Macro 10 - Fiscal policy Flashcards
What is public expenditure?
Public expenditure is spending by the government including capital and current spending and transfer payments
What are the three main reasons for government spending?
1- Overcoming market failure and improving efficiency
2- Redistributing income and wealth
3- Macro-economic management
What are some of the factors that affect the level of government spending?
- Changing incomes
- Changing age distribution and population size
- Political priorities
- The trade cycle
Define the term ‘automatic stabilisers’
Automatic stabilisers relate to the fact that some forms of government expenditure and revenues from some taxes change automatically and in line with changes in GDP and the state of the economy
Define the term ‘discretionary fiscal policy’
Discretionary fiscal policy refers to deliberate changes in taxes and public expenditure designed to achieve the government’s macroeconomic objectives
How do automatic stabilisers work in a boom?
During a boom, the automatic stabilisers create a budget surplus as tax revenue increases and government spending on benefits falls
How do automatic stabilisers work in a recession?
During a recessions, government spending will increase because the government will pay out more benefits and receive less tax revenue due to unemployment
Define the term ‘fiscal policy’
Fiscal policy involves the use of government spending and taxation to influence the overall level of aggregate demand in an economy to achieve macroeconomic objectives
What are the two types of fiscal policy?
- Expansionary/reflationary fiscal policy
- Contractionary/deflationary fiscal policy
What is expansionary fiscal policy?
Expansionary fiscal policy refers to using fiscal tools in order boost aggregate demand with the purpose of improving macroeconomic performance. This will include reducing taxes, increasing government spending and government borrowing
What are some examples of expansionary fiscal policy?
1- Cutting income tax to increase disposable income and consumer spending
2- Cutting corporation tax to increase retained profits and business investment
3- Cutting indirect taxes to reduce prices and encourage consumer spending
4- Government spending on projects to create output, jobs and expenditure
When is expansionary fiscal policy likely to be used?
Expansionary fiscal policy is likely to be used during a recession or when there is a negative output gap. It will increase economic growth and reduce unemployment but will also increase inflation and worsen the current account of the balance of payments
When is contractionary fiscal policy likely to be used?
Contractionary fiscal policy is likely to be used during a boom or when there is a positive output gap. It will reduce economic growth and increase unemployment but it will also reduce price levels and improve the current account of the balance of payments
What is contractionary fiscal policy?
Contractionary fiscal policy involves using fiscal tools in order to reduce aggregate demand with the purpose of improving macroeconomic performance. This includes raising taxes, cutting government spending and reducing government borrowing
What are some benefits of fiscal policy?
- It can help manipulate aggregate demand by increasing or decreasing the government component of aggregate demand and consumption and investment meaning its impacts can be wide reaching
- Though its impact is largely on the demand side it can help improve aggregate supply
- Fiscal policy can be targeted at specific industries or regions whereas monetary policy cannot
What are some drawbacks of fiscal policy?
- Government finances can be a constraint of expansionary fiscal policy. Spending more than is received in tax revenue increases the budget deficit and therefore national debt
- There are huge time lags, it can a long time for policies to take effect
- Unintended impacts on incentives
What does the effectiveness of fiscal policy depend on?
- Confidence
- The size of the multiplier effect
- What the government spends money on/ which taxes are changed
What are some benefits of high levels of government spending?
1- Public expenditure on education, infrastructure and healthcare can increase productivity shifting SRAS to the right and LRAS to the right
2- Increased public expenditure is an injection into an economy’s circular flow. It will therefore increase AD and lead to economic growth multiplier effect will cause more growth
3- If government spending is on goods and services such as pensions, transfer payments, health and education there will be greater income equality
4- Government spending can correct market failure
What are some drawbacks of high levels of government spending?
1- Low productivity: The public sector is often considered to be less efficient than the private sector as it lacks the profit motive and therefore has less incentive to efficient
2- Crowding out: This occurs when extra government spending leads to lower private sector spending
3- Impact on government finances: High spending can have a detrimental impact on the government’s finances. It can lead to fiscal/budget deficits and then high levels of national debt over time
What are the two types of crowding out?
- Resource crowding out
- Financial crowding out
What is resource crowding out?
Resource crowding out occurs when the economy is at full employment and public sector spending means there is a lack of resources available for the private sector
What is financial crowding out?
Financial crowding out occurs when increased public sector spending is financed by borrowing. This increases the demand for loanable funds and pushes up interest rates. This reduced the incentive and ability of private sector firms to invest
Why may crowding out not occur?
- In recession demand for funds from private sector may be low so there may be little opportunity cost of the government borrowing
- Government spending on grants, infrastructure etc could help the private sector in the long term
- Government spending creates work for the private sector
What are the two types of fiscal budget deficits?
- Cyclical budget deficit
- Structural budget deficit
Define the term ‘structural budget position’
A structural budget position is a government’s long term fiscal stance. This means their budget position over a whole period of the economic cycle including booms and/or recessions
Define the term ‘cyclical budget position’
A cyclical budget position is a government’s fiscal stance in the short term. This is affected by where the economy is in the economic cycle. Automatic stabilisers are likely to create a surplus during a boom and a deficit during a recession
Define the term ‘cyclical budget deficit’
A cyclical budget deficit is a budget deficit caused by an expansionary cyclical budget position
Define the term ‘structural budget deficit’
A structural budget deficit is a budget deficit caused by an expansionary structural budget position (where spending is more than revenue in the long term)
What is stamp duty?
Stam duty is a tax which must be paid when property is bought. The more properties being bought the more stamp duty will be paid to the government
What are the causes of a structural fiscal deficit?
1- Demographic pressures
2- Discretionary fiscal policy
3- Debt interest
4- High levels of tax avoidance and tax evasion
5- High levels of income and wealth inequality
What does the extent to which a fiscal deficit is a problem depend on?
- The country’s credit rating and the cost of borrowing
- Whether the budget deficit is cyclical or structural
- Whether the money is used for current or capital spending
- The size of the deficit as a percentage of GDP
Define the term ‘national debt’
National debt is the accumulation of past budget deficits over multiple years
What are the problems of having a high national debt?
1- It can create inter-generational inequality as it is later generations who are burdened with paying off the debt
2- National debt can force governments to make short-term decisions such as selling assets for sub optimal prices
3- National debt can lead to inflation as it involves more government spending than taxation
4- High levels of government debt can lead to high interest costs
5- Growing national debt can reduce a country’s credit rating
What are the reasons why national debt may not be a cause for concern?
1- If inflation is occurring the real value of debt will fall over time
2- If economic growth is occurring at a greater rate than the rate of interest the value of debt as a percentage of GDP will fall
3- Debt may be necessary to bring an economy out of a recession more quickly
4- Debt can be used to fund long term capital spending to help growth in the future. This will make it easier to generate tax revenue in the future
