Fiscal Policy: Definitions/Concepts Flashcards
Discretionary measures
Public expenditure and taxation are actively
manipulated by the government in order to dampen fluctuations in economic activity
Automatic stabilisers
The mechanism whereby the prevailing system of
public finances automatically mitigates fluctuations in activity, without active intervention by the government
Government balance
= Budget balance
= Net lending (+) or net borrowing (-)
Primary budget balance
Budget balance, excluding interest payments on the national debt from expenditure
Cyclically-adjusted primary budget balance
Primary budget balance, excluding impact of the business cycle and macroeconomic developments on the budget
Structural primary budget balance
Cyclically-adjusted primary budget balance, excluding one-off and temporary measures (‘one-offs’)
Changes in the structural primary balance = used to assess the fiscal policy stance (= ‘discretionary policy’
Disposable income channel
Tax/benefit system reduces fluctuations in disposable income, thereby stabilizing
aggregate demand.
Marginal incentives channel
With progressive tax system, tax rate rises in booms and falls in recessions, encouraging intertemporal substitution of work effort away from booms and into
recessions
Redistribution channel
If those that receive funds have higher propensities to spend than those who give funds, aggregate consumption and demand will rise with redistribution
The ‘crowding out effect‘ of budgetary policy
Increased government expenditure or tax reductions will have to be financed by borrowing.
If the government’s use of the capital market is substantial, this may lead to higher interest rates
in the economy.
This may reduce other interest-sensitive spending components (business investment, house building, etc.), so that the overall effect on aggregate demand is less than the original fiscal expansion.
The ‘export crowding out‘ of fiscal policy
In case the economy operates under a floating exchange rate regime, an expansionary fiscal policy may trigger an appreciation of the domestic currency as a consequence of increasing interest rates.
The latter indeed makes investments in financial assets issued in the domestic currency more attractive, thus creating capital inflows.
The accompanying appreciation erodes the international competitiveness of domestic firms, which in turn adversely affects exports.
Expansionary fiscal contraction
The reasoning is that government savings not only reduce the expected future fiscal pressure, but also increase consumer and producer confidence.
Consumers will therefore save less and consume more, and producers will produce and invest more.
The initial restrictive policy can thus ultimately have expansionary effects.
These may not only be beneficial demand effects, but also beneficial supply effects. Restrictions on wages and salaries of public employees, reduction of public employment and of social security transfers can improve the competitive position and make the labour market more flexible and thus generate positive supply effects.
The ‘fiscal multiplier’
This measures the change in economic activity as a result of measures that fall within the scope of fiscal policy. In other words, by how much does real GDP increase (decrease) if the government increases (decreases) the budget deficit by one percentage point of GDP
‘Lucas critique
Keynesian thinking ignores the fact that economic agents adapt their behaviour to the changed environment, so that multipliers can look different than expected a priori (i.e., the ‘Lucas critique’).
This means that the ‘crowding out effects’ already mentioned take place.
Self-defeating Austerity
During the European sovereign debt crisis, the desirability of a restrictive budgetary policy against the background of a persistently fragile economic situation was the subject of intense debate.
The question was whether excessive austerity will not burden the economic malaise to such an extent that it becomes ineffective or even counterproductive.
