Government Policies Flashcards
Fiscal Policy
Involves the use of government borrowing, spending and taxation (indirect and direct) to influence the economy (e.g. jobs, output and AD).
Current spending
- Transfer Payments
- Recurring Spending
Short term spending on state-provided goods and services, e.g. salary’s for NHS workers and resources for state-provided education.
- Transfer payments (welfare spending)
- Recurring spending (public services)
Capital Spending (Investment projects)
Government investment spending on expanding the countries capital stock, e.g. spending on infrastructure such as roads.
Crowding Out
The expansion of the (inefficient) public sector reduces the availability of financial and real resources to the more efficient and productive private sector.
Financial Crowding Out
- Chains
- Idea that government borrowing, to finance expenditure, can dampen aggregate demand through rising interest rates.
- government may issue more bonds to finance spending = increases demand for loanable funds = rising interest rates = more expensive for consumers and private sector businesses to borrow = less C + I
Financial Crowding In
The idea that well-timed, targeted and temporary increases in government expenditure can absorb spare capacity and create a strong multiplier effect, leading to private sector investment.
Cyclical Deficit
A fiscal deficit that is caused by an economy’s business cycle entering a recession, this is due to tax receipts decreasing and spending on the welfare system increasing.
Structural Deficit
A fiscal deficit that is not cause by state of the economy, but is instead a long-term effect that means tax receipt can not finance spending. An example could be an ageing population.
National Debt
The governments stock of outstanding debt, in £bns, £000s per household or % of GDP.
Types of tax Examples
- Direct
- Indirect
Direct
- Income tax
- Coporation tax (19%)
- Inheritance tax
- Hypothecated tax (BBC licence)
Indirect
- VAT (20%)
- Custom duty
- Sales tax
VAT is an example of a … tax
What?
Causes?
Ad Valorem
Percentage of the unit price
Supply curve becomes more inelastic
Monetary Policy
Involves changes in interest rates, the supply of money & credit, exchange rate and forward guidance to influence aggregate demand
Bank of England’s Targets
- Monetary Stability: Inflation 2% (+/- 1%)
- Financial Stability: Oversees banks’ activities and ensures high confidence in financial intermediaries.
Affect of rising interest rates
- Mortgages become more expensive, reduces demand for houses. Decreases household wealth and squeezes equality withdrawal (where consumers borrow money secures on rising house prices).
- Disposable income falls for homeowners with variable-rate mortgages, especially when debt is high.
- More disposable income for savers if inflation is less than interest rates.
- Less consumption, e.g. cars, due to the increasing cost of paying the debt on credit cards.
- More expensive to invest financed by borrowing, and confidence may fall. But there are many factors that influence investment.
- Business and consumer confidence; FALL IR could reassure due to BOE being aware and preventing recession OR could worry that emergency IR cut due to economic difficulty.
- Increase hot money, increase exchange rate.
Interest Rates Time Lag
- Time scale
- Reasons
18-24 months
- Fixed interest rates e.g. mortgages
- Bank rates: commercial banks delay passing on fall in base rate to consumers
- Imperfect knowledge
- Uncertainty: is IR change permanent
- Long term contracts = C + I patterns don’t change in short term
Quantitive Easing
- Definition
- Chains
- Involves the central bank buy assets from the private sector in order to increase the money supply and stimulate the economy.
BoE creates money = purchase bonds and financial assets from the private sector = increase liquidity = increases the supply of money = banks lower interest rates to loan out the excess supply of money = increase C+ I = increase AD (multiplier) and LRAS
Quantitive Easing
- Evaluations
- Depreciation of the exchange rate
- Ultra-low interest rates (liquidity trap)
- Banks risk averse so still, charge high-interest rates
- Increase property value
- Budget deficit
- Time lag (interest rates)
Forward Guidance
When central banks announce to markets that it intends to keep interest rates at a certain level until a fixed point in the future.
Supply-side Policies
- Definition
- Effect on AD-AS diagram
- Policies that increase a country’s productive potential and RNO through efficiency improvements.
- Rise in LRAS and SRAS.
Supply-side Policies
- Examples
- Lower benefits = work incentives
- Lower income tax = work incentives
- Increase the retirement age
- Higher minimum wage or living wage = work incentive
- Tax break for firms in deprived areas = -U
- Increase labour market flexibility e.g. relaxed immigration policies, -trade union power
- Increase contestability: deregulation and, anit-monopoly and cartel laws.
- Privatisation of state assets
- Open economy up to overseas trade and investment
- Reduce red-tape (deregulation) to cut costs, e.g. licences and patent power = +investment
- Lower business/corporation tax = increase investment
- Lower indirect taxes = -CoP
- Lower interest rates = increase investment
- Tax breaks to entrepreneurs
- Subsidies startups
- Tax concessions on investment
- Subsidies R+D or investment
- Government spending on education and training improvements
- Government spending on health services (NHS)
- Government spending on infrastructure = +EEoS AND -structural U
- Managed exchange rate = improved competitiveness of exports
Supply-side Policies
- Impact on objectives
- Improves BoP though increase international competitiveness
- Reduces inflation through increased productive potential
- Reduced unemployment though short-run growth
- Short-run and long-run growth through investment and productivity improvements
Supply-side Policies
- Evaluations
- Time lag
- Phillips curve; reduced unemployment can cause inflation (UK arguably near NRU)
- Business confidence may be low; Brexit scepticism
- Budget deficit
- UK productivity puzzle (+inflation, TU and bad management)
Average Rate of Tax =
Marginal Rate of Tax =
(Total income tax paid / total income) x 100
(Change in total income tax paid / change in total income) x 100
Taxable Income =
Total income - Tax free allowance (12,500)
