4.5 Role of the state in macro

Question 1

What is the primary purpose of government spending?

Answer 1

To control AD and achieve macroeconomic objectives: economic growth, low and stable inflation, balanced current account, and low unemployment

Additionally, it aims for equity and equality by providing services to those who would otherwise not receive them.

Question 2

What are the three main types of government expenditure?

Answer 2

• Capital government expenditure
• General government final consumption
• Transfer payments

Question 3

What is capital government expenditure?

Answer 3

Spending on investment goods such as new roads, schools, and hospitals which will be consumed over a year

This type of spending focuses on long-term infrastructure.

Question 4

What does general government final consumption include?

Answer 4

Spending on goods and services that will be consumed within the next year, such as public-sector salaries.

Question 5

What are transfer payments?

Answer 5

Government payments for which there is no corresponding output, where money is taken from one group and given to another, e.g., benefits and pensions.

Question 6

What major areas of expenditure does the government focus on?

Answer 6

• Defence (6%)
• Protection (4%)
• Education (12%)
• Pensions (20%)
• Welfare (15%)
• Transport (2%)
• Healthcare (18%)
• Interest repayments (7%)

Question 7

How does the average income of a country relate to government spending as a percentage of GDP?

Answer 7

The lower the average income of the country, the lower the percentage of GDP spent by the government.

Question 8

What impact did the Global Financial Crisis have on government spending?

Answer 8

It led to huge increases in government spending as governments increased welfare payments and bailed out banks.

Question 9

What has been the trend of government spending in the UK since 2010?

Answer 9

The UK government has been following a policy of austerity to reduce debt.

Question 10

What demographic trend will pressure government spending in Europe and Japan in the coming decades?

Answer 10

Aging populations leading to larger pension bills and higher levels of care needed.

Question 11

What is the argument of free market economists regarding government spending?

Answer 11

They argue that government spending is wasteful and causes inefficiency.

Question 12

What is the multiplier effect in the context of government spending?

Answer 12

Through spending, the government can create a multiplier effect that can focus on areas with high unemployment, creating growth.

Question 13

How does government spending improve living standards?

Answer 13

By correcting market failure, providing public goods, and reducing absolute poverty.

Question 14

What is the crowding out effect?

Answer 14

When government borrowing competes with the private sector for finance, leading to higher interest rates and discouraging investment.

Question 15

What is the relationship between high government spending and taxation?

Answer 15

High levels of government spending typically require high levels of taxation to be sustainable.

Question 16

What is a progressive tax?

Answer 16

A tax where those with higher incomes pay a higher marginal rate of tax.

Question 17

What is a regressive tax?

Answer 17

A tax where the proportion of income paid in tax falls as the income of the taxpayer rises.

Question 18

What does the Laffer curve illustrate?

Answer 18

That a rise in tax rate does not necessarily increase tax revenue and there is an optimal tax level that maximizes revenue.

Question 19

How does a progressive tax system affect income distribution?

Answer 19

It increases the equality of income distribution by taking more from the rich than the poor.

Question 20

What are automatic stabilizers?

Answer 20

Mechanisms that reduce the impact of changes in the economy on national income, such as government spending and taxation.

Question 21

What is the difference between a fiscal deficit and national debt?

Answer 21

A fiscal deficit occurs when the government spends more than it receives in a year, while national debt is the total of all government debts built up over many years.

Question 22

What is discretionary fiscal policy?

Answer 22

The deliberate manipulation of government expenditure and taxes to influence the economy.

Question 23

What is the national debt of the UK in 2018?

Answer 23

Around £1.8 trillion

As a percentage of GDP, the UK’s national debt is 87.7% of total GDP.

Question 24

What is the fiscal deficit of the UK in 2018?

Answer 24

£48 billion, 2.3% of GDP

Fiscal deficit is the difference between government spending and revenue.

Question 25

What is a cyclical deficit?

Answer 25

The part of the deficit that occurs due to fluctuations in government spending and tax around the trade cycle.

Question 26

What occurs at the peak of an economic boom in terms of deficits?

Answer 26

There is no cyclical deficit; any deficit at this point is a structural deficit.

Question 27

What is a structural deficit?

Answer 27

The fiscal deficit that occurs when the cyclical deficit is zero; it is long-term and not related to the state of the economy.

Question 28

How is the actual deficit calculated?

Answer 28

Structural deficit plus fiscal deficit.

Question 29

What is a structural surplus?

Answer 29

Occurs when there is an actual fiscal surplus at the peak of the boom.

Question 30

What is a structural balance?

Answer 30

Occurs when the actual fiscal balance is 0 at the peak of the boom.

Question 31

What happens to national debt when there is a structural deficit?

Answer 31

It is likely to grow over time due to the need for consistent borrowing.

Question 32

What major factor influences the size of fiscal deficits?

Answer 32

The trade cycle.

Question 33

What happens to government tax revenue during a downturn?

Answer 33

It decreases while government spending increases, causing the deficit to increase.

Question 34

What impact do unforeseen events have on fiscal deficits?

Answer 34

They can lead to huge increases in spending, which increases the deficit.

Question 35

How do interest rates affect fiscal deficits?

Answer 35

If interest rates on government debt increase, interest repayments increase, likely raising the deficit.

Question 36

What percentage of UK government spending is on interest repayments of loans?

Answer 36

7%.

Question 37

How do events like privatization affect the deficit?

Answer 37

They provide one-off payments that can decrease the deficit in the short term.

Question 38

What effect does an aging population have on national debt?

Answer 38

It contributes to a high national debt due to structural deficits for funding pensions and care.

Question 39

What is a primary budget deficit?

Answer 39

The actual budget deficit excluding interest repayments on national debt.

Question 40

What is a current budget deficit?

Answer 40

When government revenues are less than current expenditure.

Question 41

What is the risk associated with high fiscal deficits?

Answer 41

They can cause inflation if government spending increases without a fall in private sector spending.

Question 42

What can happen if a government is unable to borrow money?

Answer 42

It may print more money, potentially leading to hyperinflation.

Question 43

What is the relationship between high levels of debt and credit ratings?

Answer 43

High debt can result in a reduced credit rating, leading to higher interest rates for borrowing.

Question 44

What happens when a government borrows from abroad?

Answer 44

It may have difficulties getting enough foreign currency to make repayments.

Question 45

How can government borrowing benefit growth?

Answer 45

If used for capital spending, it can improve the supply side of the economy.

Question 46

What are the main types of policies that governments can use to achieve economic goals?

Answer 46

Fiscal policy, monetary policy, supply-side policy, exchange rate policy, direct controls ## Footnote Direct controls include minimum/maximum prices/wages, quotas on imports, limits on currency, and regulation.

Question 47

What policy has the UK government been using since 2010 to decrease national debt?

Answer 47

Austerity policies which involve decreasing spending ## Footnote Increasing taxes is another option, but both are unpopular and can limit growth.

Question 48

What alternative do opposition parties offer to reduce national debt?

Answer 48

Demand stimulus through high spending to cause economic growth ## Footnote This approach can bring about higher tax revenues.

Question 49

What is an automatic stabilizer in the context of national debt?

Answer 49

A mechanism that allows the economy to grow, reducing national debt as a percentage of GDP ## Footnote The US used this approach after the Global Financial Crisis.

Question 50

What is one potential consequence of a government defaulting on its loans?

Answer 50

Significant economic costs ## Footnote Governments only default as a last resort, as seen in Russia and Argentina.

Question 51

What does a progressive tax system aim to achieve?

Answer 51

A more equal distribution of income after tax ## Footnote Inheritance taxes also help reduce wealth inequality.

Question 52

What are means-tested benefits?

Answer 52

Benefits available only to individuals with low income/wealth ## Footnote They provide a safety net and are targeted at those needing the most help.

Question 53

What is the impact of universal benefits on inequality?

Answer 53

They are available to everyone who meets certain criteria, regardless of income ## Footnote Examples include winter fuel allowance and child benefits.

Question 54

What is one way the government can reduce wage differentials?

Answer 54

Implementing a national minimum wage ## Footnote This can improve incomes of the poor but may also cause unemployment.

Question 55

True or False: The law of diminishing marginal utility suggests that redistribution increases total utility.

Answer 55

True ## Footnote A poorer family gains more satisfaction from an additional £10 than a richer family.

Question 56

What can central banks do to control inflation?

Answer 56

Change interest rates and adjust the monetary supply ## Footnote They may also need to respond to global economic issues.

Question 57

What is quantitative easing?

Answer 57

A policy used by central banks to stimulate the economy when interest rates are low ## Footnote Implemented after the financial crisis of 2007-08.

Question 58

How can the government improve international competitiveness?

Answer 58

By increasing productivity and flexibility through supply-side measures ## Footnote This can include tax incentives and deregulation.

Question 59

What is the impact of external shocks on macroeconomic policies?

Answer 59

They can necessitate expansionary or deflationary policies to mitigate negative effects ## Footnote Examples include commodity price shocks and financial crises.

Question 60

What are transnational companies (TNCs) known for?

Answer 60

Creating jobs, raising tax revenue, and bringing investment ## Footnote They can also have negative impacts on local cultures and environments.

Question 61

What is transfer pricing?

Answer 61

A method used by firms for tax avoidance by setting prices for goods transferred between subsidiaries ## Footnote It can lead to reduced tax bills in high-tax countries.

Question 62

What challenges do governments face in controlling TNCs?

Answer 62

Difficulty in regulating due to the vast resources and influence of TNCs ## Footnote Small countries may earn less in revenue than TNCs earn in profits.

Question 63

What is one problem policy makers face regarding economic data?

Answer 63

Inaccurate short-term information, such as GDP figures ## Footnote This can lead to misjudging the state of the economy.

Question 64

What is a challenge faced by the government regarding tax evasion and avoidance?

Answer 64

The government does not have the full picture on the level of avoidance, who is avoiding tax, and the best way to reduce it. ## Footnote This makes it difficult to effectively combat tax evasion and avoidance.

Question 65

Why might past data be unreliable for the Bank of England's decisions?

Answer 65

Trends in the economy may be changing, making past data an inaccurate representation of the current economic climate. ## Footnote Low interest rates for an extended period could further distort the accuracy of past data.

Question 66

What makes full cost-benefit analyses impractical for the government?

Answer 66

They can be time-consuming and costly, making it impractical to gather every single piece of information needed. ## Footnote This can hinder effective policy-making.

Question 67

What is a key uncertainty faced by the government in decision-making?

Answer 67

The government cannot accurately predict the future, making it difficult to know if extra spending is necessary. ## Footnote Consumers often react unexpectedly, which could undermine government policy.

Question 68

What role does risk management play in government decision-making?

Answer 68

Managing risk is an essential part of good decision-making. ## Footnote It helps the government navigate uncertainties and potential negative outcomes.

Question 69

What are external shocks, and how do they affect government policy?

Answer 69

External shocks are events that the government cannot control or prepare for, and they can undermine current policies. ## Footnote For example, Brexit has delayed government plans to balance the budget.

Question 70

Fill in the blank: The government struggles to know the full impact of their decisions because _______.

Answer 70

consumers often react unexpectedly.

Question 71

True or False: The Bank of England relies solely on current data to make decisions.

Answer 71

False.