Fiscal Policy Flashcards
examples of fiscal policy during recession
taxes go down
government spending increases
the aim of fiscal policy during a recession is to shift the aggregate demand curve in what direction
to the right (expand)
examples of fiscal policy during expansionary periods
taxes go up
government spending goes down
the aim of fiscal policy during an expansion is to shift the aggregate demand curve in what direction
left (back down)
formula for national savings
Y - T - C + ( T - G )
private savings of households - public savings
what is government revenue made up of
taxes
what is public savings
T - G
the amount of money that the government has left after spending
what are private savings
Y - T - C
The amount of income that households have after paying their taxes and consumption
if tax revenue is greater than government spending, the government has a budget…
surplus
if tax revenue is less than government spending, the government has a budget…
deficit
how can government get more money if theyre in a deficit
borrow to cover expenditure
take out of savings
deficits build up and become
debt
how can deficits be justified
spending on health, education and public services may have been needed, not bad investments
spending now can boost growth in future eg motorway and infrastructure increases jobs and business
what is debt usually compared to
gdp
what is the EU target of national debt
60%
how has irish debt changed over time since 1994
1994 - 2007 we had steady debt with surpluses as often as deficits
after 2007, there was a big increase in debt
where does most government spending focus on
the young
old
unemployed
how can countries be left with large deficits after ating too early
acting too early in an expansionary period, the current government revenue will not be permanent but the money committed to be spent will be needed to be paid back over many years
how could ireland consider rising its taxes to raise more government revenue
higher taxes for higher earners
increase property tax
what is autonomous consumption
even without income, people will use their savings to consume
in the Keynesian cross what is the equilibrium line
where expenditure = national income
what type of relationship is there between expenditure and national income
positive, meaning if national income increases, people will consume more and as people consume more, national income increases and so on
what is the deflationary gap
the difference between potential and actual output of the economy
why might there be a deflationary gap
resources not being used effectively
fall in consumer spending
few business investment
fall in exports
what is the basis of the Keynesian cross
that government can influence AD through fiscal and monetary policy
what does MPC stand for
marginal propensity to consume
what is MPC
for each new dollar of income, what is spent on consumption
what does MPS stand for
marginal propensity to save
what is MPS
for each new dollar of income, what is saved
what will MPS + MPC be
1
explain how the multiplier effect works with government spending
if government spending increases, so will GDP as this spending is consumption for some citizens eg construction workers, whoever receives the benefits
as a result, consumption will rise
and because of that, GDP rises and so on
what is the multiplier formula for government spending
1 / 1-MPC
If the MPC was 0.75 and the government increased spending by 100 what would AD increase by
1/(1-0.75)
1/0.25
4
100x4=400
explain how the multiplier effect works with government taxes
if taxes decrease, households will have more take home pay and so their consumption will increase
GDP will increase because consumption increased and this goes on in that cycle
what is the tax multiplier formula
-MPC / (1-MPC)
If the government were to decrease taxes by 100, what would the effect be on AD, mpc = 0.75
-0.75/(1-0.75)
-3
100x3
300
which has a more direct impact on boosting AD
reducing Taxes
increasing government spending
increasing government spending
which effects AD less
decreasing taxes
increasing government spending
decreasing taxes
If the government were to increase taxes by 100, what would the effect be on AD, mpc = 0.75
-0.75/(1-0.75)
-3
100x3
300
AD decrease by 300
are multipliers unique to government spending
no, multiplier effects are also relevant for NX and I but the government can control government spending directly
what is crowding out
when private investments reduce due to high interest rates casused by government spendinf
why is crowding out caused
when government spending increases, the interest rate increases and so private firms have less incentive to borrow moneu to make investments as itll turn out to be more expensive
does multiplier effect apply to private investments
yes
Pros of government policy
smooths fluctuations
multiplier effect
Cons of government policy
should be all the time not just to smooth out cyclces
crowding out
potential debt
how much is being spent on imports
if the government spends money on foreign imports where will the multiplier effect be
in the foreign economy
example of why fiscal policy is needed as well as monetary policy
monetary policy can be limited eg interest rates are 0 and cant be lowered any further
fiscal policy has more of a direct effect on people’s lives
best time for government to save money & pay off debts
in years of expansion
which can be implemented more quickly:
fiscal policy
monetary policy
monetary policy
why cant fiscal policy be implemented as quickly as fiscal policy
need to hire people
need approvals
so on
why does an aging population cause an increase in government spending
more costs on pensions, medical care etc
shrinking labour force
what happens when a country continues to borrow but never pays back
countries will stop lending
how could an economy shift both AD and LRAS together
foreign investment
develops net exports (AD)
shifts LR AS as quantity of resources in the economy has also increased
how would
AD
and AS
change in Brexit without fiscal policy
Initially SR AS shifts down
SR AS could shift back up on its own as alternative supply chains are established
However this may not happen meaning there would be a permanent effect on supply (LRAS), having a negative effect on growth in the economy
how would AD and AS change in Brexit with fiscal policy
Initially SR AS shifts down
Government spending could push the AD back up in order to read the LR equilibrium again
could cause inflationary problems
how does the government know how much to increase government spending by to reach the long run equilibrium again
use the multiplier
how would AD and AS change in Covid-19 crisis with no fiscal policy
(assuming that shops can open)
initially negative demand shock
SRAS shifts to the right to go back to LR equilibrium
Firms will slowly adjust their prices and wages
Negative effect on growth
how would AD and AS change in Covid-19 crisis with fiscal policy
(assuming that shops can open)
initially negative demand shock
however the AD curve shifts back up due to government spending
Minimize effect on growth
