The Role Of The State Flashcards
What is resource crowding out?
Resource crowding out is when all the resources in the economy are being used efficiently and the government increases public expenditure. This moves the economy along the PPF and means that there are fewer resources available for firms in the private sector.
Resource crowding out occurs when the economy is using all resources (factors of production) efficiently and the government then increases public expenditure. This will increase the price of these resources, which will mean that there is an opportunity cost to the private sector. For example, an increase in government spending on infrastructure projects will increase the demand for construction workers, which will then increase their wage. This means that the private sector will have to pay more for construction workers.
What is financial crowding out?
Financial crowding out is when government borrowing pushes up the interest rate which decreases private sector investment.
Financial crowding out occurs when an increase in government borrowing increases the demand for borrowed money, which then increases the interest rate.
What impact does an increase in government borrowing have on the interest rate?
An increase in government borrowing will increase the demand for money. This will push up the price of money, which is known as the interest rate. This makes it more expensive for firms in the private sector to borrow.
What does government spending not include?
Public expenditure includes current expenditure, capital expenditure and transfer payments. The government spending part of the aggregate demand formula is similar but it doesn’t include transfer payments.
Transfer payments are not included in ‘G’ because they don’t actually involve spending on goods and services. For example, benefits are just a transfer of money from the government to low-income families. The money spent on benefits usually appears in AD under consumption because most of it is spent by the individuals receiving it.
What is an economic cycle?
The economic cycle shows the changes in real GDP as an economy moves from boom to recession over time.
What is a recession?
A recession is two consecutive quarters (6 months) of negative economic growth.
What is cyclical deficit?
A cyclical deficit occurs when public expenditure increases and tax revenue decreases during a recession. For example, an increase in unemployment during a recession means spending on benefits will increase and income tax revenue will decrease.
What is structural deficit?
Structural deficits are the budget deficits that remain at any stage of the Economic Cycle.
A structural budget deficit is the budget deficit that remains at any point of the business cycle. It occurs when public expenditure is greater than tax revenue.
For examples, A decision by the government to reduce corporation tax in order to attract FDI has nothing to do with the business cycle. It is a decision to try to change the structure of the economy to one which welcomes investment from abroad.
Japan spends 10% of its Gross Domestic Product on pensions. How is an ageing population likely to impact a government’s budget ?
As a result of an ageing populations, governments will increasingly need to prioritise pension payments to make sure that retired people have enough money to live off. They will also need to prioritise heathcare as older people are more likely to require medical treatment. In addition, they will receive less income tax as there are fewer people working.
So, an ageing population will require an increase in public expenditure and a decrease in tax revenue. This will increase the size of the budget deficit.
1 in 3 people in Botswana are under the age of 15. How is this population structure likely to impact a government’s budget ?
As a result of a young population, governments will increasingly need to prioritise education spending. In addition, they will receive less income tax as there are fewer people working.
So, a young population will require an increase in public expenditure and a decrease in tax revenue. This will increase the size of the budget deficit.
Why is a structural deficit much worse than a cyclical deficit?
Structural deficits are the budget deficits that persist throughout the business cycle i.e. during booms, recessions, slumps and recoveries! A cyclical deficit only occurs during a recession.
What might the government of Benin sell in order to borrow money?
Government bonds, also known as treasury bills, are a method of government borrowing.
Government bonds are a method of government borrowing. They Sell government bonds to investors, individuals, banks and businesses. In return, they agree to pay back these investors with Interest.
What is national debt?
National debt is the total debt built up by government borrowing over time.
How does government may increase their national debt?
Government bonds are a method of government borrowing. They sell government bonds to investors, individuals, banks and businesses. In return, they agree to pay back these investors with interest.
National debt is the total debt built up by government borrowing over time.
If a government has a budget deficit, it may sell government bonds in order to borrow money to pay for the deficit. However, this will increase their national debt.
How is a recession likely to impact the national debt ?
During a recession, the government is likely to try to encourage economic growth by using expansionary fiscal policy to increase public expenditure and decrease tax revenue. This will increase the size of the budget deficit.
If a government has a larger budget deficit, it may sell government bonds in order to borrow money to pay for the deficit. However, this will increase their national debt. National debt is the total debt built up by government borrowing over time.
What is the impact on interest rate by an increase in budget deficit and national debt?
If a country has a budget deficit, the government will need to borrow money in order to fund its public expenditure. An increase in government borrowing will increase the demand for money. This will then increase the price of money which is known as the interest rate.
This will increase the cost of borrowing for private sector firms, which means they will decrease their investment and this is called financial crowding out.
What is the likely impact of a high national debt on future generations?
A high national debt will need to be paid back at some point. In order to do this, the government will either need to increase taxes or decrease public expenditure - or a combination of both.
Why a large national debt may be a problem?
A large national debt can be a problem for several reasons, for example:
1. There is an opportunity cost for interest payments (for example, the money could have been spent on schools).
2. It may lead to financial crowding out of private sector firms (by increasing the demand for borrowed money, increasing the interest rate and therefore decreasing investment).
3. A decrease in consumer and business confidence as they expect taxes will rise or public expenditure will fall in the future in order to pay back the debt.
Why might a national debt not be a problem?
A large national debt is less of a problem if:
1. The government is able to continue to borrow at a low interest rate (as this means that there will be a lower opportunity cost).
2. The national debt is a small percentage of GDP - this means that is is less significant and easier to pay back.
3. The money borrowed was used to pay for capital expenditure as these will encourage future economic growth - for example, money borrowed for a new school will increase human capital.
What is the primary role of the Office for Budget Responsibility?
The Office for Budget Responsibility’s job is to ensure that the government meets its fiscal Target.
For instance, right now, we aim to get a balanced budget where Taxation equals public expenditure by the year 2025.
What is the secondary goal of the OBR?
The OBR produce forecasts for the Economic and Fiscal Outlook twice per year (just before the Chancellor announces his budget). If the economic outlook looks good (e.g. higher predicted economic growth) then they will allow the Chancellor to spend more cash! This is great for the Chancellor. They do this because they have forecasted stronger economic growth which usually means stronger tax revenues. If the government is likely to receive more in tax revenues then they will have more cash to spend.
What is a short run Philips curve?
L shaped curve showing the-trade-off relationship between unemployment and inflation
Describe the trade-off between inflation and unemployment
When unemployment is low, firms compete to hire the few remaining workers, increasing the wage that they are willing to pay. So wages increase, and firms will then increase their prices, so that they can make a profit despite the higher wage costs. And so, as unemployment decreases, the price level increases, which, as we know, is inflation!
Lower unemployment -> fewer unemployed people available to Work -> more bargaining Power -> negotiate Higher wages -> higher Costs for firms -> firms increase Price -> inflation.
What is natural rate of unemployment? (NRU)
The rate of unemployment which an economy will always return to - it occurs when the inflation rate is zero.
The Natural Rate of Unemployment is the level of unemployment where the Inflation rate is zero in the short run.
NRU stands for the Natural Rate of Unemployment. The NRU is the rate of unemployment where the inflation rate is zero. If the inflation rate is zero, this means that the price level is neither increasing (positive inflation rate) nor decreasing (negative inflation rate). So, at the NRU, the inflation rate is zero and this means that the price level is not changing
