public sector finances Flashcards
what are automatic stabilisers?
are mechanisms which reduce the impact of changes in the economy on national income
prevents too much change in the economy
give examples of automatic stabilisers
govt spending
taxation
benefits
how are benefits used as a stabiliser?
in a recession, benefits inc as more people are unemployed as so benefits are a stabiliser as the overall fall in AD is reduced
how is tax used as an automatic stabiliser?
- during a boom, tax inc as people have more jobs and higher incomes
- this tax reduced disposable income
- decreases consumption and AD so demand doesnt grow too high
how can you evaluate the use of automatic stabilisers?
- these automatic stabilisers cant prevent fluctuations
- they simply reduce the size of these problems and there can be negative aspects to these stabilisers
- benefits may act as a disincentive to work and lead to higher unemployment
- high levels of tax can decrease the incentive to work had
what is discretionary fiscal policy?
the deliberate manipulation of govt expenditure and taxes to influence the economy
what is national debt?
the sum of all govt debts built up over many years
what is a fiscal deficit ?
when the govt spends more than it receives that year
how can a fiscal deficit be measured
- they can either be measured in money terms or as a % of GDP
which way of measuring fiscal deficit is more useful?
GDP measure is more useful as it gives an indication of how easy it will be for the govt to finance a deficit or repay national debt
what is the public sector net cash requirement?
- the public sector net cash requirement- the total amount of money that the govt needs to borrow in order to fulfil its spending plans
- the difference between spending and revenue
what is a cyclical deficit?
the part of the deficit that occurs because gov spending and tax fluctuates around the trade cycle
budget deficit rises in the downturn of the economic cycle and falls in the recovery part of the economic cycle
what is a structural deficit? When does a fiscal deficit occur
the fiscal deficit which occurs when the cyclical deficit is zero
its long term and not related to the state of the economy
results from structural change in the economy (not from the economic cycle)
- at the peak of the boom there is no cyclical deficit→ any deficit at this point is a structural deficit
what is an actual deficit?
the structural deficit plus the fiscal deficit
when does a structural surplus occur?
structural surplus occurs when at the peak of the boom there is an actual fiscal surplus
when does a structural balance occur?
structural balance occurs when at the peak of the boom, actual fiscal balance is 0
why will a structural deficit cause national debt to grow?
this is because govt will have to consistently borrow to finance spending
- therefore it is argued that structural deficits need to be eliminated
why is it difficult to eliminate a structural deficit?
this is difficult as its impossible to know what part of the deficit is structural and what part is cyclic just as its impossible to know the size of the output gap
recall the factors affecting the size of the fiscal deficit?
the trade cycle
interest rates
unforseen events
privatisation
govt aims
the number of dependents in a country
how does the trade cycle affect fiscal deficit?
during a downturn, govt tax revenue decreases while spending increases so the deficit inc
how do unforseen events affect the size of the fiscal deficit?
e.g natural disasters, recessions lead to increases in spending which inc the deficit
how do interest rates affect the size of fiscal deficit?
- if interest on govt debt inc, the amount the govt pays in interest repayments inc
- likely to inc the deficit
- the impact of this depends on how significant interest repayments are in the size of the deficit
- interest rates depend on market rates and the credit ratings of the govt
how does privatisation affect the size of fiscal deficit?
- privatisation provides one of payments to the govt which will decrease the deficit in the short term
- depends on the value
how do govt aims affect the size of a fiscal deficit?
- govt aims are important in the size of the deficit
- this will influence their fiscal policy
- e.g austerity aim has helped to decrease the size of the deficit but attempting to inc AD would increase spending
what factors affect the size of national debt?
- if the gov is continuously running a budget deficit, then the national debt will increase overtime
- there is a view that fiscal deficits over 3% will lead to growing national debt as a proportion of GDP
- it is only when a govt runs a budget surplus that the size of the national debt increases
- ageing populations tend to contribute to a high national debt since the govt runs a structural deficit in order to fund their pensions and care
- leads to high national debt
recall the effects of fiscal deficits and national debts?
-high levels of borrowing may raise interest rates
-countries have to spend a large amount of money on servicing their national debt
-some argue that high fiscal deficits and national debts benefit citizens today at the expense of future generations
- can cause inflation
- a reduced credit rating for the gov
-if a govt has borrowed from abroad it may have difficulties getting enough foreign currency to make repayments on its debt
why may high levels of borrowing raise interest rates and fiscal deficit? how can you evaluate this
- as theres an inc in demand for money will increase the price of money
- could cause crowding out
however govt may borrow from overseas and during a recession, private sector investment always falls which means interest rates may remain unchanged
how do countries service their national debt?
- countries have to spend a large amount of money on servicing their national debt through interest repayments
- high opportunity cost
what is a primary budget deficit?
a primary budget deficit is the actual budget deficit but doesnt include interest repayments on national debt
what is the impact of a primary budget deficit dependent on?
the impact will depend on the level of interest rates and the size of the primary deficit compared to interest repayments
what is a liquidity trap?
in a liquidity trap (when interest rates are extremely low) the govt can often borrow at very low rates for long periods of time
why do some think that fiscal deficits cause intergenerational inequality?
- some argue that high fiscal deficits and national debts benefit citizens today at the expense of future generations
- can cause intergenerational inequality
More spending now may mean higher tax for future for the govt to finance this deficit
- can cause intergenerational inequality
what do the concerns over a fiscal deficit depend on
depend upon whether the deficit is caused by current expenditure alone or whether its just caused by capital expenditure
what is a current budget deficit?
- one where the govt revenues are less than current expenditure
- govt has to borrow money to finance day to day spending
why is it argued that the govt should run a budget surplus?
- its argued that the govt should run a current budget surplus to enable it to invest for the future
- except in recessions where they can run a deficit to inc AD
why are current budget deficits problematic?
as it means future generations are forced to pay the bill for todays expenditure
how can you evaluate the point that a current budget deficit is problematic?
- if the deficit is due to their capital expenditure, the future generations benefit from increased spending
- so their extra tax bill to pay for todays borrowing can be justified
- the value of the debt tends to fall overtime as inflation erodes its value
- also because a countrys GDP grows meaning that debt is easier to pay off so this limits the impacts on future generations
how do high fiscal deficits cause inflation?
- if the govt increases their spending and there is no similar fall in the private sector spending, AD will rise and this can be inflationary
- also if a gov is unable to borrow money they will print more money which will cause hyperinflation
- e.g Germany in 1923
how can you evaluate the point that high fiscal deficits can cause inflation?
depends on how much money is printed and where the economy is producing on the LRAS
how can high levels of debt result in a reduced credit rating for the gov?
- private sector companies estimate the likelihood that a govt will default on its debt and give it a rating
- lower credit rating = lending to the gov is riskier and so higher interest rates are demanded from lenders
how can you evaluate the point that high levels of debt can result in a reduced credit rating for the govt?
- its not the size of the debt that influences the level of risk involved with lending the money
- its whether the country has ever defaulted on their loans before and their current economic/political climate
why may a govt borrowing from abroad cause issues?
if a govt has borrowed from abroad it may have difficulties getting enough foreign currency to make repayments on its debt
- could cause problems for consumers because if theres not enough foreign currency they wont be able to import goods
how can you evaluate the point that govt borrowing from abroad may cause issues?
- govt borrowing can benefit growth if used for capital spending
- will improve supply side of the economy
- therefore reduce deficit in the long term
- budget deficit can be used as a tool for short term demand management
- Keynesians argue a deficit is acceptable to use as a stimulus in demand during recessions
what are the cyclical factors which affect the size of the fiscal deficit
unemployment rate
consumer spending
business profits
automatic stabilisers
what are the structural factors affecting the size of fiscal deficit
size of welfare assistance available
relative level of welfare benefits
demographic factors e.g ageing population
size of tax base and tax rates
efficiency/productivity of the public sector
what is the difference between a deficit and debt
deficit is a flow concept measured over a period of a time
debt is a stock concept at a certain point in time
a budget deficit adds to national debt while a surplus reduces it
what is the debt to GDP ratio
govt will finance a structural deficit through borrowing
lenders keep an eye on debt to GDP ratio because if it rises too much then the govt will not be able to repay the debt
or the govt may allow inflation to rise to reduce the real value of the debt
what may be the effects of large national debt
countries may stop lending to that countries govt
future tax payers may be left wit large interest payments on debt to pay off
debt repayments have an opportunity cost
country with a large debt is less attractive to FDI due to uncertainty
could lead to crowding out
govt may default on debt
