3.1 Fiscal Policy

Question 1

What is a fiscal policy?

Answer 1

Involves all the manipulation of government spending and/or the overall level of taxation in an economy over a given period of time

Question 2

What is an expansionary stance?

Answer 2

Government spending is higher than tax revenue
(Budget deficit)

Question 3

What is a deflationary stance ?

Answer 3

Government spending is lower than tax revenues
(Budget surplus)

Question 4

What is exhaustive spending and non exhaustive spending?

Answer 4

Exhaustive spending is public sector spending on goods and services (affects AD directly)
Non exhaustive spending is public spending on transfer payments (affects AD indirectly: government spending on transfer payments such as benefits, subsidies are accounted for their affect on consumption and investment (C and I but not G)

Question 5

Classification of government spending

Answer 5

-current expenditure
-capital expenditure
-transfer payments
-debt interest payments

Question 6

What is current expenditure ?

Answer 6

An acquisition by the government of goods and services for current to directly satisfy the individuals or collective needs of the community
(For example, salaries of public workers)

Question 7

What is capital expenditure ?

Answer 7

Government spending on goods and services intended to create future benefits. (Such as infrastructure, transport, new school/hospital)
———-> effects AD and LRAS

Question 8

What are transfer payments?

Answer 8

Money transferred by the government to individuals in the form of benefits (JSA, state pensions)

Question 9

What are debt interest payments ?

Answer 9

These are made to the government creditors, holder of the government debt (the amount the government need to pay to holders of government bonds)

Question 10

What is a direct tax?

Answer 10

Direct tax is imposed on income (more formally, taxes imposed on the income of individuals and firms; they include income tax and corporate tax)

Question 11

What is an indirect tax?

Answer 11

Indirect taxes are taxes imposed on the expenditure of individuals and firms on goods and services, the include excise duty, tax on specific products and VAT

Question 12

What is a progressive tax?

Answer 12

Is a tax system which takes a higher proportion (%) of income in tax as income increases.

Question 13

What is a proportional tax

Answer 13

A proportional tax takes the same proportion of income in tax at all income levels

Question 14

What is a regressive tax ?

Answer 14

A regressive tax is one which takes a lower proportion (%) of income in tax as income increases.

Question 15

How to calculate average tax?

Answer 15

Average tax rate = (total tax paid/total income) x 100
The average tax rate is the proportion (%) of total taxable income paid in tax

Question 16

What is the marginal tax rate ?

Answer 16

The marginal all tax rate is the proportion of tax paid on each extra additional pound earned.

Question 17

What is a coupon rate?

Answer 17

The coupon rate is the percentage of the face value (maturity value) of the bond

Question 18

Equation of bond yield (%)

Answer 18

(Annual coupon payment/the current market price) x 100
Bond yield are inversely proportional to market prices

Question 19

What are automatic stabilisers ?

Answer 19

This is where the revenue from some taxes and some form of government expenditure change automatically to help stabilise fluctuations in economic activity
when economic activity increases, automatic stabilisers tend to dampen down increases in aggregate demand; tax revenue increases and government expenditure falls as a proportion of GDP
when economic activity falls, automatic stabilisers tend to reduce the decrease in aggregate demand; tax revenue falls and government expenditure rises as proportion of GDP

Question 20

How effective are government stabilisers ?

Answer 20

-depends on the extent to which you have a progressive tax system
-depends on the specific tax thresholds and tax rates used a more progressive income tax is more likely to result in greater automatic stabilisation effects.
The higher the tax free threshold the more progressive the tax system is likely to be

Question 21

Discretionary fiscal policy

Answer 21

Are changes to taxes and spending that may be implemented by the government in responses to changing economic activity, to help achieve a specific policy objective.

Question 22

What is a structural budget deficit?

Answer 22

A structural budget deficit is the underlying fundamental imbalance in total government receipts and expenditures, where govern,ent expenditure (G) is greater than taxation revenue (T). It is not affected by the economic cycle.
thus, the structural budget deficit is the element of the budget deficit which remains even when the economy is operating at full employment level.

Question 23

Cyclical element of budget deficit?

Answer 23

The part of budget deficit which falls in the boom phase of the economic cycle and rises in the slowdown/recession phase of the economic cycle. The cyclical deficit is related to the size of the output gap.

Question 24

Overall budget deficit

Answer 24

The overall budget balance is the sum of the cyclical and structural parts.

Question 25

Should we worried about a structural budget deficit?

Answer 25

Extent to which we should we be concerned is dependant on: 1) is real GDP growing faster to debt 2) credibility of government 3) Crowding out / higher interest rates

Question 26

Debt to Real GDP ratio (evaluation of being concerned by a budget deficit)

Answer 26

The extent to which a structural deficit presents a problem for government will depend on how fast the economy is growing relative to the structural budget deficit. If real GDP is growing faster than the structural deficit, the national debt will be falling as a proportion of GDP. In this case, the size of the structural deficit may not be considered a problem, as public finance could be viewed as improving (falling debt to real GDP ratio)

Question 27

Credibility of government (evaluation of should we be concerned of a budget deficit)

Answer 27

The government has to finance its budget deficit through public borrowing. If people have confidence in the governments ability to repay their debt, then a deficit is unlikely to be a problem

Question 28

The use of bonds (evaluation of whether we should be concerned about a budget deficit?)

Answer 28

Growing structural deficit: ->this implies government has to issue more bonds -> leads to a supply of bonds increasing ->the price of bonds decreases ->using the formula for bond yields a decrease in price leads to an increase in bond yields ->there is an upward pressure on other market interest rates ->investment tends to fall ->this is known as crowding out of private investment ->also leads to higher debt payments

Question 29

Advantages of fiscal policy

Answer 29

1.Automatic stabilisers 2.dealing with deep recession 3. The direct impact of government spending 4. Ability to target sectors and regions 5. Supply Sid effects

Question 30

Automatic stabilisers (advantage of fiscal policy)

Answer 30

Fiscal policy incorporates changes in taxation and government spending to stabilise fluctuations in real GDP and help achieve greater stability

Question 31

Dealing with deep recessions (Advantage of fiscal policy)

Answer 31

A government can borrow significant sums to spend, including directly on goods and services to offset significant fall in spending by households and firms. I.e it can overcome a lack of AD even when the economy is well below the full employment level

Question 32

The direct impact of government spending (advantage of fiscal policy)

Answer 32

Changes in government spending directly affect AD (as G is a component of aggregate demand). Direct spending may have a greater impact on AD than monetary policy, as interest rates take time Also, the multiplier effect of spending is greater than the multiplies effect from tax cuts and households may not spend all their additional disposable income.

Question 33

Ability to target sectors/regions (advantage of fiscal policy)

Answer 33

Fiscal policy can be directed to supporting specific industries/sectors of an economy The government could provide increased spending on training in areas suffering from high structural unemployment, in an attempt to increase occupational mobility of labour .

Question 34

Supply side effects (advantage of fiscal policy)

Answer 34

If government decides to implement an expansionary fiscal policy and decides to spend more on health and education, there may be an increase in the productive capacity of the economy over time

Question 35

Disadvantages of fiscal policy

Answer 35

1.crowding out 2. Time lags 3.public debt constraints 4. Overcoming a lack of confidence

Question 36

Crowding out (disadvantage)

Answer 36

Reduces the ffectivness of expansionary fiscal policy

Question 37

Fiscal policy Time lags (disadvantage)

Answer 37

Time taken for government to recognise problem Time taken to identify and agree on the appropriate policy The time Aiken for policy the actually start affecting economic variables

Question 38

Fsical policy Public debt constrains (disadvantage)

Answer 38

Expansionary fiscal policy may be less effective if the size of the accumulated stock of government debt becomes too large The additional borrowing required to finance the increased budget deficit will force up the interest rates paid on debt. If the debt is deemed to reach unsustainable levels, the additional levels of spending in the economy may be restricted

Question 39

Overcoming a lack of confidence (disadvantage)

Answer 39

In a deep recession, tax cuts may not be effective in increasing aggregate demand. This is because the increase in disposable income for households and firms may not lead to an increase in total spending by firms and households. If the confidence is low firms and households may spend less as a proportion of their income (MPC falls). This leads the to the multiplier affect being smaller