13 Fiscal Policy and Supply-Side Policies Flashcards
(301 cards)
1
Q
What is fiscal policy?
A
The part of the government’s economic policy concerning government spending, taxation and the budgetary position (surplus or deficit)
2
Q
What is supply-side economic policy?
A
Government policies aimed to expand LRAS and hence improve the efficiency and productivity of the economy
3
Q
What is supply-side fiscal policy?
A
Fiscal policy which aims to increase supply capacity in the long run
4
Q
Eval: all successful fiscal policy is…
A
Supply-side in the long run, to prevent inflation
5
Q
Are all supply-side policies fiscal?
A
No. Some involve changing the underlying structure of the economy e.g. deregulation
6
Q
When was fiscal policy most used?
A
1950s-70s Keynesian governments
7
Q
What part of the economy, micro or macro, does fiscal policy confront?
A
BOTH, often on the same occasion:
- MACRO - stimulate AD and hence employment and growth
- MICRO - alter relative prices and hence influence consumer behaviour
8
Q
How can the government use fiscal policy to improve the functioning of the labour market? What part of economics is this considered to be?
A
Improve incentives and eliminate poverty trap
Microeconomics
Microeconomics
9
Q
What is a balanced budget?
A
G = T
Where G is all spending by government, and T is all revenue, including taxes and other sources
Where G is all spending by government, and T is all revenue, including taxes and other sources
10
Q
What is a budget surplus?
A
G < T
11
Q
What is a budget deficit?
A
T < G
12
Q
In the explanation of surpluses, deficits and balanced budgets, what does T symbolize?
A
ALL SOURCES OF GOVERNMENT REVENUE, including taxes
13
Q
How can a budget deficit be financed?
A
Finding ways to afford a budget deficit e.g. by issuing bonds
Public sector borrowing, e.g. bonds
14
Q
How can we eliminate a budget deficit?
A
Reaching the point where G = T, or even where T > G
Done by raising taxes or reducing spending
15
Q
What was fiscal policy primarily used for in the period 1950s-1970s?
A
Control the level of aggregate demand in the economy
16
Q
What is Keynesian fiscal policy?
A
Another term for demand-side fiscal policy
17
Q
What does demand-side fiscal policy often involve?
A
Using fiscal policy to stabilise and manage AD
Deficit financing
18
Q
What is a positive borrowing requirement?
A
The increase in borrowing required when the government runs a budget deficit
19
Q
What is the opportunity cost of using demand-side fiscal policy to stimulate AD?
A
The positive borrowing requirement and the risk of higher bond yields
20
Q
What has largely replaced fiscal policy since 1979?
A
Monetary policy, since 1979.
Active fiscal policy has retained a place, e.g. 350 billion of furlough during COVID-19
21
Q
Ceteris paribus, why might a positive borrowing requirement increase the cost of borrowing for governments, leading budget deficits to be a bad thing?
A
- Supply > Demand for bonds, leading to lower prices, higher yields and hence higher costs for government. Higher yields may also be demanded if inflationary expectations are higher.
- Crowding out because bonds are attractive assets, so private sector investment may suffer at the exact time when private investment is most needed to stimulate AD.
22
Q
Why do Keynesians believe fiscal policy is necessary?
A
Tendency for unregulated free market to settle into an equilibrium below full employment, with involuntary unemployment resulting
23
Q
What is the Keynesian view of fiscal policy?
A
- The free market would create persistent negative output gaps and volatile cycles
- AD could be managed to correct this by using interventionist fiscal policy
- Subsequently, discretionary microeconomic fiscal policy could be used to fine-tune the economy at full employment
- The supply-side could be addressed by microeconomic transfers in the aforementioned discretionary phase of fiscal policy, with business confidence likely to be higher in the absence of extreme fluctuations in AD
24
Q
How did Keynesians address the supply-side? Eval?
A
- The government would use DISCRETIONARY MICROECONOMIC FISCAL POLICY at full employment to transfer to industry
- The increased business confidence the certainty of consistent demand created would drive investment
The limits of deficit financing, as well as the presence of economic shocks, makes this a weak argument
The limits of deficit financing, as well as the presence of economic shocks, makes this a weak argument
25
What is the main reasons Keynesians are not so concerned with the budget deficit and eval?
The presence of a multiplier effect, such that the subsequent increase in national output and tax revenues is more than proportionate to the increase in spending - A DEFICIT FINANCES ITSELF
Real-world research suggests the government multiplier is not often more than one
26
What are four reasons government multipliers are often lower than thought?
1. Macro conditions - close to full employment?
2. RICARDIAN EQUIVALENCE
3. Crowding out - higher borrowing, hence lower business investment
4. Monetary policy conflict - if central banks respond in kind by raising interest rates
27
What is sound finance?
The belief by pre-war governments that they had a moral duty to balance their budgets, since failing to do so transferred the burden of debt to a future generation
28
What is Ricardian Equivalence?
The classical idea that people save all of their fiscal stimulus in anticipation of the tax rise that will reclaim it to eliminate the budget deficit
29
A PUBLIC SECTOR DEFICIT IS A
PRIVATE SECTOR SURPLUS
30
Why did Keynesians believe the private sector would settle into an under full employment equilibrium?
Excessive saving, which could be redistributed by fiscal policy
31
When did Keynesianism begin to die?
1976 - James Callahan - no longer an option to 'spend... way out of a recession'
32
How was neoclassical and neoliberal budget balancing different though?
Different reasons - neoliberal was for borrowing costs and neoclassical for moral reasons
33
What is budget day?
October-November - the Chancellor reads the statement for the upcoming financial year
34
Illustrate expansionary fiscal policy when the government spending multiplier is unity.
Give certainty and expectations to business
35
What is a stealth tax?
A tax which is either obfuscated or concealed by inflation
36
What happens to the AD curve during expansionary fiscal policy when the government spending multiplier is unity?
AD shifts right
37
What is expansionary fiscal policy?
Expand AD and shift AD curve right via fiscal policy
38
What are three words for cyclical unemployment?
1. Demand-deficient
2. Keynesian
3. Cyclical
39
What are two things which determine the extent to which expansionary fiscal policy is inflationary?
1. Shape of SRAS curve
2. Multiplier
40
During the Keynesian era, the main method of controlling the macroeconomy to meet macroeconomic objectives was...
Fiscal policy
41
What is discretionary fiscal policy?
Deliberate fiscal policy to influence G and T to influence AD
42
What are three problems with expansionary fiscal policy?
1. Risk of demand-pull inflation
2. Risk of an exchange rate crisis if too many imports were purchased
3. Positive borrowing requirement and strain on public finances
43
What do Keynesian governments want in their economies for fiscal policy to be most effective?
Large multipliers, facilitated by high MPCs
44
What other marginal propensity, besides a high MPC, do Keynesians desire for fiscal policy to be most effective? Why?
Low MPI
1. Increase the effect on the domestic economy
2. Reduce the risk of a balance of payments crisis
## Footnote
1. Increase the effect on the domestic economy 2. Reduce the risk of a balance of payments crisis
ONE OF THE REASONS FOR THE DECLINE OF KEYNESIANISM WAS THAT OUR DOMESTIC PRODUCTION CAPACITY FELL DUE TO DEINDUSTRIALISATION/LOSS OF COMPARATIVE ADVANTAGE. RESULTANTLY, MPM ROSE AND OUR CURRENCY PROGRESSIVELY DEPRECIATED. FISCAL POLICY BECAME LESS EFFECTIVE.
45
What is crowding out frequently used to explain?
The reason for the government's relatively low national income multiplier
46
What is crowding out?
A situation in which an increase in government borrowing has the opportunity cost of a fall in private sector investment, with little or no final increase in AD
47
How is crowding out explained?
1. The government seeks to finance expansionary fiscal policy by using public sector borrowing
2. Issuing bonds attracts private sector investment. Bonds are safe assets, with both high liquidity on the secondary market and secure profitability
3. There is only a fixed supply of money, so private sector investment, e.g. on corporate bonds, falls
4. Resultantly, I falls
5. The fall in I serves to counteract the rise in G
48
What are five evaluation points with crowding out?
1. Does NOT occur when the economy is inside its PPF (private sector savings unutilised)
2. The presumption of a fixed money supply is refuted by Keynesians, who argue that the availability of credit to buy assets such as bonds offsets the spending on public sector borrowing
3. Globalisation means demand is unlikely to be influenced by the increase in supply - a property of a COMPETITIVE MARKET
4. Monetary policy can help, e.g. by QE to increase funds for spending
5. CROWDING IN - if government spending reduces business costs e.g. by creating external economies of scale via public transport investment, then actually the effect may be more beneficial than detrimental. EMPIRICAL EVIDENCE SHOWS THIS
49
What should always be mentioned in an essay evaluating budget deficits?
Crowding out
50
What happened to fiscal policy after 1979?
Shifted from demand-side to supply-side
51
What is the main way supply-side fiscal policy works?
Non-interventionist - increase incentives
52
Why does supply-side improvement not usually lead to benign deflation?
AD shifts right too
53
What are three uses of taxation?
1. Finance government projects
2. Redistribution and correcting market failure
3. Reduce AD
54
What important property do transfer payments have?
No claim on national output - instead redistributes income
55
3 times when taxes must rise to finance government debt increasing?
1. When interest rates rise
2. When the government runs a budget deficit
3. When bond prices fall, also likely when more bonds are issued (see 2)
56
Why do rising interest rates increase government cost of borrowing?
Increased price competition with other financial assets which are interest-bearing
57
What is total managed expenditure (TME)?
All government spending
58
What are the largest destinations for government spending in 2020?
1. Social protection (i.e. safety net and welfare state) - 29%
2. Health - 22%
3. Education - 12%
59
What is the evaluation of TME since 2020?
Larger obligation to bondholders
60
How has spending on social protection increased?
1. 2008 cyclical effects
2. post-2011 - triple-lock and increased proliferation of old people
61
Who said triple lock was a problem?
OBR
62
What is demand-led spending?
A wide term, encompassing cyclical deficits. Spending when more of a benefit is demanded
63
What are government spending which are not transfer payments generally considered?
Investments, since they are usually discretionary spending on boosting national output
64
What form of government spending is a far more accurate measure of the state's involvement in the economy?
TME - transfer payments
Spending on just factors of production directly owned by the state
## Footnote
Spending on just factors of production directly owned by the state
65
What happens to debt interest as a fraction of nominal GDP when national debt as a fraction of nominal GDP can be reduced?
Percentage of TME towards interest payments falls
66
What are the three main tax revenue sources in 2021?
1. Income tax - 19%
2. NIC - 14%
3. VAT - 15%
67
Increasing taxes and cutting government spending to cool down the economy.
Contractionary fiscal policy
68
What fiscal policy functions are considered macroeconomic?
1. Redistribution for means of vertical equity and transfer payments
2. Achieve macro objectives e.g. reduce inflation
69
What fiscal policy functions are considered microeconomic?
1. Correction of market failures
70
How can MPC be linked to fiscal policy?
Government should target lower income first since they have the highest MPC
71
What are three taxes on income?
1. Income tax
2. NIC
3. Corporation tax
72
What are the two main sources of indirect tax revenue?
1. Excise duties
2. VAT
73
Why do indirect taxes fall in a recession?
Falling consumption
74
Why do direct taxes fall in a recession?
Falling income
75
Eval on wealth taxes?
Underutilised in UK
76
Most significant source of government revenue (NOT all finance e.g. not borrowing)?
Taxes
77
Why are excise duty revenues declining in the long run?
Consumption of demerit goods and other things frequently taxed has fallen
78
What is the UK's main indirect tax?
Income tax
79
How is UK income tax progressive?
First 12,570 is tax free, then increases in rate, from 20% for the lowest group to 45% to 125,140 and above. These are MARGINAL rates to prevent poverty trap, making the system progressive
80
Why is UK direct tax less progressive than it could be?
NICs are usually regarded as regressive
81
What major reform to direct taxes was proposed by the Tories?
2023 - merge NIC and income tax
## Footnote
Complexity
82
Corporation tax eval?
Lower than income tax. Lower in other countries, so why try and compete? Furthermore, evidence excess profits go to shareholders
## Footnote
Could raise
83
What is VAT's secondary function?
Used as a form of market failure correction e.g. higher rates on junk food, lower on books
84
What are the properties of excise duties?
1. Unit, not ad valorem
2. Increased in each budget since nominal
85
Stamp duty eval?
Indirect tax on land purchases
Could be lowered for supply-side reasons
## Footnote
Could be lowered for supply-side reasons
86
What is the main wealth tax in the UK?
Inheritance tax
Not paid by vast majority
## Footnote
Not paid by vast majority
87
Capital gains tax eval?
Not updated since 1993, and therefore has experienced a kind of fiscal drag. Relative values ignored, council tax now much higher
88
What is direct tax?
Taxes whose incidence cannot be shifted. Levied on income and wealth
89
What is indirect tax?
Taxes on spending, that can be shifted by the person legally liable to pay the tax e.g. by raising prices
90
What is regressive taxation?
When the proportion of income paid in tax falls as income increases
91
What is progressive taxation?
When the proportion of income paid in tax rises as income increases
92
What is an example of inequity?
Flat tax rates or regressive taxation - normative statement
93
Why are demerit good taxes often flawed?
USUALLY REGRESSIVE - LINK TO MARKET FAILURE TOPIC
94
What are two examples of regressive taxes?
1. Cigarette duty
2. NIC
95
Why is demerit taxation regressive?
Generally the same physical quantity consumed
96
How can progressive, regressive and proportional taxation be illustrated?
y-axis - tax paid
x-axis - income
straight y=x = proportional
sloping above y=x - progressive
sloping below y=x - regressive
97
What is a flat tax?
Proportional tax
98
What is proportional tax?
When the proportion of income paid in tax stays the same as income increases
99
Why are flat taxes unpopular?
1. Inequitable
2. Would lead to higher deficits and the opportunity cost is high
100
What is the marginal tax rate?
The extra tax from the last unit of income
## Footnote
FORMULA? Delta T / Delta Y
101
What is the average tax rate?
T / Y
Average proportion of income which is taken as tax
## Footnote
Average proportion of income which is taken as tax
102
What property does a regressive tax have?
Average tax exceeds marginal tax
103
What property does a progressive tax have?
Marginal tax exceeds average tax
104
In proportional tax, what is the relationship between marginal tax and average tax?
Marginal tax = average tax
105
Why is average tax useful?
It illustrates the average tax burden
106
What is the marginal tax rate?
The extra tax from the last unit of income.
107
What is the formula for average tax rate?
T / Y.
108
What is a regressive tax?
A tax where the average tax exceeds the marginal tax.
109
What is a progressive tax?
A tax where the marginal tax exceeds the average tax.
110
What is true about proportional tax?
Marginal tax = average tax.
111
Why is average tax useful?
It illustrates the average tax burden.
112
Why is marginal tax useful?
It can be used to explain consumer behaviour, e.g., income vs substitution effects.
113
What is the canon of taxation?
A principle of judging whether a tax is good or effective.
114
Who proposed the canons of tax?
Adam Smith.
115
What are the 4 Smithian canons of taxation?
1. Certainty
2. Convenience
3. Equitable
4. Economic.
116
What are the 6 canons of taxation?
4 Smith ones:
Certainty, convenience, equitable, economic
2 added ones:
Efficient, flexible
117
What defines a good tax?
One which satisfies as many canons as possible.
118
Why are good taxes rare?
Due to trade-offs.
119
Economy as a canon of taxation
Should be cheap to collect compared to revenue.
120
Convenience/certainty as a canon of taxation
Easy to pay and definite for the taxpayer.
121
Efficiency as a canon of taxation
Minimum unintended consequences, INCLUDING MINIMISING DISINCENTIVE RISK
122
Flexibility as a canon of taxation
Tax must be easy to change to meet new circumstances.
123
Tax as a proportion of average UK income and eval?
1/3
Wide income inequality
124
Why might privatisation allow us to cut taxes?
Government revenue from other sources.
125
What percentage of government revenue doesn't come from taxation and why does this fluctuate?
~8.5%
Depends on return on government investments as well as the sale of nationalised assets
## Footnote
Depends on return on government investments as well as the sale of nationalised assets.
126
What is the biggest share of taxes in the UK?
Income taxes, specifically direct taxes.
127
What is tax evasion?
Illegal avoidance of tax.
128
What is tax avoidance?
Legal avoidance of tax.
129
What is PAYE?
A system where employers deduct direct taxes such as income tax from worker's pay before giving them their post-tax income. Most of the cost is shifted to business, making the tax more efficient from a consumer point of view, but not necessarily better for firms.
Pay As You Earn
130
How do different earners avoid tax?
1. Low-income - work for cash. No records or receipts for consumer rights and no evidence for tax.
2. High-income - offshoring and financial manipulation.
131
Which type of income tax is most likely to cause unintended consequences and why?
A very progressive tax
Disincentivising and incentivising tax avoidance
132
Why is income tax important to governments?
Broad base of payers means that tax revenue is high.
133
How are excise duties unit taxes?
Paid on the number of units of the good.
134
Why are spending taxes often preferable to income taxes? Eval?
Can secondarily be used to correct market failure
Free-market economists condemn this
135
What is neutrality in taxation?
Taxes should not be different for different goods unless a good is a proven demerit/merit good.
136
How could spending taxes reduce extreme income inequality?
Tax some necessities less than luxuries.
137
How to evade spending taxes?
Agree in cash/agreement between buyer and seller.
138
What is the % change formula?
(new - old)/old x 100.
139
Why are indirect taxes less likely to face government failure?
Harder to avoid.
140
What is money laundering?
Illegally obtained money entered into the official money supply via an official transaction at a secondary partner.
141
What is an example of how wealth taxes have fallen out of fashion?
Capital gains tax, introduced in 1965 - rates are relatively low, below 2% most of the time
142
Which tax revenues fall most sharply during recessions?
Capital gains tax - asset prices fall
Also spending on taxed consumption (indirect taxes) falls
143
Commentary on current tax revenues?
1. Corporation tax revenue declining.
2. Capital gains tax fell off hard in 2008 and took over a decade to recover.
3. Direct tax income has become more strained since 2008, increasingly dependent on higher income earners, particularly in devolved nations, with low wage growth and low productivity gains plaguing the increase in tax revenues.
144
How has the UK tax system become more regressive? IMPORTANT!
Since 2008:
1. Capital gains taxes have become more important
2. VAT has risen to 20% in 2012, with income tax becoming les significant, making indirect spending taxes now the main source of government tax revenue
OVERALL MORE REGRESSIVE TAXES AT WORK - HENCE WIDENING UK INCOME INEQUALITY!
## Footnote
Overall more regressive taxes at work - hence widening UK income inequality!
145
What is the trade-off in taxes?
Efficiency versus equity.
146
Is the negative substitution effect for progressive taxes irrational or lazy?
No - due to higher welfare outside work.
147
Non-interventionist supply-side fiscal policy explained
1. Cut taxes and welfare benefits.
2. This increases the opportunity cost of not working and encourages the unemployed and economically inactive to substitute for labour.
3. Those already in work are incentivised to work harder, because marginal disposable income is higher.
4. Growth results and trickle down benefits everyone.
148
How are the low income better off after trickle-down fiscal policy has been applied?
1. Relatively worse off due to widening inequality.
2. Absolutely better off.
149
Did the UK government deliberately increase income inequality in the 1980s and 1990s? Why?
Yes, to an extent
Encourage substitution to labour
150
What evidence shows non-interventionist supply-side fiscal policy has made the UK more unequal?
UK Gini coefficient ~37% versus Germany/France ~29%.
151
How to evaluate a tax in an exam?
Canons of taxation are a good place to start.
152
What is the evaluation on recent LFS?
Bad data! Economist reports in 2025 that data is getting harder for economists to find. LFS sample shrank.
153
What is national debt?
Stock of all government borrowing that has not been paid back.
154
When does the national debt not matter? Why?
When GDP growth outpaces the growth of the debt
Expanding tax revenues to finance the borrowing requirement
155
What is the debt:GDP ratio?
The government's debt as a percentage of GDP.
156
IN ALL QUESTIONS REGARDING THE VIABILITY OF A GIVEN NATIONAL DEBT...
USE DEBT-GDP RATIO
157
Can the deficit fall whilst the debt rises?
Yes, so long as the deficit exists.
158
How has the national debt grown in recent years?
Between 2015-20, the national debt was around 80% of GDP. After COVID-19 was around 100% of GDP.
159
Why is the national debt a burden on the economy and eval?
Need to finance debt payments
Gets worse when deficit expands due to falling bond prices
160
Why is the effect on government costs of borrowing when market interest rates rise?
When interest rates are higher:
1. Bond yields must rise to remain competitive
2. Cost of borrowing rises
Bonds are competitive assets
## Footnote
Bonds are competitive assets.
161
How does a budget surplus work?
Allowing the government to increase spending on interest payments, repaying some of the national debt.
162
What are the 2 types of budget deficit?
1. Cyclical - that which rises in the downswing of the economic cycle but falls in the upswing.
2. Structural - that which is not affected by the economic cycle but results from structural change in the economy and government finances.
163
What is a better measure of the 'underlying' deficit?
The size of the structural deficit.
164
Is the structural deficit calculable?
Not directly.
165
What are 2 causes for a changing structural deficit?
1. Changes in the structure of the UK economy.
2. Discretionary fiscal policy decisions.
166
What are 2 examples of things that have increased the structural deficit in recent years?
1. Globalisation and offshoring.
2. Changing demographics e.g., ageing population.
167
Between the 1950s and 1979, Keynesian governments used ___ to manage the economy
Why did this work?
Discretionary fiscal policy
COUNTER-CYCLICAL DEMAND MANAGEMENT meant that growth was continuous, keeping the debt:GDP ratio under control
## Footnote
COUNTER-CYCLICAL DEMAND MANAGEMENT meant that growth was continuous, keeping the debt:GDP ratio under control.
168
What is counter-cyclical demand management policy?
When DISCRETIONARY FISCAL POLICY is used to manage demand to keep the economy at the trend growth level of real national output.
169
What are the 3 approaches to fiscal policy?
1. Keynesian discretionary and interventionist approach
2. Use of AUTOMATIC STABILISERS
3. Neoliberal laissez-faire approach
170
What are automatic stabilisers?
Non-discretionary fiscal policy that automatically stimulates and deflates AD over the course of the economic cycle.
171
What are examples of automatic stabilisers?
1. Tapered welfare benefits.
2. Progressive taxation.
172
Why must the tax system be progressive for automatic stabilisers to work?
The injection into the circular flow must exceed the leakage.
173
Explain how automatic stabilisers smooth the economic cycle.
1. Suppose a demand-side shock such as a collapse in consumer confidence occurs.
2. National income must decline by the same amount as the fall in demand for the goods and services that national income produced.
3. Demand-led public spending on welfare benefits therefore rises. Simultaneously, progressive taxes fall. The result is a net injection into the circular flow.
4. The deflationary impact of the initial fall in aggregate demand is reduced.
5. The contractionary multiplier is mitigated.
174
What is a key macro evaluation for any progressive tax?
Can help with automatic stabilisers.
175
Why is it necessary for the automatic stabilisers to increase tax revenues during a boom?
1. To prevent overheating.
2. To prepare reserves for the cyclical deficit of a downturn.
176
Success of progressive taxation?
Widely acknowledged that, since 1939, automatic stabilisers have contributed to reducing the volatility of the economic cycle.
177
Is discretionary or non-discretionary fiscal policy more significant for the macroeconomy?
Hard to know, but both West Germany and the UK had similarly stable Keynesian periods, and in West Germany discretionary fiscal policy was rarely used.
178
Why did austerity under George Osborne violate the established understanding of macroeconomics?
Most economists accept that the deficit must grow in the downturn, but will recover from cyclical gains during the upswing. Osborne did not seem to accept this.
179
Why do free market economists oppose the use of counter-cyclical demand management?
1. Huge risk of government failure:
- Asymmetric information as Hayeck pointed out
- Political business cycles
- Time lags
2. Free-market forces will achieve cyclical stability
3. "Big government" - risk of CROWDING OUT
4. Disincentive effects because it necessitates a progressive tax system
180
What is resource crowding out?
The rivalry of resources between the private and public sector.
181
What fundamental economic concept underlines financial crowding out? Eval?
Rivalry - a limited money supply
Not necessarily true or valid assumption
182
What are 2 reasons financial crowding out allegedly occurs?
1. Limited money supply.
2. Bond sales drive up interest rates, making the cost of borrowing for firms via commercial bonds and hence investment more expensive.
183
Who argued that the cost of budget deficits depends on what kind of budget deficits we are referring to?
Megan McArdle, free market economists.
184
How does McArdle evaluate budget deficits?
Differentiate between cyclical and structural:
1. Cyclical are not a problem.
2. Structural can be a problem.
185
Evaluation of the cyclical deficit, for an exam question which may ask about this.
Megan McArdle - it is "GREAT DEPRESSION INSURANCE"
1. Real value likely to be eroded by inflation if only we can restore the economy to growth
2. The debt can be recovered by automatic stabilisers during the subsequent boom
Automatic stabilisers good. Discretionary COUNTER-CYCLICAL GOOD unless it is EXCESSIVE
186
Evaluation of the structural deficit, for an exam question which may ask about this.
If GDP growth > national debt growth then a structural deficit is manageable.
BUT IF IT EXCEEDS WE CAN ENTER A SPIRAL:
1. Interest payments rise as a proportion of TME
2. Higher taxes can erode incentives
3. Cuts to spending can harm the most vulnerable/increase inequality and poverty
## Footnote
BUT IF IT EXCEEDS WE CAN ENTER A SPIRAL:
1. Interest payments rise as a proportion of TME.
2. Higher taxes can erode incentives.
3. Cuts to spending can harm the most vulnerable/increase inequality and poverty.
187
Eval on budget surpluses?
1. Reduce inflationary pressures and reduce the national debt
2. But can cause AD failure, malign deflationary spiral etc.
3. Damage incentives and supply-side performance
188
Why fundamentally is national debt seen as a problem?
Because it is seen as a burden on future generations who must service the debt via interest payments.
189
How can we begin evaluating whether the national debt is a problem or not?
Split into reproductive national debt and deadweight national debt.
190
Explain reproductive national debt and evaluate it.
1. Government borrows for a supply-side project such as HS2.
2. The infrastructure boosts real-national output - so assets exceed liabilities, or are at least equal
3. Debt:GDP ratio remains constant and the burden on future generations is not significant
BUT
1. Crowding out - believe it is better left to the private sector
2. CAPITAL CONSUMPTION - not immortal
3. Government failure, HS2 was a disaster
## Footnote
BUT:
1. Crowding out - believe it is better left to the private sector.
2. CAPITAL CONSUMPTION - not immortal.
3. Government failure, HS2 was a disaster.
191
Explain deadweight national debt and evaluate it.
1. Government borrows for immediate consumption demands
2. Liabilities exceed assets
3. Debts rise
BUT
1. In recent examples e.g. war, more than economics was at stake. And Keynes negotiated a debt relief after the war
## Footnote
BUT:
1. In recent examples e.g. war, more than economics was at stake. And Keynes negotiated a debt relief after the war.
192
What is an example of how governments view reproductive national debt more favourably?
2024 - Rachel Reeves announces plans to change rules around deficits for investment projects.
193
Is deadweight debt always bad?
No - for instance, we won WW2 and WW1 on deadweight debt, and many would argue, normatively, that this was worth it.
194
What happens if the rate of inflation is greater than the rate at which the budget deficit and borrowing requirement add to the nominal national debt?
The money value of the debt as a proportion of money or nominal GDP falls.
195
How can governments suffer inflation psychology? Eval?
Borrowing costs are lower for nominal bonds when inflation is higher
If debtholders figure this out, they will likely demand higher interest rates
196
What is rolling over the national debt?
1. Each year, some of the national debt matures.
2. Unless there is a surplus, the government must sell new debt in order to repay the face value of the debt.
3. Raising the interest rates to keep bonds attractive to keep this cycle going can cause crowding out.
197
What is servicing the national debt?
Paying interest on the debt.
198
When is debt servicing a problem?
If debt is held by those outside the country
Because instead of the government taxing to pay for it and hence redistributing, it is instead sending money out of the circular flow
199
What are 2 times debt servicing is not a problem?
1. Small national debt.
2. Internally held national debt.
200
OBR created in...
2010.
201
What is the purpose of the OBR?
Provide independent analysis of the UK's public-sector finance.
202
What are 2 sources of forecasts of UK macro performance?
1. OBR - biannual.
2. Treasury - monthly compilation of forecasts.
203
What is the OBR's role in relation to Treasury forecasts?
Instead of the Government relying on Treasury forecasts, the OBR rules on whether the government has a greater than 50% chance of meeting Treasury fiscal targets
204
When is debt servicing not a problem?
1. Small national debt
2. Internally held national debt
205
What is the OBR?
Office for Budget Responsibility, created in 2010 to provide independent analysis of the UK's public-sector finance.
206
What are the two sources of forecasts of UK macro performance?
1. OBR - biannual
2. Treasury - monthly compilation of forecasts
207
What is the OBR's role in relation to Treasury forecasts?
The OBR rules on whether the government has a greater than 50% chance of meeting Treasury fiscal targets.
208
What institution is comparable to the OBR?
The MPC - attempting to remove politics from government macroeconomic policy.
209
Main argument for OBR? Example?
DEFICIT BIAS or PRO-CYLICALITY
Governments would naturally overboost the economy before elections etc.
Truss vindicates this view
210
Example of how the OBR is impartial?
Set up in 2010 by Cameron - in 2013, when Cameron said there was "no alternative" to austerity, OBR corrected him
211
Why might Sandel's research help us evaluate supply-side economics?
Michael Sandel argues that people are not always motivated by concerns of pay.
212
What are supply-side policies?
Government economic policies to take LRAS right.
213
What is the most significant source of supply-side policy?
Fiscal.
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What is supply-side economics?
Branch of FREE MARKET ECONOMICS arguing that government policy should be used to improve the competitiveness and efficiency of markets and, through this, the performance of the economy
215
When did supply-side economics become popularised?
1980s, as part of the free market revival.
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What did early supply-side policy focus on?
The effects of fiscal policy on the economy.
217
Why was supply-side fiscal policy seen as unusual initially?
Fiscal policy was primarily seen as a demand-management tool.
218
Are supply-side policies micro or macroeconomic?
BOTH; but many are primarily microeconomic - by altering incentives we can change behaviour of agents
219
What did Laffer say about supply-side economics?
It relies on incentives.
220
What is supply-side improvement?
Reforms undertaken by the private sector to increase productivity, so as to reduce costs and become more efficient and competitive
221
What do free marketeers believe about interventionist supply-side policies? Eval on this?
Often counterproductive in the long run because they prop up uncompetitive firms
Not necessarily fair if the government's interventionist supply side policy is macroeconomic in nature e.g. training schemes
222
What is an external economy?
A thing beyond the firm's market which it depends on for a business cost e.g. training workers
223
Enabler, rather than provider
The way free-marketeers describe the role of the government in non-interventionist supply-side policy
224
The policy proposed by supply-siders towards the end of the Keynesian era can be described as...
MICROECONOMIC in nature, affecting incentives, decisions and competitiveness
225
What does industrial policy encompass?
The sum of regional policy, competition policy, and industrial relations policy.
226
Do non-interventionist supply-siders support any interventionism?
No - they tend to support a little bit to provide EXTERNAL ECONOMIES for firms e.g. public goods and merit goods
227
What is the MARKET-BASED SUPPLY-SIDE POLICIES TOOLBOX?
1. Privatisation
2. Deregulation
3. Marketisation
4. Tax reform
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Enterprise culture
The stated goal of supply-siders - a society in which innovation is the norm and where aspiration and entrepreneurship rule
REPLACES DEPENDENCY CULTURE of Keynesianism
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How did supply-siders aim to achieve better macroeconomic performance?
1. Growth by LRAS shifts
2. Unemployment by reducing structural and other involuntary unemployment
3. Inflationary pressure eliminated
4. BoP stabilised
230
Why would supply-side reforms help with the BoP?
Supply-side reforms will allegedly produce conditions where domestically produced goods are both price and quality competitive in overseas markets
231
The significant index which can measure the success of supply-side policy is...
Labour productivity.
232
Laffer Curve effect explained
Illustrates how high rates of tax and the overall tax burden creates disincentives which reduce national income as taxation increases, reducing actual tax revenue
At 0% average tax rate, revenue is nothing, but as tax rates approach 100%, there are no incentives to produce goods and services for trade
233
What did supply-siders argue about tax rates during the Keynesian era?
They had surpassed the peak on the Laffer Curve.
234
2 ways tax revenue is maximised by cutting taxes, according to supply-siders and illustrated by the Laffer Curve?
1. Incentive effects drive growth to national income, meaning more long run tax revenues
2. Incentive to engage in tax evasion or avoidance falls, meaning governments benefit from more taxpayers
235
Why is supply-side economics more optimistic in terms of how achievable it believes macroeconomic objectives are when compared to Keynesianism?
Keynesianism involves trade-offs particularly in the short-run. Supply-side believes that in the long run it can accomplish all objectives equally
236
In reducing unemployment, what do supply-siders focus on?
The NATURAL RATE of unemployment/voluntary unemployment
237
Why are supply-side policies particularly effective on the labour market?
Do not create upwards pressure on wages/not inflationary
238
Why is supply-side fiscal policy for the labour market not inflationary?
Because ADL expands (reduced cost of employment e.g. less employer NIC contributions) and ASL expands (opportunity cost higher)
239
How does a tax and benefits cut increase ASL?
1. Increase incentives
2. Increase opportunity cost of not working.
240
What is the supply-side view of monetary policy?
1. Need to maintain "SOUND MONEY" and reduce inflationary psychology
2. Ensure demand is attendant to absorb increases in AS, but NO MORE than this
241
What are the two main ways governments borrow?
1. Short-dated TREASURY BILLS
2. GILTS
242
Why are monetary policy and fiscal policy often in conflict?
The Central Bank's control of the money supply can be affected by the Treasury's bond issuance.
243
2 reasons supply-siders often encourage deficits to be reduced?
Public-sector does one of two things:
1. Private sector investment is affected by crowding out and rising interest rates as government bond prices fall
2. Can create POLICY CONFLICT with monetary policy
244
Why does the interest rate on bonds rise as the government increases its budget deficit?
1. Government must increase interest rates to stay competitive
2. Government must increase bond yields if prices fall
Remember government does bond issues to a narrow band of MARKET MAKERS in the first instance
245
Since the supply-side revolution, what has fiscal policy been subordinate to?
Monetary policy.
246
2 ways supply-siders argue that successful supply-side policy reduces cost-push inflation?
1. Markets made more competitive because nationalised monopolies are broken up
2. Reduce business costs of production e.g. tax incidence on firms
247
How do supply-siders argue that supply-side policy will help reduce DEMAND-PULL inflation?
Firms can grow in line with changes in AD.
248
How can supply-side policies improve the BOP? Eval?
Increased:
1. QUALITY COMPETITIVENESS - firms are not satisficing due to increased competitive pressure. They innovate and produce high-quality goods which consumers demand.
2. PRICE COMPETITIVENESS - firms are more price competitive due to competitive pressure
Without abnormal profits, firms are not quality competitive because no profit for R&D.
249
How does increased quality and price competitiveness allegedly stabilise UK BOP? Eval?
1. More consumers at home transfer to pice competitive domestic goods/services
2. More consumers abroad begin buying UK exports
250
What is expansionary fiscal contractionism?
ILLUSTRATE USING A PPF WHICH IS DISPROPORTIONATELY BOWED OUT TOWARDS PRIVATE SECTOR OUTPUT AND SPENDING
A trade off exists between private sector output and spending and public sector output and spending
When the government reduces spending and ownership, it allows the private sector to expand in. The lack of a crowding out effect will add to this too. Overall, the private sector is assumed to be more productive and efficient. So the fiscal contractionism has a net expansionary effect.
251
What is the trickle-down effect?
Government spending to boost real national output by fiscal policy is inefficient and ineffective. Better to give tax cuts to the rich, who by employing labour and capital are likely to stimulate economic growth when given the chance, increasing employment, output and hence living standards
252
What are three evaluations against trickle-down economics?
1. The rich are likely to move wealth to countries with lower taxation policies in order to maximise their rate of return
2. Little empirical evidence due to rich's low MPC
3. The trade offs involved even if a small effect did occur. Worsening effects on income inequality
253
What did Osborne say about fiscal austerity in the UK as opposed to the US?
He didn't cut taxes on the assumption that he was at "some point on the Laffer curve" - he would not condone unfunded tax cuts in the assumption it would raise revenues
254
When did myopic obsession with the Laffer curve preclude balanced judgement about UK fiscal policy?
2022 - Liz Truss and reduction in taxes which were unfunded in belief the stimulus effect would overwhelm
255
What is the 'extreme' Laffer Curve argument and proponent?
Tax cuts can be self-funding, as argued by Chancellor Kwasi Kwarteng.
256
Which groups in society are worst affected by large cuts in public spending?
Lowest income groups.
257
How does supply-side policy depend on microeconomics?
It focuses on incentives, such as in the labour market.
258
Why do tax cuts equate to an increase in labour supply?
Increase in wages and then incentive effect
259
The supply-side fiscal policy position for increasing the labour supply depends on...
The incentive effect of the labour market supply curve overcoming the tendency to substitute for leisure
260
Most damning evaluation on the free-market supply-side argument that tax cuts lead to increased employment?
Backward bending labour supply curve due to income and substitution effect
261
Explain how the income and substitution effects can weaken the argument for lower taxes in order to incentivise labour
1. Beyond a certain point, consumers reach a point where the opportunity cost of more work exceeds the marginal utility of the first unit of leisure time. This is because they already have enough income and do not demand more, even if wage rates rise.
2. Hence, for high-income earners, the effect of a tax cut may not be to incentivise labour but rather to create the opposite, since once these workers reach their target income, they will only work as much as they need to to receive this, which will be less if real post-tax incomes rise.
262
Is the backward-bending labour supply curve on the spec?
Weirdly, no it isn't, but it is so useful I have included it anyway.
263
Microeconomic supply-side policies can be categorised into what 3 categories?
1. Industrial policy measures
2. Labour market measures
3. Financial and capital market measures
264
5 industrial policy measures which can act as supply-side policies
1. Privatisation
2. Marketisation
3. Deregulation
4. Internal markets
5. Subsidising spending on R&D
265
What is the purpose of an internal market?
Provide a form of commercial discipline to nationalised industries, improving efficiency
266
What is the most common way to subsidise R&D?
Corporation tax cut.
267
What are seven labour market measures that can act as supply-side policies?
1. Lower rates of income tax
2. Reducing the relative income provided by state welfare
3. Changing employment law to reduce trade union power
4. Changing employment law to increase employer's freedom to employ
5. More flexible pension arrangements (state pension?)
6. Improving the training and hence factor mobility of labour
7. Short-term labour contracts
268
Training tax and eval?
A proposed tax (rejected) which would have forced producers to pay for training costs, presently an external economy free rided by firms
269
What are two changes to employment contracts?
1. Zero-hours contracts and flexible contracts
2. Performance-linked pay
270
What are four financial and capital market policies that could act as supply-side policies?
1. Deregulate financial markets
2. Encourage saving
3. Promote entrepreneurship
4. Reduce CROWDING OUT
271
Eval on deregulation of financial markets?
1. Main constraint on business investment is finance
2. But could have UNINTENDED CONSEQUENCES -> GOVERNMENT FAILURE
3. 2007 credit crunch e.g. ...
272
How is encouraging saving a financial market regulation which could help the supply-side?
1. Need money for investment - 63% of UK business investment is retained profit. So Government has encouraged saving
2. CONFLICT SINCE LOW IR IN RECENT YEARS
3. Also - AD consequences
4. Tax-breaks for savers has worsened inequality
273
What are four examples of interventionist supply-side policies?
1. Government spending on education and training
2. Industrial and regional policy
3. Spending on infrastructure such as motorways
4. Subsidising R&D
274
Interventionist supply-side policy is associated with economists who believe that...
Economic growth can be held back by short-termism and over-saving.
275
6 key objectives of supply-side economic policy with evaluation?
1. Increase productivity
2. Improve incentives
3. Promote non-inflationary growth
4. Promote competition (COMPETITION DOES NOT DRIVE INNOVATION - abnormal profits gone!)
5. Increase mobility
6. Increase investment and research
276
Eval on corporation tax cuts?
1. Can worsen income inequality if the profits are not reinvested and simply passed on as dividends, since ownership of shares is concentrated in the hands of the highest income/wealthiest
2. Opportunity cost on government finances
277
What are two ways the Laffer Curve allegedly works?
1. Same income tax at higher incomes because rates are lower
2. Globalisation and workers entering UK
278
Example of interventionist supply-side policy from a perspective of building infrastructure?
Crossrail and HS2.
279
How could home building be an interventionist supply-side policy and eval?
1. Increase geographic mobility of labour
2. But a negative wealth effect and negative equity from rising house prices could dampen consumer confidence
280
How exactly does education improve the supply-side?
1. Workers higher productivity and higher MRP
2. Hence get hired, reducing unemployment
3. At the firm, they are more productive, increasing output
281
What is the NRU unaffected by?
AD.
282
What is an example of interventionist supply-side policies to reduce structural unemployment?
Schemes to get ex-soldiers into civilian employment.
283
What is the NRU formula?
Structural + frictional.
284
What is an example of structural unemployment being reduced by a supply-side improvement?
Morgan Stanley offers employment to ex-military.
285
What is the marginal propensity to withdraw?
MPS + MPT + MPM.
286
How fast did America recover after 2008 and why?
By 2010 were back at 2% growth due to stimulus including ARRA and AJA 2009
287
What is the supply shrinkage view of the Financial Crisis?
HYSTERESIS EFFECT of financial crisis
1. Bank lending was undermined so permanently reduced investment
2. Hysteresis from unemployment occurred
3. Capital consumption occurred
288
Tory debt reduction?
From 100bn to a figure half that size within 7 years.
289
What is an example of the opportunity cost of the national debt?
More spent on interest payments than defence in the UK.
290
What is evidence that other countries worry less about debt:GDP
Japan over 200% and they aren't worried
291
What is the supply shrinkage view of the Financial Crisis?
Bank lending was undermined, leading to permanently reduced investment.
## Footnote
Hysteresis from unemployment occurred and capital consumption occurred.
292
What was the Tory debt reduction?
The debt was reduced from 100 billion to a figure half that size within 7 years.
293
What is an example of the opportunity cost of the national debt?
More was spent on interest payments than defense in the UK.
294
Which country has a high GDP debt but is not worried about it?
Japan has a GDP debt over 200% and they aren't worried.
295
Example of an internal market
State-sector schools compete
296
Supply-side fiscal policy illustrated
SRAS and LRAS both shift right
297
fixed
298
Why is NIC regressive? Caveat?
There is an Upper Earnings Limit. Above this point, the marginal tax rate falls.
It has the same bottom threshold (12570) as income tax, so progressive at low levels of income
299
What percentage of tax revenues in the UK come from which taxes in the year 2023-24?
28% Y tax
18% NIC
17% VAT
11% Corporation Tax
10% other indirect tax
16% other taxes
300
ANOTHER MAGIC 63
In 2023-24 - about 63% of tax revenues were Y tax, NIC and VAT
301
What percentage of taxes in 2023-24 were Y tax and NIC (direct)?
46%
