Fiscal Policy

Question 1

Define fiscal policy

Answer 1

Adjusting levels of government expenditure and taxation to influence aggregate demand in the economy

Question 2

What are policy instruments?

Answer 2

Tools used to help the government achieve its macroeconomic objectives and implement its policies such as interest rates, rates of taxation and levels of government spending

Question 3

Define budget

Answer 3

Government’s spending and revenue plans for the next year

Question 4

As the main source of revenue for a government is from taxes, why do they impose taxes?

Answer 4

• To pay for public sector services
• To discourage activities e.g. taxes on cigarettes to reduce consumption and on dumping garbage in landfill sites to reduce waste
• To control aggregate demand in the economy (fiscal policy and to control inflation)
• So the distribution of wealth is more fair
• to reduce current account deficit?

Question 5

What are the 4 main macroeconomic objectives fiscal policy is used to achieve?

Answer 5

Unemployment
Economic Growth (GDP)
Inflation
Balance of Payments (Current Account)
Environment/Sustainability

Question 6

What are the 8 main areas of focus for government expenditure

Answer 6

Social protection - state benefits, pensions
Healthcare - medicines, salaries, equipment
Education - salaries, equipment
Defence - armed forces
Interest - interest paid on government borrowing such as national debt
Public order/safety - police/fire services/justice system
Social Services - care of children, elderly, disabled
Other - transport, recreation, training, industry/agriculture

Question 7

Define fiscal deficit

Answer 7

Amount by which (% of GDP) the government spending exceeds government revenue in a period of time

Question 8

Define fiscal surplus

Answer 8

Amount by which (% of GDP) the government revenue exceeds government spending in a period of time

Question 9

Why is a fiscal deficit undesirable? (negative balance)

Answer 9

• gvt must borrow to fund deficit
• increases national debt and interest payments on it
• high opportunity cost - instead lower taxes, spend on welfare benefits, infrastructure development which creates jobs.
• Unfairly burdens future generations
• lowers consumer confidence (expect taxes to rise in the future and therefore spend less).

A04 - depends on % of fiscal deficit of country’s GDP

Question 10

Define national debt

Answer 10

The total amount of money owed by a country over the whole course of its existence

Question 11

What is the impact of a fiscal surplus? (positive balance)

Answer 11

The revenue collected can be used in numerous positive ways:
lower taxes
provision of public services/new projects
pay off national debt which reduces future interest payments and stabilises the economy

Question 12

Limits of fiscal policy/ AO4

Answer 12

It is important to analyse fiscal deficits in relation to the country’s GDP - only a problem if it is a large %

Question 13

Effects of expansionary fiscal policy

Answer 13

Reducing taxes:

• cut in income tax gives consumers more disposable income
• raises consumption/aggregate demand in the economy
• cut in corporation tax increases profit for firms
• may stimulate investment

Increasing government spending: The government may spend on infrastructure, roads or increase the pay of public servants, education/healthcare

AO4 Increases the budget deficit – By increasing borrowing, the government is able to spend more on projects however paying off the debt has a high opportunity cost - may increase taxes in the future

Question 14

Define expansionary fiscal policy

Answer 14

fiscal measures designed to stimulate aggregate demand in the economy - cut taxes/increase spending

Question 15

Define contractionary fiscal policy

Answer 15

fiscal measures designed to reduce aggregate demand in the economy - raise taxes/decrease spending

Question 16

Effects of contractionary fiscal policy

Answer 16

Increasing taxes:

• rise in income tax reduces disposable income
• decrease consumption/aggregate demand(shift left)
• reduces inflation

Cutting government spending: The government may cut back on certain projects which may be inflationary or unaffordable.

Reducing the budget deficit: Interest on government borrowing can be very expensive, reducing borrowing can help to stabilise the economy and move towards a surplus

Question 17

impact of fiscal policy on macro objectives: inflation, CA, economic growth, unemployment

Answer 17

inflation/ CA: rising aggregate demand too quick may cause demand-pull inflation (overheated)/used to reduce DI relieving inflationary pressure - higher income for households increase demand for imports worsening current account/expansionary could improve quality - contractionary reduce DI reduce aggregate demand reducing demand imports

expansionary fiscal policy used to stimulate growth increase aggregate demand from firms/consumer gov e.g. investment leading to econ growth economy expanding - meet extra demand firms produce more employ more - construction industry labour intensive job creating reducing unemployment

use fiscal policy e.g. taxes landfill tax, aggregate levy increase costs reduce environmental damage, subsidies used to encourage environmentally friendly activities e.g. solar panels, more produced lower cost consumption increase renewable energy less pollution from fossil fuels

Question 18

A04

Answer 18

cannot guarantee increased income will be spent - may be saved, worsening gov finances opportunity cost, gov spending may be inefficient, time lags both tax cuts and spending projects - depends on amount of spending/tax changes and on consumer/business confidence if they expect taxes to rise