Macro 15 - fiscal policy.

Question 1

define fiscal policy?

Answer 1

Use of taxes and government spending to change aggregate demand.

Question 2

what can the government change in terms of taxation?

Answer 2

• How much to tax.
• Tax brackets.
• What to tax.
• Type of tax they want to impose.

Question 3

What can the government
change about it’s spending?

Answer 3

• Amount to spend.
• What its spends on.

Question 4

what is income tax?

Answer 4

tax on income.
- 12,500>, personal allowance.

Question 5

what is VAT?

Answer 5

sales tax - sales of goods.
VAT in the UK is 20%.
Reduced rate is 5%.

Question 6

What is excise duty?

Answer 6

Tax on harmful goods such as alcohol and tobacco.

Question 7

What is capital gains tax?

Answer 7

Tax on the sales of assets.

Question 8

what is corporation tax?

Answer 8

Tax on profits.
25% for all limited companies.
Lowest amongst the G7 countries.

Question 9

What is inheritance tax?

Answer 9

Tax on inheritance - 40%.

Question 10

what is tax evasion?

Answer 10

never paying tax - illegal.

Question 11

what is tax avoidance?

Answer 11

finding loopholes to pay lowest amount possible legally.

Question 12

What are the 4 types of spending?

Answer 12

Capital expenditure.
Current expenditure.
Transfer payments.
Debt interest payments.

Question 13

what is capital expenditure?

Answer 13

Covering investment in assets. Spending on capital goods.
Expenditure to increase productive capacity

Question 14

what is current expenditure?

Answer 14

Day-to-day operational expenses incurred by the government.

Question 15

what are transfer payments?

Answer 15

Government payments to individuals through social programmes such as welfare and student grants. No goods are exchanged.

Question 16

what are debt interest payments?

Answer 16

Interest payment paid by the government. Payments made to holders of government bonds.

Question 17

Who verifies the governments budget?

Answer 17

The Office for Budget Responsibility (OBR).

Question 18

What is the aim of fiscal policy?

Answer 18

To influence the level of aggregate demand in the economy.

Question 19

What is expansionary fiscal policy?

Answer 19

Expands aggregate demand.

Question 20

Why might the government want to use expansionary fiscal policy?

Answer 20

To increase growth during a recession.
To reduce unemployment.

Question 21

Expansionary fiscal policy on a diagram:

Answer 21

Question 22

What is contractionary fiscal policy?

Answer 22

Reducing aggregate demand.

Question 23

Why might the government want to use contractionary fiscal policy?

Answer 23

To reduce inflation during a boom

Question 24

Contractionary fiscal policy on a diagram:

Answer 24

Question 25

What are the 2 different mechanisms through which government can carry out fiscal policy.

Answer 25

• Discretionary fiscal policy.
• Automatic stabilisers.

Question 26

What is discretionary fiscal policy?

Answer 26

When the government actively intervenes to influence aggregate demand. For example, cut tax when in a recession.

Question 27

What is automatic stabilisers?

Answer 27

Changes in government spending and revenue that happen becaseu of changes inthe economic cycle. For example, in a recession, government spending will increase because you have to pay more beenfits and tax revenue is decreasing.

Question 28

What is a cyclical budget deficit?

Answer 28

when the government budget is determined by the economic cycle.

Question 29

what is a structural budget deficit?

Answer 29

When the government runs a budget deficit regardless of the economic cycle.

Question 30

What are the 2 fiscal rules?

Answer 30

• The golden rule: That a government should borrow only to invest, not to fund current spending.
• The sustainable investment rule: the Government debt to GDP ratio should not exceed 40%

Question 31

why has the 2 fiscal rules rendered redundant in recent years?

Answer 31

The government debt levels have increased during the financial crisis and covid.

Question 32

what are the 3 advantages of fiscal rules?

Answer 32

• Policy works automatically to stabilise the economy.
• Changes in govt spending directly affects AD.
• Has the potential to increase both AD and AS simultaneously.

Question 33

Explain “Policy works automatically to stabilise the economy” as an advantage of fiscal policy:

Answer 33

A number of forms of government spending adjust automatically to offset fluctuations in GDP - fiscal policy can therefore stabilise the economy without any real action required.

Question 34

Explain “Changes in govt spending directly affects AD” as an advantage of fiscal policy:

(also enables the govt to target spending in specific areas)

Answer 34

Don’t rely on a complicated transmission mechanism to have a final effect on the economy. For example, increasing spending in the economy will put money into people pocket directly, whereas time lag in monetary policy.

Question 35

Explain “Has the potential to increase both AD and AS simultaneously” as an advantage of fiscal policy:

Answer 35

subsidies.
cutting corporation tax.
cutting VAT.

Question 36

What are the 6 disadvantages of fiscal policy?

Answer 36

• TIme lag exists.
• Difficult to estimate the size of the multiplier and MPC.
• May have an adverse effect on incentives.
• May damage other macro objectives.
• May be offset by circumstances in other countries.
• Monetarist argument.

Question 37

Explain “Time lag exists” as a disadvantage of fiscal policy:

Answer 37

It takes time to form and implement new policy. It also might take time for households to adjust to change in their disposable income, meaning spending might not immediately increase when tax rate is cut.

Question 38

Explain “Difficult to estimate the size of the multiplier and MPC” as a disadvantage of fiscal policy:

Answer 38

The policy might have greater or smaller impact on the economy than desired. Success is determined by the MPC. If MPC is small, investment may leak out of the circular flow.

Question 39

Explain “May have an adverse effect on incentives” as a disadvantage of fiscal policy:

Answer 39

A rise in income tax may discourage some people form working and higher corporation tax might discourage investment.

Question 40

Explain “May damage other macro objectives” as a disadvantage of fiscal policy:

Answer 40

A rise in taxation designed to reduce inflation, may increase unemployment.

Question 41

Explain “May be offset by circumstances in other countries” as a disadvantage of fiscal policy:

Answer 41

If the UK is pursuing expansionary fiscal policy, but the US is experiencing a recession, AD may still fall if the economy is reliant on exports.

Question 42

Explain “monetarist argument” as a disadvantage of fiscal policy:

Answer 42

LRAS is inelastic so any increase in AD will cause inflation, especially if it is caused by borrowing.

Question 43

Explain “crowding out argument” as a disadvantage of fiscal policy:

Answer 43

• There is a profit incentive for private sector, not govt.
• supply of money is fixed, and equilibrium shows the rate of interest charged for borrowing money.
• IF govt uses expansionary FP by borrowing, it will increased demand for money and therefore the IR deteriorates private sector investment.
• Private sector will have to cut costs to be more efficient as they are the ones with profit incentive and not govt.

Question 44

Whether or not fiscal policy is effective depends on what 5 things?

Answer 44

• The level of spare capacity in the economy.
• size of the multiplier.
• size of the MPC
• The phase of the cycle.
• Level of confidence in the economy.