LS19 - Public Sector Finances

Question 1

Automatic Stabilisers

Answer 1

Feature of tax and transfer system that reduces economic activity during booms and stimulates activity during slumps, WITHOUT govt intervention
Recession - unemployment benefits; amount taxed falls –> leads to higher disposable income, more consumption to boost AD and recover economy; EV: depends on level of unemployment benefits, and taxes
Boom - people pay more in tax, unemployment benefits fall so income decreases, reduces rises in AD to prevent overheating

Question 2

Discretionary Fiscal Policy

Answer 2

Fiscal policy implemented at the discretion of policy makers

Question 3

Fiscal Deficit

Answer 3

When govt spending is higher than govt revenue in a certain time period

Question 4

Debt

Answer 4

Fiscal/Budget Deficit - when govt spending is higher than govt revenue
National Debt - govt total outstanding debt - what gov towes from budget deficits over time
Debt to GDP ratio - total govt debt as a ratio of GDP - the higher the ratio, the less likely the repayment is

Question 5

Cyclical Budget Deficit

Answer 5

When budget deficit occurs due to automatic stabilisers
* recovery/boom - budget deficit falls as tax rev rises, transfer payments decrease
* downturn/recession - budget deficit rises as transfer payments increase and tax revenue falls

Question 6

Structural Budget Deficit

Answer 6

Part of budget deficit that occurs due to discretionary fiscal policy rather than automatic stabilisers

Question 7

Factors Influencing Deficit

Answer 7

• State of the economy - if economy in boom, higher incomes/profit, higher spending so govt is earning more tax revenue and paying out less unemployment benefits - reduce budget deficit
• Age distribution - more ageing population, so higher dependency ratio –> higher pension/healthcare payments and lower tax revenue, so budget deficit rises
• Discretionary Fiscal Policy - used to recover out of recession, or appease political supporters - increases budget deficit

Question 8

Impact of Budget Deficits and National Debt

Answer 8

• Interest Rates - if government services deficit through borrowing money, interest rates rise, increasing cost of borrowing for all agents
• Debt Servicing - greater national debt leads to larger dept repayments, so debt servcing becomes harder, especially if interest rates are high, worsening the budget deficit and national debt
• Intergenerational Equity - increasing debt through budget deficits can be seen unfair to future generations as they pay for it through higher taxes and lower government spending. But if long term this causes GDP growth, increasing govt revenue and improving ability to service its debt
• Rate of inflation - if govt services debt through issuing bonds (borrowing), then the G of AD rises, with private sector components fall by an equal amount, so AD doesnt rise. If govt prints money instead, then AD rises, plus more money chasing same goods leads to demand pull inflation
• Credit Ratings - credit rating is likely to fall if debt to GDP ratio rises as creditworthiness falls
• FDI - high debt to GDP ratio reduces investor confidence as it is deemed a credit risk with low return on their investment, so inward FDI falls