4.5. Role of the State in the Macroeconomy

Question 1

What is the primary reason for government spending?

Answer 1

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

Government spending also aims for equity and equality by providing services to underprivileged groups and correcting market failures.

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 does capital government expenditure include?

Answer 3

Spending on investment goods such as new roads, schools, and hospitals

These are typically consumed over a year.

Question 4

What is general government final consumption?

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, such as benefits and pensions

Question 6

What percentage of government spending is allocated to pensions?

Answer 6

20%

Question 7

How does the average income of a country influence government expenditure as a percentage of GDP?

Answer 7

Lower average income usually leads to a lower percentage of GDP spent by the government due to lower tax revenue

Question 8

What was one major effect of the Global Financial Crisis on government spending?

Answer 8

Huge increases in government spending due to increased welfare payments and bank bailouts

Question 9

What is the impact of an aging population on government spending in Europe and Japan?

Answer 9

Increased pressure on government spending due to larger pension bills and higher levels of care needed

Question 10

How can government spending improve productivity and growth?

Answer 10

• Provides necessary infrastructure
• Develops human capital through education
• Reduces illness through healthcare
• Supports research and development

Question 11

What is the crowding out effect?

Answer 11

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

Question 12

True or False: Transfer payments cause crowding out.

Answer 12

False

Transfer payments do not take resources from the economy; they merely redistribute money.

Question 13

What is a progressive tax?

Answer 13

A tax where higher income earners pay a higher percentage of their income in tax

Question 14

What is a regressive tax?

Answer 14

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

Question 15

What is the Laffer curve?

Answer 15

A theory that shows that increasing tax rates does not necessarily lead to increased tax revenue

Question 16

What is the difference between structural and cyclical deficits?

Answer 16

• Cyclical deficit occurs due to fluctuations in the trade cycle
• Structural deficit exists when the economy is at full employment

Question 17

What happens to the fiscal deficit during a recession?

Answer 17

Tax revenues decrease and government spending increases, leading to a larger deficit

Question 18

What role do automatic stabilisers play in the economy?

Answer 18

They reduce the impact of economic changes on national income, such as increasing benefits during a recession

Question 19

What is discretionary fiscal policy?

Answer 19

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

Question 20

What is the main purpose of taxation?

Answer 20

To pay for goods and services provided by the government and to correct market failure

Question 21

Fill in the blank: A ______ tax system increases income equality by taking more from the rich than the poor.

Answer 21

progressive

Question 22

What is the impact of high marginal tax rates on work incentives?

Answer 22

They may discourage individuals from working

Question 23

What is a potential negative effect of high levels of taxation?

Answer 23

They can lead to a disincentive to work hard

Question 24

True or False: High VAT has a greater disincentive effect than high income tax.

Answer 24

False

Income tax is considered more disincentive than VAT.

Question 25

What can high corporation taxes lead to in terms of income distribution?

Answer 25

They take money from wealthier shareholders and redistribute it through government spending

Question 26

What impact do indirect taxes have on inflation?

Answer 26

They often cause cost-push inflation

Question 27

What is the relationship between tax changes and trade balance?

Answer 27

A rise in taxes can decrease income and consumption, potentially improving the trade balance in the short run

Question 28

What is the risk of low taxes on profit and investment?

Answer 28

It can lead to a 'race to the bottom' among countries, reducing overall tax revenues

Question 29

What is a structural deficit?

Answer 29

A situation where the government consistently borrows money to finance spending, leading to a likely growth in national debt over time. ## Footnote Structural deficits are challenging to identify as they contain both structural and cyclical components.

Question 30

What factor significantly influences the size of fiscal deficits during economic downturns?

Answer 30

The trade cycle, where tax revenue decreases and government spending increases, leading to a larger deficit. ## Footnote In the UK, the fiscal deficit peaked at 10.1% of GDP in 2010.

Question 31

What role do interest rates play in government fiscal deficits?

Answer 31

Higher interest rates on government debt increase the amount paid in interest repayments, likely increasing the deficit. ## Footnote 7% of all UK government spending is on interest repayments.

Question 32

How can events like privatisation affect the fiscal deficit?

Answer 32

Privatisation can provide one-off payments to the government, decreasing the deficit in the short term. ## Footnote The impact depends on the value of the company sold.

Question 33

What is the relationship between fiscal deficits and national debt?

Answer 33

Continuous fiscal deficits lead to an increase in national debt, especially if deficits exceed 3% of GDP. ## Footnote A budget surplus is required for the national debt to decrease.

Question 34

How does an ageing population affect national debt?

Answer 34

It contributes to high national debt due to structural deficits needed to fund pensions and care. ## Footnote This leads to increased government borrowing.

Question 35

What is a primary budget deficit?

Answer 35

The actual budget deficit excluding interest repayments on national debt. ## Footnote The impact of primary deficits depends on interest rates and their size relative to interest repayments.

Question 36

True or False: High fiscal deficits can cause inflation.

Answer 36

True. ## Footnote Increased government spending without a decrease in private sector spending can lead to inflation.

Question 37

What happens if a government prints more money to cover deficits?

Answer 37

It can lead to hyperinflation, depending on the amount printed and the economy's position on the LRAS. ## Footnote Historical examples include Germany in 1923 and Zimbabwe in 2008.

Question 38

What is the impact of high national debt on a government's credit rating?

Answer 38

It tends to result in a reduced credit rating, leading to higher interest rates demanded from lenders. ## Footnote Credit ratings range from AAA to D based on default risk.

Question 39

What is one potential benefit of government borrowing for capital spending?

Answer 39

It can stimulate growth by improving the supply side of the economy, potentially reducing the deficit in the long term. ## Footnote Keynesians support using deficits as a stimulus during recessions.

Question 40

What policy has the UK government implemented since 2010 to reduce national debt?

Answer 40

Austerity measures aimed at decreasing spending. ## Footnote This approach is often unpopular and can limit growth.

Question 41

What is one method to redistribute income and reduce inequality?

Answer 41

Implementing a progressive tax system that taxes higher incomes at higher rates. ## Footnote Inheritance taxes can also help reduce wealth inequality.

Question 42

What are means-tested benefits?

Answer 42

Benefits available only to individuals with low income or wealth, targeted to provide support where it is most needed. ## Footnote They are effective in improving inequality.

Question 43

What is the effect of a national minimum wage on income inequality?

Answer 43

It can improve the incomes of the poor but may lead to unemployment. ## Footnote Maximum wages or pay ratios can also reduce the incomes of the rich.

Question 44

What is the law of diminishing marginal utility in relation to income redistribution?

Answer 44

It suggests that redistribution increases total utility, as the poor gain more satisfaction from additional income than the rich. ## Footnote This supports the argument for redistributing income.

Question 45

How do central banks influence interest rates and money supply?

Answer 45

They can change interest rates to control inflation and manage economic stability. ## Footnote Changes in bank rates affect the demand for loans.

Question 46

What does quantitative easing aim to address?

Answer 46

It aims to combat deflation when interest rates are already low and cannot be further reduced. ## Footnote Used by central banks like the Bank of England post-financial crisis.

Question 47

What are supply-side policies aimed at improving?

Answer 47

They aim to enhance productivity and competitiveness in the economy. ## Footnote Includes measures like tax incentives and deregulation.

Question 48

What are automatic stabilisers in relation to national debt?

Answer 48

Economic mechanisms that help stabilize the economy and reduce the deficit as GDP grows, without direct government intervention. ## Footnote The US used this approach after the Global Financial Crisis.

Question 49

What is the role of exchange rate policies in government economic strategy?

Answer 49

They can be used to control inflation and ensure macroeconomic stability. ## Footnote For example, China may devalue its currency to make exports cheaper.

Question 50

What is the impact of globalisation on national economies?

Answer 50

It increases interdependence, making economies more susceptible to external shocks. ## Footnote Governments need to adapt policies to mitigate these effects.

Question 51

What is one potential consequence of implementing price controls on essential goods?

Answer 51

It can lead to excess supply and the development of black markets. ## Footnote Price controls aim to increase the spending power of the poor.

Question 52

What was the initial action taken regarding rates to improve confidence?

Answer 52

Rates were lowered.

Question 53

Why were rates raised after being lowered?

Answer 53

To deal with inflation caused by the falling value of the pound.

Question 54

How much has the chancellor set aside to deal with the effects of Brexit?

Answer 54

Around £3bn.

Question 55

What is the estimated amount to be spent in order to leave the EU?

Answer 55

Around £35bn.

Question 56

What can changes in exchange rates cause?

Answer 56

Inflation or a fall in growth and a poor balance of payments.

Question 57

What is one potential impact of political instability on the economy?

Answer 57

It may require government action.

Question 58

What are the positive impacts of Transnational Companies (TNCs)?

Answer 58

* Creation of jobs * Tax revenue * Knowledge transfer * Investment

Question 59

What are some negative impacts of TNCs?

Answer 59

* Destroying local culture * Affecting the environment * Withdrawing more in profits than they inject * Influencing politicians for favorable decisions * Involvement in tax avoidance

Question 60

Is it legal for TNCs in the EU and USA to use bribery or corrupt practices?

Answer 60

No, it is illegal.

Question 61

What requirement do some developing countries impose on TNCs?

Answer 61

To set up a joint company with a local partner.

Question 62

What is transfer pricing?

Answer 62

A method for firms to engage in tax avoidance by manipulating prices between subsidiaries in different countries.

Question 63

What is the aim of companies using transfer pricing?

Answer 63

To increase profits in low tax countries and decrease them in high tax countries.

Question 64

What has HMRC done regarding companies that don't allocate sufficient profits in the UK?

Answer 64

They challenge these companies, leading to billions in tax collection.

Question 65

What principle do the OECD Transfer Pricing Guidelines aim for?

Answer 65

The 'arm’s length' principle.

Question 66

What is a challenge for governments in controlling TNCs?

Answer 66

Small countries may earn less revenue than TNC profits.

Question 67

What are two examples of legal tax avoidance schemes in the EU?

Answer 67

* Dutch sandwich * Double Irish

Question 68

What is the proposed tax loss ratio for other countries compared to Luxembourg?

Answer 68

For every £1 gained in extra taxes by Luxembourg, other countries lose possibly £1000.

Question 69

What is a major difficulty in finding solutions for taxation issues?

Answer 69

It requires worldwide agreement.

Question 70

What type of information can be inaccurate for policymakers?

Answer 70

Short-term information like GDP figures.

Question 71

What is a risk for the government when trying to predict economic needs?

Answer 71

The inability to accurately predict the future.

Question 72

What are external shocks?

Answer 72

Events that the government cannot control or prepare for.

Question 73

What has Brexit delayed regarding government plans?

Answer 73

Plans to balance the budget.