Macro A2 - Public Sector Finances

Question 1

Automatic stabilisers

Answer 1

Automatic fiscal changes as the economy moves through states of the business cycle e.g. a fall in tax revenues from the circular flow in a recession. Can be shown as; PPF graph, LRAS graph or the business cycle.

Question 2

Discretionary fiscal policy

Answer 2

When there is deliberate manipulation of variables to influence the economy. E.g. tax & government spending.

Question 3

Cyclical fiscal balance

Answer 3

The size of the fiscal deficit is influenced by the state of the economy. E.g. in a boom tax receipts are relatively high and spending on unemployment benefit is low

Actual Deficit= cyclical deficit + structural defecit

Question 4

Structural fiscal balance

Answer 4

The part of the deficit that is not related to the state of the economy. It will not disappear when the economy recovers.

Question 5

Key causes of a budget defecit

Answer 5

Recession causing rising unemployment.
Decrease in consumer spending and profits leading to less tax revenue.
Increase in inactivity leading to a rise in welfare benefit spending.
Use of fiscal stimulus by a government to lift AD.
Increase in interest rates on debt lending to a rise in debt service costs.
Demographic factors.

Question 6

Current defecit

Answer 6

Current budget defecit occurs when government revenue is less than expenditure
E.g. spending on health, education, welfare payments, debt interest etc

Question 7

Primary deficit

Answer 7

Primary budget deficit does not include debt interest

Question 8

factors affecting the size of deficits

Answer 8

Structural deficit
Cyclical deficit
Unseen deficit
Debts deficit

Question 9

Public sector debt

Answer 9

Public sector debt owed by central and local government and by public

Question 10

Problems of sustained government debt & borrowing

Answer 10

Cost of servicing debt.
Who has the burden of paying back the debt.
Government will have to increase taxes to repay it, mainly the interest (negative multiplier).
Possible crowding out.
Might not be sustainable.
Potential for FDI to decrease (confidence will decrease).
Structural deficit will only worsen due to aging demographic (Pensions).
Long term decrease in public spending.
Markets become reluctant to lend to uk government.
Potential negative impact on exchange rates (loss of confidence).

Question 11

How to solve government debt issues

Answer 11

Raise Taxes.
Lower interest rates.
Expansionary policies (Increase inflation).
Privatise / Nationalise industries.
Run a budget surplus.
Government spending cuts.
Depreciation policies.
Reduce tax avoidance/evasion.
Efficiency policies in the public sector.

Question 12

Reasons for limiting the scale of a country’s national debt

Answer 12

• high & rising stock of government debts risks leading to higher taxes in the future.
• rising mountain of debt is expensive to service (this has a potentially significant opportunity cost for the government)
• higher taxes & bond interest rates can “crowd out” the private sector.
• supporter of small governments believe a lot of state spending and borrowing is wasteful and alocatively inefficient.
• cutting national debt allows lower taxes which can increase bot AD & LRAS.

Question 13

Reasons a increase in national debt might not be a proble

Answer 13

• government borrowing id required to fund investment in critical infrastructure (important for raise in LRAS and competitiveness )
• raise in national debt is inevitable when a economy experiences a severe external shock (e.g. Covid / financial crisis / Ukrainian war)
• it is rational to borrow to invest when market bond yield is very low
• the risks of crowding out are limited if bonds remain attractive to overseas investors
• modern monetary theory ( a central bank can buy almost unlimited amounts of government debt)
• borrowing to stimulate the economy can be partly self-financing via higher tax revenues.