fiscal policy - government borrowing

Question 1

Public sector borrowing

Answer 1

• Public sector net borrowing (PSNB). This is the annual difference between net spending and net taxation. It is the amount the government need to borrow in a particular year. It is referred to as the budget deficit.
• Public sector net debt PSND: (also referred to as the National Debt) This is the total (cumulative) amount of debt that the government owes the private sector; this is approx £1,100bn (67% of GDP 2013).

Question 2

Chancellors Golden Rule

Answer 2

Under Labour, the govt said they would only borrow over the course of the economic cycle, in order to finance sustainable investment. But, in the recession of 2008/09, borrowing increased dramatically because of the fall in tax receipts and also the need to bailout financial sector

Question 3

Cyclical Deficit

Answer 3

During a recession, it is likely that there will be an increase in govt borrowing.
1. Tax revenues will be lower. E.g. less income tax and VAT
2. Government spending will increase. E.g. more unemployment benefits
Furthermore, in a recession, a government may pursue discretionary fiscal policy (e.g. change tax rates) to try and boost growth causing a bigger deficit.

Question 4

Economic Effects of Government Borrowing (consequences of a budget deficit) 1

Answer 4

1. Increased aggregate demand (AD) - A budget deficit implies lower taxes and increased Gov’t spending; this will increase AD and this may cause higher real GDP and inflation.
2. Higher taxes and lower spending - In the future the govt may have to increase taxes or cut spending in order to reduce the deficit. Higher taxes may cause reduced incentives to work.
3. Loss of Confidence - Countries with high levels of government borrowing may struggle to attract foreign investors, e.g. Eurozone economies.

Question 5

Economic Effects of Government Borrowing (consequences of a budget deficit) 2

Answer 5

4. Higher debt interest payments - To finance the budget deficit the govt will have to sell more bonds which will increase the national debt. This increases the annual debt interest payments; therefore future generations may have to pay higher taxes to pay these debt interest obligations.
5. Crowding out - Increased Govt spending to increase AD may cause a corresponding decrease in the size of the private sector. This is because for the govt to finance the deficit they sell bonds, this will reduce the amount that the private sector can spend. Also, Monetarists and other economists argue the govt sector may be more inefficient in spending money.

Question 6

Economic Effects of Government Borrowing (consequences of a budget deficit) 3

Answer 6

6. Increased Interest rates - If the govt sells more bonds this is likely to cause interest rates to increase. This is because they will need to increase interest rates in order to attract investors to buy the extra debt. If government interest rates increase this will push up other interest rates as well. (N.B. This may not always occur e.g. in liquidity trap)
7. Inflation - Government borrowing indicates there is a rise in net injections into the economy creating inflationary pressures. Also, in extreme circumstances the govt may increase the money supply to pay the debt. This could reduce the value of the currency and foreign investors could see their savings diminish.

Question 7

Advantages of Govt Borrowing 1

Answer 7

Govt Borrowing can be beneficial under certain conditions.
1. Recession - If there is a downturn in the economy there will automatically be a fall in taxation and higher govt spending on benefits, this will cause a budget deficit.
• However if the govt attempted to solve the budget deficit by increasing the rate of taxes this would further deflate the economy leading to lower growth and more unemployment.
• Therefore in a recession a government deficit is necessary to offset the rise in private sector saving and to try and increase AD and hence improve economic growth.
• In a recession, the private sector want to save more, so there is usually high demand for government bonds.

Question 8

Advantages of Govt Borrowing 2

Answer 8

2. Investment. If the govt increases spending on infrastructure spending, such as better roads. This can increase productivity and enable a higher rate of economic growth and more tax revenues in the future.
   • However, govt spending may not necessarily increase productivity. Some argue, government spending is generally less efficient than leaving it to the free market.
3. Bailout key industries. In the case of the banking sector, the government thought it necessary to bailout banks to prevent them going bankrupt and causing a possible loss of confidence in the banking system.

Question 9

Policies to reduce a budget deficit

Answer 9

Cut government spending - For example, in the 1990s, Canada cut spending by up to 20% within four years. This proved a successful policy in reducing the budget deficit and improved growth which helped reduce the budget deficit. Eval - depends what you cut, could worsen situation, may conflict.
Tax increases - more revenue. Eval - France increased taxes on the rich to over 70% – however, some have complained this is too high and creates disincentives to work in France. Reduction in growth
Economic Growth - people pay more VAT, companies pay more corporation tax and workers pay more income tax. However, many countries with fiscal deficit crisis are often stuck in recession and find it hard to grow.

Question 10

Economic Effects of Government Borrowing aka

Answer 10

(consequences of a budget deficit)