macro 22 fiscal policy

Question 1

define fiscal policy?

Answer 1

When the government uses tax and govt spending to manipulate AD.

Question 2

what does the laffer curve suggest?

Answer 2

That there is an optimal tax rate.

Question 3

What 3 things will happen if you increase tax above the optimal rate?

Answer 3

1. Tax revenue falls - (EVAL: no statistical evidence of optimal rate. Model assumes only top rate of tax is increased).
2. Less investment (EVAL: investment is also affected by animal spirits).
3. Tax evasion (EVAL: they have so much money, a small increase in tax won’t make a difference).

Question 4

what does the laffer curve look like?

Answer 4

Question 5

Define:
1. Budget deficit?
2. Budget surplus

Answer 5

1. G>T in a given time period.
2. T>G in a given time period.

Question 6

define national debt?

Answer 6

an accumulation of budget deficits expressed as a percentage of GDP.

Question 7

What are the 2 golden rules of debt?

Answer 7

1. Debt should fall at least once every 5 years.
2. National debt should not exceed 60% of gdp.

Question 8

define bond?

Answer 8

A type of security that is sold by the govt to raise money.

Question 9

What does the buyer of the bond receive?

Answer 9

Interest

Question 10

what 3 reasons are government bonds bought by people?

Answer 10

1. Safe investment - guaranteed to receive money back.
2. People can sell the bond when the value is high.
3. Interest gained from bonds is higher than interest from banks.

Question 11

What is included in a government bond?

Answer 11

1. Coupon/interest.
2. maturity period - the year the bond expires.
3. Market price - the price at which it is currently trading.
4. Nominal value - financial worth of the bond, which stays the same from the start.

Question 12

What are long term and short term UK bonds called?

Answer 12

Long term - Gilts.
Short term - Bills

Question 13

What is the formula for the yield of a bond?

(return)

Answer 13

Yield = Coupon/market price x 100.

Question 14

What is the relationship between price and Yield?

Answer 14

Inverse relationship.
When market price increases, the yield decreases.

Question 15

What does a high yield mean for an economy?

Answer 15

The economy is recovering.
This is because bond price is falling as demand for government bonds fall. Investors are moving to corporate bonds.

Question 16

What happens to demand for bonds in a recession?

Answer 16

The demand for bonds will increase because people are seeking safe investments and banks drop interest rates.

Question 17

What other reason can raise the Bond yield?

Answer 17

If the government’s credit rating is deteriorating.

Question 18

What is the winter fuel payment?

Answer 18

Energy subsidy for old people.

Question 19

Why might structural deficits be a concern to bond investors?

Answer 19

If interest rates go up in the US, countries that have borrowed money in dollars will struggle to pay it back.

Question 20

What does means-tested mean?

Answer 20

Based on income

Question 21

what Budget does expansionary fiscal policy lead to?

Answer 21

Budget deficit - caused by an increase in spending or a fall in taxes.

Question 22

Explain “interest payments” as a problem of running a budget deficit?

Answer 22

When IR goes up, payments go up. Govt has less money to spend on essentials and can potentially default on their loan.
EVAL:
- Depends on how much they have borrowed.
- Extent of damage depends on if they actually have to default as that would lead to their credibility falling.

Question 23

Explain “makes it difficult to borrow in the long run” as a problem of running a budget deficit?

Answer 23

MIght make it difficult to borrow in the long run as their credibility might deteriorate. Eg: Greece in the eurozone crisis and argentina in the past 20 years.
EVAL:
- Countries are still able to borrow at a higher interest rate.
- Countries like japan that have high debt to gdp ratio can still borrow as they run a CA surplus, and so have large amounts of foreign reserves.

Question 24

Explain “higher taxes” as a problem of running a budget deficit?

Answer 24

Leads to higher taxes in the long run. the money that needs to be paid back can only be generated by increasing taxes or decreasing spending.
EVAL:
- Unlikely to happen as growth is more important. Also more politically important.
- Time lag.

Question 25

what is capital control?

Answer 25

controlling the amount of money leaving and entering a country.

Question 26

define crowding out?

Answer 26

When an increase in government spending reduces AD because private sector investment falls.

Question 27

hoe does crowding out work?

Answer 27

If the government wants to increase spending, they will need to issue bonds to raise money. This will increase the demand for money and so interest rates will be increased by the banks. This increases the cost of borrowing and so investment will fall.

Question 28

to what extent is crowding out a problem?

Answer 28

• investment depends on animal spirits.
• In a recession, investment is low anyways, and the government needs to kickstart spending.

Question 29

define crowding In?

Answer 29

A decrease in government spending leads to an increase in AD because of a rise in private sector investment.

Question 30

is running a budget deficit always bad?

Answer 30

1. Depends on if the debt has been increasing/sustained every year.
2. If the rate growth of the economy is faster, then rising debt is not a problem.
3. depends on the state of the economy. If the country is in a recession, it is better to get out of it

Question 31

define automatic stabilisers?

Answer 31

Changs in govt expenditure and revenue that varies in line with the economic cycle

Question 32

What happens to government spending and tax revenue in a boom?

Answer 32

Spending on benefits falls.
Tax revenue increases.
Reduces debt.

Question 33

What happens to spending and tax revenue in a recession?

Answer 33

Spending on benefits rise.
Tax revenue falls.
These help limit fall in AD.
Debt rises.

Question 34

What does discretionary fiscal policy mean?

Answer 34

Actively intervening by using fiscal policy to tackle recessions and booms.