Gov't Macro Intervention Flashcards
Fiscal Policy
- The use of government spending and taxation to influence the economy
Government Budget
Definition -> Annual financial statement showing the estimates of expected revenue and spending during a fiscal year
National Debt
-> Amount of money Government owes both domestically and abroad, which has accumulated over the years
Government ends up Needing to Raise Extra Finance -> Printing more money, or by borrowing even more money
Printing Money -> Reduces its actual value in the greater scheme/term, leading to inflation
Further Borrowing -> Either short or long term, and domestic or foreign sources
Main Takeaway -> Either method increases the National Debt
Main Issue -> When large proportion is owed abroad, or it looks as if it can’t be paid
Domestic Debt -> Paid back to those with government bills through tax revenue
National Debt is NOT the Same -> National debt is internal, while BOP is external
Automatic Stabilisers
Automatic stabilisers in economics are built-in government policies that help to soften the impact of economic fluctuations without the need for new legislation or direct intervention.
During a recession: If people lose their jobs, they automatically receive unemployment benefits. This extra money helps them continue to spend, which supports the economy.
During a boom: When people earn more, they pay more in taxes. This reduces the amount of money they have to spend, which helps prevent the economy from overheating.
In short, automatic stabilisers work like a cushion that helps keep the economy stable by adjusting spending and taxes automatically in response to changes in the economy.
Reasons for Taxation
1)Raise Revenue for Government Spending Taxation is used along other methods simultaneously
2)Manage Aggregate Demand Taxation is one of various methods to meet the Government’s economic objectives
3)Alter Distribution of Income & Wealth Income tax’s aim is to take money from the better off and give it to the poorer
4)Manage Market Failure or Environmental Issues Taxation is one way in which market failures can be reduced/minimised
Direct Tax VS Indirect Tax
Direct Tax -> Tax levied directly on incomes & wealth, individuals or firms
Indirect Tax -> Levied when goods & services are bought, taxes on expenditure
Capital Expenditure VS Current Expenditure
Definition -> Spending by the Government on goods & services intended to create future benefits
Alias -> Government Investment; Gross Capital Formation
Infrastructure -> Roads, buildings, etc.
Health & Education -> New hospitals, Schools or Sewage Systems
Research/Innovation -> Defence, Space or Vaccinations
Definition -> Government Consumption spending on goods & services for current use to directly satisfy the needs of members of the community
Examples -> Wages of Public Sector’s Workforce, Road Maintenance, etc.
Rates of Tax
A)Average Rate of Tax
Alias -> “Effective Rate of Tax” ; “Average Propensity to Pay Tax”
Calculation -> ART = (Total Tax Due) / (Total Taxable Income)
B)Marginal Rate of Tax
Alias -> “Proportion of Increase in Income which is Taken in Tax”
Calculation -> MRT = (Change in Tax Due) / (Total Taxable Income)
Reasons for Government Spending
1)Supply Goods & Services that Private Sector Would Fail to Do Public goods (eg. Defence), Merit goods (eg. hospitals), and Transfer Payments (eg. Benefits)
2)Achieve Supply-Side Improvements in Macroeconomy Spending on Education = Labour Productivity
3)Reduce Negative Externalities Effects Eg. Pollution
4)Subsidise Industries in Need of Financial Support Eg. Agriculture
5)Redistribute Income Thus achieve more equity
6)Inject Extra Spending into Macroeconomy Help increase Aggregate Demand and Economic Activity
Expansionary // Reflationary Fiscal Policy
- Use of fiscal policy to enable the economy to grow, increase the level of AD
- Methods: Cut in Taxes, Increase in Government Spending; Main Outcome -> C rises, I rises, G rises
- Unemployment Falls
- Inflation Rises, since Price Level increases
- Balance of Payments Possible Deficit
- National Budget Results in Deficit Generally
Contractionary // Deflationary Fiscal Policy
- Use of fiscal policy to reduce the size of the economy, decrease in the level of AD
- Methods: Rise in Taxes, Decrease in Government Spending; Main Outcome -> C falls, I falls, G falls
- Unemployment Falls
- Inflation -> Falls since Price Level decreases
- Balance of Payments -> NA
- National Budget Results in Surplus, as Government Revenue is increased
Con of fiscal policy
- Demand pull inflation
- Current account deficit
- Worsening of Gov. finances
- Gov spending is heavenly borrowing fuel that’s going to increase the demand the loanable funds, which pushes up equilibrium interest rates -> More expensive for private business to borrow money -> No money to fund their investment
- Time Lag
Evaluation of fiscal policy
- Consumer business confidence
- State of the gov’s finance
- Long run returns to the gov (Positive)
- Role of automatic stabilizer is good no need for big op
Monetary policy
Central Bank’s use of interest rates, money supply and exchange rates to control the economy
Monetary (Interest Rates)
Definition -> Cost of borrowing money, and reward on lending/saving money
Interest Rate Policy -> Use of interest rates to influence AD, through consumers and businesses
Other Banks -> Set their rates according the Central Bank’s base rate
Purpose -> Ensure targeted inflation rate and liquidity in the economy
Expansionary
- Interest rates Lower Rates; Main Outcome: C rises, I rises, AD rises
- Cost of borrowing is Lower, hence people can borrow more money
- Saving is Discouraged, since reward for saving is lower
- Spending greater than Saving
Contractionary
- Interest rates Higher Rates; Main Outcome: C falls, I falls, AD falls
- Cost of borrowing is Higher, hence people borrow less money
- Saving is Encouraged, since reward for saving is higher
- Spending is smaller than Saving
