Contractionary fiscal policy (Deficit & Debt Reduction) Pros, Cons, Eval

Question 1

What is a budget surplus?

Answer 1

When government revenue exceeds spending in a given year.

Question 2

What is a structural budget surplus?

Answer 2

A surplus that exists even at full employment.

Question 3

What is a cyclical budget surplus?

Answer 3

A surplus that occurs during an economic boom.

Question 4

What is contractionary fiscal policy?

Answer 4

Higher taxes and/or lower government spending to reduce deficits or national debt.

Question 5

Give one key benefit of contractionary fiscal policy.

Answer 5

Improves government finances and reduces national debt, increasing investor confidence.

Question 6

How can a stronger fiscal position benefit government borrowing?

Answer 6

Leads to lower interest rates on bonds due to improved credit rating.

Question 7

How can a budget surplus attract FDI?

Answer 7

Signals fiscal stability, making the country more attractive to foreign investors.

Question 8

What is “fiscal headroom”?

Answer 8

The space for the government to use fiscal stimulus in the future if needed.

Question 9

What is one potential drawback of contractionary fiscal policy?

Answer 9

May lead to slower economic growth and higher unemployment in the short term.

Question 10

Why might contractionary fiscal policy be politically unpopular?

Answer 10

Involves spending cuts or tax rises, which can affect public services and household incomes.

Question 11

How does falling national debt reduce debt interest payments?

Answer 11

It frees up fiscal space for more productive spending or tax cuts during future recessions.

Question 12

Why is fiscal sustainability important in recessions?

Answer 12

It allows the government to use expansionary fiscal policy without worsening debt unsustainably.

Question 13

How does reducing the deficit lower crowding out?

Answer 13

Less government borrowing reduces pressure on loan markets, keeping interest rates low for private investors.

Question 14

What is a benefit of reduced crowding out for the private sector?

Answer 14

Private firms can borrow more affordably to fund investment.

Question 15

How can debt reduction reduce x-inefficiency?

Answer 15

Encourages the government to spend efficiently, especially on costly projects like infrastructure.

Question 16

How can contractionary fiscal policy reduce inflation?

Answer 16

Lower AD reduces demand-pull inflation pressures.

Question 17

How can contractionary policy help the current account?

Answer 17

Lower AD reduces imports, potentially improving the current account balance.

Question 18

What is the main risk of contractionary fiscal policy?

Answer 18

Can trigger a demand-side shock: lower growth, higher unemployment, and recession.

Question 19

What are social costs of contractionary policy in the short term?

Answer 19

Lower living standards, higher unemployment, and reduced public services.

Question 20

What is a microeconomic impact of cutting healthcare spending?

Answer 20

Longer wait times, lower care quality, and strain on medical staff due to reduced recruitment.

Question 21

What is a micro impact of cutting education spending?

Answer 21

Larger class sizes, fewer teachers, and lower teaching quality.

Question 22

How does reduced infrastructure spending affect individuals?

Answer 22

Poorer transport quality, which affects daily commuting and accessibility.

Question 23

How do cuts to welfare and public sector wages impact individuals?

Answer 23

They can reduce living standards, especially for low-income households.

Question 24

What is a microeconomic concern of increasing regressive taxes?

Answer 24

It can harm low-income households’ living standards disproportionately

Question 25

What is a macroeconomic consequence of cutting healthcare and education?

Answer 25

It can reduce the long-run productive potential of the economy.

Question 26

How can higher income and corporation tax affect macro performance?

Answer 26

It may reduce investment and competitiveness, harming growth.

Question 27

Why is government investment in health and education important for productivity?

Answer 27

It boosts human capital, increasing efficiency and international competitiveness.

Question 28

What is a potential long-run benefit of increased government spending or tax cuts?

Answer 28

Higher economic activity can generate greater tax revenue returns in the future.

Question 29

Why might policymakers ignore long-run tax returns from spending/tax cuts?

Answer 29

They may focus on short-term fiscal balances, overlooking future revenue growth from economic expansion.

Question 30

What is the incentive distortion caused by high taxation?

Answer 30

Lower motivation to work, reduced entrepreneurship, and increased tax avoidance/evasion.

Question 31

How does high corporation tax affect firms?

Answer 31

It discourages investment, harming long-run productivity and tax revenue growth.

Question 32

What risk arises from cutting benefits and increasing regressive taxation?

Answer 32

It can worsen income inequality, particularly for low-income households.

Question 33

When is it necessary to run a budget surplus or reduce national debt?

Answer 33

When budget deficits are high or debt levels are unsustainable.

Question 34

When might contractionary fiscal policy do more harm than good?

Answer 34

When government finances are stable, the costs may outweigh the benefits of such policies.

Question 35

What can happen if contractionary policies reduce GDP too much?

Answer 35

The debt-to-GDP ratio could rise, even if national debt falls, due to shrinking GDP.

Question 36

Why could government finances appear worse despite debt falling?

Answer 36

Because GDP falls faster, increasing the debt burden relative to national output.

Question 37

Do fiscal consolidation policies have to involve both spending cuts and tax rises?

Answer 37

No, only one (e.g., just spending cuts) can be used, which may reduce negative side effects.

Question 38

When is the best time in the economic cycle to run budget surpluses?

Answer 38

During a boom, when the economy can absorb contractionary effects more easily.

Question 39

Why is contractionary policy risky in a recession?

Answer 39

It can deepen the downturn, causing lower growth and higher unemployment.