4.5.3

Question 1

Automatic stabilisers

Answer 1

• Mechanisms which reduce impact of changes in economy on national income
• Gov spending and taxation are automatic stabilisers
• In a recession - benefits increase due to high unemployment - overall fall in AD is reduced
• In a boom - tax increases due to more jobs and high income - decreases AD - demand doesn’t grow too high
• Automatic stabilizers cannot prevent fluctuations - reduce size of problem
• Negative aspects - benefits reduce incentive to work - higher unemployment - High tax levels reduce incentive to work hard

Question 2

Discretionary fiscal policy

Answer 2

• Deliberate manipulation of government expenditure and taxes to influence the economy
• Expansionary and deflationary

Question 3

Fiscal deficit vs national debt

Answer 3

National debt: sum of all government debts built up over many years - total amount owed and accumulated from all past deficits and surpluses

Fiscal deficit: government spending exceeds revenue within a year

• Can be measured as percentage of GDP - gives indication of how easy it is to finance a deficit or repay debt

Question 4

Structural vs cyclical deficits

Answer 4

Cyclical: - part of deficit that occurs because government spending and tax fluctuates around the trade cycle

Structural deficit: Fiscal deficit that occurs when the cyclical deficit is zero - LT - unrelated to state of economy - persistent imbalances

Actual deficit: structural+cyclical

• If gov has structural deficit - likely that national debt will grow over time - consistently must borrow money to finance spending - structural deficits must be eliminated but it is difficult to know what part is structural and what part is cyclical

Question 5

Factors influencing size of fiscal deficits

Answer 5

• Businesses cycle: during a recession - gov spending increases - deficit increases
• Unforseen events - natural disasters
• Interest rates - if IR increase - repayments increase
• Impact of this is dependent on how significant repayments are in size of deficit
• Privatisation - one-off payment to improve deficit
• Oil-producing countries

Question 6

Factors influencing size of national debts

Answer 6

• Continuous deficit - debt will increase overtime - only if gov run budget surplus - debt decreases
• Aging populations - run structural deficit to fund pensions and care - high debt

Question 7

Significance of fiscal deficits and national debts

Answer 7

• High levels of borrowing - raise interest rates due to high demand for money - cause crowding out - BUT gov may borrow from overseas - during a recession private sector investment falls - IR may remain unchanged - also encourage people to buy bonds to finance debt if they have lost confidence
• Cause inflation - if no crowding out - AD increase - if unable to borrow - print more money - could cause hyperinflation - depends on how much is printed - where economy is producing
• If in liquidity trap - must borrow to finance day-to-day things
• Must service national debt through interest repayments - high opp cost - £70 billion a year but only a small proportion of GDP
• Future generations must repay - BUT - if spent on capital expenditure - they will benefit so it is justified - inflation can reduce value of real debt - GDP grows - easier to pay off debt
• High levels of debt reduce credit rating of government - likelihood of defaulting
• Making foreign currency repayments can be difficult - if there is not enough foreign currency - also consumers cannot import goods
• Benefit growth - capital spending - supply side improved - reduce long-term deficit
• Keynesians - acceptable use of deficit - stimulate demand management - ST

Question 8

Significance of national debts

Answer 8

• Must service national debt through interest repayments - high opp cost - £70 billion a year but only a small proportion of GDP
• Future generations must repay
• Reduced credit rating - likelihood of defaulting - receive higher rates in future
• Level of foreign currency reserves important - overseas repayments