
Induced investment through the accelerator is hard to predict
Behaviour of commercial banks may be hard to predict
Multiplier/accelerator interactions - initially hard to estimate but their interaction is even harder
Time lags
- Time lag to recognition- business cycle irregular, governments won’t take action until they are sure
- Time lag between recognition and action- significant changes in gov expenditure have to be planned in advance, as budgets occur anual y there could be a long time lag between an issue Being noticed and corrected
- Consumption may respond slowly to changes in taxation
- Time lag between action and taking effect- a change in tax rates may not have an immediate effect, as some taxes are paid in long durations and may take time to apply
- Time lag between changes in gov expenditure and taxation and the resulting change in national income,prices and employment- accelerator effect takes time and it constantly interacts with the multiplier, it all takes time
Accelerator and multiplier effect
Multiplier- an initial injection causes a greater increase in national income
Multiplier (K)=Change in real GDP (Y)/ change in injections (J)
Accelerator- increase in national income sees results in a proportionally larger increase in capital investement by private firms
Political history
Recent years gigs have preferred a more passive approach, instead of changing the policies as the economy changed they created a set of rules
Related to measures of government deficits and to the stock of accumulated Debt
Taxes and expenditure can then be planned to meet these rules
Only problem is economies are hit by shocks some require inflation more discretion than others
After the financial crisis of 2008 countries resorted to discretionary policies and abandoned fiscal rules
However rules where reinstated after the world pulled out of recession
