Macroeconomics: Fiscal Policy Flashcards

1
Q

State the sources of government revenue.

A
  • Tax revenue - direct and indirect
  • From the sale of goods and services
  • From the sale of state-owned assets/property
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

State the types of government expenditure.

A
  • Current expenditure (day-to-day spending)
  • Capital expenditure (public investment)
  • Transfer payments
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Define fiscal policy.

A

Manipulating tax rates and government expenditure to affect aggregate demand

Aims to achieve economic objectives and stabilize short-term fluctuations

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Define expansionary fiscal policy.

A

Increases aggregate demand by reducing tax rates and increasing government expenditure

Used to

  • Increase economic growth (boost during recession)
  • Reduce cyclical unemployment
  • Increase inflation
  • Redistribute incomes (transfer payments)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Define contractionary fiscal policy.

A

Decreases aggregate demand by increasing tax rates and reducing government expenditure

Used to
* Reduce demand-pull inflation
* Reduce budget deficit
* Redistribute income (e.g. increase progressive tax rate)
* Reduce current account deficit

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Bill Clinton Deficit Reduction Act 1993 (Contractionary Fiscal Policy)

A
  • Raised taxes to reduce the nation’s $60 billion deficit
  • Raised the top income tax rate from 28% to 36% for those earning over $115,000 per year
  • Increased corporate tax rate from 34% to 36%
  • Taxed social security benefits for top-income earners
  • Freeze on the pay of federal workers in the following year, and lower raises than scheduled in the following years
  • Cut spending on military and medicare
  • New spending on short-term stimulus programs, e.g. investment in infrastructure, creating 500,000 new jobs
  • Employment rose by 2.4%, real GDP rose by 3.7%
  • Dotcom boom, businesses were surging
  • US entered big trade deals like NAFTA and WTO

https://www.washingtonpost.com/wp-srv/politics/special/states/stories/sou021893.htm

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Explain direct and indirect impacts of fiscal policy.

A

Indirect Effects

  • increased confidence/certainty for businesses -> invest in capital -> long-term economic growth (increase LRAS)

Direct Effects

  • directly increase gov spending on infrastructure, education, etc.
  • directly lower business taxes to encourage private investments
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Outline the strengths of fiscal policy.

A
  • Gov spending directly affects AD, pull the economy out of deep recession
  • Ability to target specific sectors of the economy (e.g. merit goods)
  • Affects potential output (LRAS), leading to long-term economic growth
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Outline the weaknesses of fiscal policy.

A
  • Time lags (time to realize the problem, time to implement policies, time to wait for the effects to take place)
  • Political constraints
  • Inability to deal with supply-side causes of instability (e.g. stagflation, unemployment)
  • Tax cuts may not lead to more spending/investment (marginal propensity to spend and save, low confidence or certainty, deep recession: expectation that product prices will continue to fall)
  • Marginal propensity to import: rising disposable incomes may feed through to increasing demand for imports, widening the net trade deficit (imports > exports)
  • May lead to an acceleration in the rate of price inflation which then cuts real incomes and spending by households
  • Crowding-out effect: increased gov spending will lead to decreased private sector spending → may lead to higher market interest rates, reduces private sector demand for loans → lowers the incentive for borrowing, discourages spending → reduce AD
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Define automatic stabilizers.

A
  • Fiscal policy tools, automatic mechanisms without any deliberate action from the gov which help to reduce fluctuations in the economic cycle
  • e.g. unemployment benefits, progressive taxation
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

How does fiscal policy affect unemployment?

A
  • gov spending on specific areas can open up job opportunities, e.g. Clinton’s Deficit Reduction Act (1993) implemented new spending on infrastructure and training programs, opening up 500,000 jobs
  • mainly targets cyclical unemployment only and unable to combat natural unemployment
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

USA Unemployment Benefits in 2019

A
  • support and protect households during an economic slump due to COVID-19 pandemic
  • up to $600 USD of benefits per week
  • led to low incentive to work as individuals could sustain a high standard of living without jobs
  • unemployment rate tripled from 3.6% in 2019 to 13.0% in 2020
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

The U.S. Fiscal Response to COVID-19 expansionary fiscal policy

A
  • $5.2 trillion USD spent in total
  • $599 billion spent to pay for public health measures
  • $748 billion was spent to expand unemployment insurance (direct payments of up to $1,200 per person followed by $600 and $1,400)
  • $808 billion spent on loans to small businesses
  • will push the U.S. debt-to-GDP ratio from 79 percent to 110 percent

Positive Impacts

  • economists agree that the money spent helped local governments shoulder significant pandemic-related costs, and avoided deep budget cuts
  • accelerated the deployment of vaccines, advanced COVID-19 treatment plans, protected health providers
  • Personal consumption expenditures (PCE) rose by 7.6% in 2021 and by 3.9% in 2022

Negative Impacts

  • some of the funds were unfairly distributed since smaller, poorer hospitals received less federal aid in comparison
  • unemployment benefits of up to $600 USD per week lowered the incentive to work, causing the unemployment rate to triple from 3.6% in 2019 to 13.0% in 2020
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Evaluate expansionary fiscal policy.

A

Cons

  • Higher demand-pull inflationary pressure (conflicts economic objectives)
  • More spending on imports, widen current account deficit
  • Gov. finances worsen, budget deficit, national debt increases
  • Crowding out effects: highly debt-fueled gov spending increases demand for loanable funds, pushes up equilibrium interest rates, more expensive for firms to invest, reduces private sector investment
  • Time lags in realizing the issue, implementing the issue, and allowing effects to take place in the economy

Evaluation

  • Size of the output gap
  • Consumer/business confidence
  • State of gov finances
  • Long-run tax returns to the gov overtime (long-term economic activity)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Explain how automatic stabilizers work.

A

Boom (cushion demand)

  • Progressive taxation
  • Growth leads to rising incomes
  • Workers pushed into higher income tax bands
  • Increases the average rate of tax (amount of income tax paid as a proportion of total income)
  • Less disposable income
  • Slow down increases in C
  • Slow down increases in AD

Recession (support output)

  • Progressive taxation
  • Negative growth, incomes fall
  • Workers fall into lower income tax bands
  • Reduce average rates of tax
  • Prevents large decreases in consumption
  • Prevents deep recession

Recession (support output)

  • Unemployment benefits
  • Negative growth, firms lay off workers to retain profits, more individuals eligible for u benefits
  • Increase in disposable income
  • Prevents large decreases in consumption
  • Prevents deep recession
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

10 Marker Real life examples

A

Direct Tax

  • in 2015, Singapore announced a hike in the top marginal income tax rate from 20% to 22%
  • in 2010-2012, Nigeria increased corporate tax from 30% to 39%

Indirect Tax

  • Singapore implemented its first carbon tax in 2019 - firms that emit carbon soot into the atmosphere and power stations will be charged
17
Q

Evaluate contractionary fiscal policy.

A

Pros

  • Confidence in government finances
  • Flexibility with fiscal policy
  • Less crowding-out
  • Lower demand-pull inflation
  • Lower spending on imports, reducing current accounts deficit

Cons

  • Shock economy into a deep recession (demand-side shock) -> lower growth, higher unemployment
  • impacts of less government spending, e.g. lower quality of healthcare, poor education quality, less public transportation, lower welfare
  • impacts of higher taxation can harm long-term production, reduce productive capacity, growth rates, productivity
  • lower incentive to work, for people to enter the workforce, lower incentive to invest, encourage tax evasion
18
Q

Great Recession 2008 expansionary fiscal policy

A

Why?

  • US GDP fell from 2007 Q4 to 2009 Q2, a total decline of 5.3%
  • implemented discretionary fiscal policies, including $153 billion stimulus on gov spending like infrastructure on roads, and a 21% reduction in income taxes; 55% reduction in corporate taxes

Evaluate

  • Time lag: recession began in 2007 Q4, but due to the official definition of a recession not being met policy only implemented in 2009 Q2, where 5 million jobs were already lost
  • further time lag for Congress to pass a bill addressing the recession, took up to 3 months for deliberation
  • Inability to deal with supply-side: OPEC oil embargo in 1970 experienced stagflation due to decrease in SRAS, gov was put in difficult position as fiscal policy was unsuitable
  • unsustainable debt: debt to GDP ratio rose from 62.6 to 82.3

Alternative Policies

  • Monetary: no constraint in crowding out due to not borrowing required; less time lag since interest rates are set by the Central bank is apolitical and requires no parliamentary approval to implement, can fine-tune economy
  • Late 2007, early signs of recession, interest rates were decreased by the Federal Reserve from 5.25% to 4.5%, then adjusted 10 times across 2008 from 4.5% to 0.25%