Chapter Fourteen Flashcards Preview

Economics > Chapter Fourteen > Flashcards

Flashcards in Chapter Fourteen Deck (26):

Explain the commonwealth budget

An annual statement of the expenses and revenue of the government of Australia, together with the laws and regulations that approve and support those expenses and revenue sources. The commonwealth budget has two purposes: to finance the activities of the federal government and to achieve macroeconomic objectives.


Explain fiscal policy

The use of the commonwealth budget to achieve the macroeconomic objectives of full employment and high and sustained economic growth


Explain the budget making process

In May of each year the commonwealth treasurer presented budget papers to parliament that outline the governments spending and tax revenue plans for the coming financial year - the year from 1 July of the current year to 30 June of the following year. The departments of finance and treasury prepare the budget based on forecasts of the economy's performance during the coming year.

The cabinet expenditure review committee examines the prosper budget to ensure that it is in line with the governments policy priorities. Parliament debated the budget and enacts the laws to implement it.


Explain the budget valve, surplus and deficit

Budget balance = revenue - expenses

The government has a balanced budget when revenue equals expenses (budget balance is zero)

The government has a budget surplus when tax revenue exceeds expenses (budget balance is positive)

The government has a budget deficit when expenses exceed revenue (budget balance is negative)


Explain the revenue side of the budget

The largest item is taxes on individuals. These are the taxes paid on wages, interest and other incomes. The second largest source of revenue is indirect taxes. Indirect taxes include the goods and services tax (GST) and taxes on the sale of petrol, beer, spirits, wine, tobacco, luxury cars and fringe benefits. Corporate income taxes which are the taxes paid by corporations on their profits are much smaller.


Explain the expenses side of the budget

The largest item is transfer payments.

Transfer payments are payments by the commonwealth government to individuals, businesses and other levels of government and the rest of the world. They include unemployment benefits and welfare payments to individuals, subsidies paid to businesses, GST payments to state governments, grants to state and local governments, aid to developing countries and dues to international organisations such as the United Nations.


Explain expenditure on goods and services

The expenditure on final goods and services.

This expenditure included the expenditure on national defence, computers for the Aus taxation office, government cars and highways. This component of the budget is the government expenditure on goods and services that appear in the circular flow of expenditure and income and in the national income , expenditure an product accounts. Debt interest and other payments is mainly the interest on the government debt.


Explain budget balance and debt

The gov borrows to finance a budget deficit and repays its debt when it has a budget surplus. The amount of debt outstanding that arises from last budget deficits is called government debt.

Debts and deficits matter because they lower credit rating and increase interest rate and they redistribute conception across generations

Lower credit rating and increased interest rate: govs are among the safest borrowers. They almost never default on their debts but there is an ever present risk that a gov will run out of funds and be unable to pay its debts

Redistribution: when a county runs a budget deficit it takes a loan and the country's consumption exceeds income. When a country runs a surplus it pays off debts and the country's consumption is less than income. So the people who are alive during the deflect years are the ones who consume more than their income and the people alive during surplus years are the ones who consume less than incomes.


What is the budget time bomb

The budget time bomb arises from trends in the age distribution of the Australian population. These trends are dominated by three facts:
- a surge in the birth rate after world war 2 that crated the baby boom generation - a bulge in the number of people reaching retirement age after 2010

Better health care - allowing people to live longer

Falling birth rate - slowing the growth of the Working age population


Explain the Keynesian view

View is that fiscal stimulus - an increase in government expenses or a decrease in tax revenue - boosts real GDP and created or saves jobs. Fiscal stimulus boosts real GDP and employment by increasing ad and the fisc stimulus has a multiplier effect. Keynesians say that these positive effects of fisc stimulus make it a vital and powerful tool in the fight against recession and slow growth


What is the mainstream view

The mainstream view is that Keynesianism overestimate the multiplier effects of fiscal stimulus and their effects are small, short lived and incapable of working fast enough to be useful. Mainstream economists say that government stimulus crowds out investment. The durable results of a fiscal stimulus are bigger government, lower potential GDP, a slower real GDP growth rate and a greater burden of government debt on future generations


Explain fiscal policy and ad

Fiscal policy is a change in government expenses or in tax revenues. Other things remaining the same, a change in any item in the government budget changes ad. These changes must occur as an automatic response to the state of the economy or as a result of new spending or tax decision by parliament


Explain automatic fiscal policy

Automatic fiscal policy is a fiscal policy action that is triggered by the state of the economy. For example, in a recession an increase in unemployment induced an increase in transfer payments and a fall in incomes induced a decrease in tax revenue.

Because tax revenue and expenses fluctuate with real GDP they act as automatic stabilisers. The automatic stabilisers are induced taxes and induced spending. Induced taxes are taxes that vary with real GDP, such as sales taxes and income taxes. Induced spending is government spending that benefits qualified people and business that vary with real GDP such as unemployment benefit


Explain discretionary fiscal policy

Is a fiscal policy action that is imitated by an act of parliament. For example, an increase in defence spending or a cut in income tax rate


Explain cyclical and structural budget balanced

A structural surplus or deficit is the budget balance that would occur if the economy were at full employment

A cyclical surplus or deficit is the budget balance that arises because tax revenues and outlays are not at their full employment level

The actual budget balance is the sum of the structural balance and the cyclical balance


Explain discretionary fiscal policy

Discretionary fiscal policy can take the form of a change in gov expenses or a change in tax revenue

Other things remaining the same, a change in any of the items in the government budget changes ad and has a multiplier effect - ad changes by a great amount than the initial change in the item in the government budget


Explain the government expenditure multiplier

The government expenditure multiplier is the effect of a change in government expenditure on goods and services on ad. An increase in aggregate expenditure increases ad which increase real GDP

The increase in real GDP induced an increase in consumption expenditure which further increases ad


Explain the tax multiplier

The tax multiplier is the effect of a change in taxes in ad. A decrease in taxes increases disposable income. The increase in disposable income increases consumption expenditure and ad. With increased ad, employment and real GDP increase and comsumption expenditure increases yet further

So a decrease in taxes works like an increase in gov expenditure. Both actions increase ad and have a multiplier effect. But the magnitude of the tax multiplier is smaller than the government expenditure multiplier. The reason: a $1 tax cut doesn't increase consumption expenditure by $1 because some is saved. So the increase in aggregate expenditure is less than $1. But a $1 increase in gov expenditure increases aggregate expenditure by $1.


Explain the transfer payments multiplier

The transfer payments multiplier is the effect of w change in transfer payments on ad. This multiplier works like the tax multiplier but in the opposite direction. An increase in transfer payments increases disposable income which increases consumption expenditure. With increased consumption expenditure, employment and real GDP increase and consumption expenditure increase yet further.


The balanced budget multiplier

The balanced budget multiplier is the effect on ad of a simultaneous change in government expenditure and taxes that leaves the budget balance unchanged. The balanced budget multiplier is not zero - it is positive - because the government expenditure multiplier is larger than the tax multiplier


Explain a successful fiscal stimulus

If real GDP is below potential GDP the government might pursue a fiscal stimulus by increasing gov expenditure on goods and services, increasing transfer payments, cutting taxes of a combination of all three


What are limits of discretionary fiscal policy

Four things hamper the use of discretionary fiscal policy

Parliament can't turn on a dime: law making takes time and actions might come too late

Parliaments area of discretion is shrinking

Potential GDP is imperfectly estimated

Economic forecasting is not an exact science


Explain supply side effects

Are the effects of fiscal policy on potential GDP. Supply side effects operate more slowly than the demand side effects. Supply side effects are often ignored in times of recession when the focus is on fiscal stimulus and restoring full employment. But in the long run, the supply side effects of fiscal policy dominate and determine potential GDP.


Explain potential GDP and growth in the supply side effects

Both sides of the governments budget influences potential GDP. Public goods and productivity: the expenses side provides public goods and services that enhance productivity. The increase in productivity make labour more productive and increase potential GDP.

Taxes and incentives: on the revenue side taxes modify incentives and change the full employment quantity of labour, as well as the amount of saving and investment. An increase in taxes drives a wedge between the prices paid by the buyer and the price received by a seller. In the labour market tax wedge is the gap between the before tax wage rate and the after tax wage rate. An increase in taxes decreases the full employment quantity of labour and decreases potential GDP.

Changes in the tax rate: a change in the income tax rate changes equilibrium employment and potential GDP. If the income tax rate is increased the supply of labour decreases yet more and the LS + tax curve shifts further leftward. Equilibrium employment and potential GDP decrease.


Explain taxes deficits and economic growth

Fiscal policy influences economic growth in two ways: taxes drive a wedge between the interest rate paid by borrowers and the interest rate received by lenders. If there is a budget deficit government borrowing to finance the deficit competed with firms borrowing to finance investment and to some degree government borrowing crowds out private investment.

Interest rate tax wedge: lenders pay an income tax on the interest they receive from borrowers, which creates an interest rate tax wedge. A tax on interest decrease the quantity of saving and investment and slows the growth rate of real GDP. A tax on interest income creates an ever widening gap between potential GDP and the potential GDP that might have been.

Investment and saving plans depend on the real after tax interest rate. The real interest rate equals the nominal interest rate minus the inflation rate. So the after tax interest rate equals the real interest rate minus the income tax paid on interest income. But the nominal interest rate not the real interest rate determines the amount of tax to be paid. The higher the inflation rate, the higher is the nominal interest rate and the higher is the true tax rate on interest income.

Deficits and crowding out: a tax cut that increases the budget deficit brings an increase in the demand for loan able funds. The increase in the demand for loan able funds increase the real interest rate and crowds out private investment. The lower income tax rate shrinks the tax wedge and stimulates employment saving and investment buy the higher budget deficit decreases investment. Some crowding out of investment occurs.

Combined demand side and supply side effects: a fiscal stimulus increases ad and potential GDP. When potential GDP increases as increases. Equilibrium real GDP increases but the price level might rise, fall or not change.


Explain long run fiscal policy effects

The long run consequences are the most profound ones. If investment is crowded out by a large budget deficit, the economic growth rate slows and potential GDP gets even farther below what it might have been. If a large budget deficit persists, debt increases, confidence in the value of money is eroded and inflation becomes likely. If government expenses and budget deficits are kept under control, investment and real GDP growth increase.