Fiscal Policy - Budget Deficits + Surpluses Flashcards
Budget balance
Fiscal balance = Total tax revenue - Total expenditure
Budget surplus
When the fiscal balance is positive (Total revenue > Total expenditure), the government is said to have budget surplus
Budget deficit
When the fiscal balance is negative (Total Revenue < Total expenditure), the government is running a budget deficit. This indicates that the government is spending more money than it is collecting in revenue (taxes).
Balanced budget
When the fiscal balance is zero (Total revenue = Total Expenditure), the government has a balanced budget. In this case, the government’s revenue exactly matches its spending, with no surplus or deficit
Budget Deficits
Definition: A budget deficit occurs when a government spends more money (total expenditures) than it collects in revenue (total income) during a specific period, typically a fiscal year.
Implications: To cover the deficit, the government may need to borrow money by issuing bonds, which can lead to an increase in the overall debt level.
- Budget deficits can be used strategically during economic downturns to stimulate economic growth or during emergencies but should be managed carefully to avoid unsustainable levels of debt
Effect on debt: Budget deficit’s contribute to the accumulation of government debt, which needs to be repaid in the future, often with interest.
Budget surpluses
Definition: A budget surplus occurs when a government collects more money (total income) than it spends (total expenditures) during a specific period
Implications: A budget surplus allows a government to save or pay down debt, invest in infrastructure, or reduce taxes.
- Budget surpluses can be used to prepare for economic downturns, reduce the debt burden, or invest in long term projects
Effect on debt - Budget surpluses can be used to reduce or eliminate government debt
National debt
The national debt is the government’s stock of outstanding debt. The national debt can be expressed in billions of pounds, or as a percentage of national income (GDP) or in terms of thousands of pounds per household.
What is the National Debt
Accumulation over time: National debt is the result of a country consistently running budget deficits, where the governments expenditures exceed its revenues. When this happens, the government borrows money to cover the deficit, leading to an increase in debt.
Purpose: Governments often use debt to finance critical infrastructure projects, public services, and other expenditures. It can also be used as an economic tool during recessions to stimulate economic growth
Debt servicing: Servicing the national debt involves paying interest on the outstanding debt and, when necessary, repaying the principal amount borrowed.
How is a budget deficit financed?
Issuing government bonds: Governments issue bonds, such as treasury bonds or government securities, to raise funds. These bonds are sold to investors, including individuals, financial institutions and foreign governments.
International borrowing: Governments can also borrow from international organisations such as the International Monetary Fund (IMF) or World Bank, or through the issuance of bonds in global financial markets.
Central bank financing: In some cases, governments may rely on their central banks to finance budget deficits. The central bank can purchase government bonds or provide loans to the government. This approach, known as “monetizing the debt,” can have implications for inflation and monetary policy, and it is typically used with caution.
Government spending > Taxation
Government issues new bonds = Sold in the bond market = Bank of England runs the auction = Bonds have different maturities = Bought by investors = Domestic (e.g. UK pension funds) = External (e.g. overseas investors) = Bonds pay fixed interest = Known as the coupon = Bond yield varies inversely with the price = Traded in the capital market after issue
What are bond yields
- Government bond yields represent the return an investor can expect to earn by investing in a government issue bond
- Coupon yield: This is the fixed annual interest rate paid by the government on the face value of the bond. It’s expressed as a percentage of the bonds face value and determines the periodic interest payments to bond holders.
- Current yield: Current yield is the annual interest payment divided by the bond’s current market price. It represents the bonds yield at its current market value, which may differ from its face value.
Budget deficits - Impact on aggregate demand
Budget deficits - negative effects on AD
Justification for the UK government running a large fiscal deficit
Reasons why a large budget deficit is problematic for a government such as the UK
Expansionary fiscal policy
