Macroeconomics: Fiscal Policy Flashcards
1
Q
State the sources of government revenue.
A
- Tax revenue - direct and indirect
- From the sale of goods and services
- From the sale of state-owned assets/property
2
Q
State the types of government expenditure.
A
- Current expenditure (day-to-day spending)
- Capital expenditure (public investment)
- Transfer payments
3
Q
Define fiscal policy.
A
Manipulating tax rates and government expenditure to affect aggregate demand
Aims to achieve economic objectives and stabilize short-term fluctuations
4
Q
Define expansionary fiscal policy.
A
Increases aggregate demand by reducing tax rates and increasing government expenditure
Used to
- Increase economic growth (boost during recession)
- Reduce cyclical unemployment
- Increase inflation
- Redistribute incomes (transfer payments)
5
Q
Define contractionary fiscal policy.
A
Decreases aggregate demand by increasing tax rates and reducing government expenditure
Used to
* Reduce demand-pull inflation
* Reduce budget deficit
* Redistribute income (e.g. increase progressive tax rate)
* Reduce current account deficit
6
Q
Bill Clinton Deficit Reduction Act 1993 (Contractionary Fiscal Policy)
A
- Raised taxes to reduce the nation’s $60 billion deficit
- Raised the top income tax rate from 28% to 36% for those earning over $115,000 per year
- Increased corporate tax rate from 34% to 36%
- Taxed social security benefits for top-income earners
- Freeze on the pay of federal workers in the following year, and lower raises than scheduled in the following years
- Cut spending on military and medicare
- New spending on short-term stimulus programs, e.g. investment in infrastructure, creating 500,000 new jobs
- Employment rose by 2.4%, real GDP rose by 3.7%
- Dotcom boom, businesses were surging
- US entered big trade deals like NAFTA and WTO
https://www.washingtonpost.com/wp-srv/politics/special/states/stories/sou021893.htm
7
Q
Explain direct and indirect impacts of fiscal policy.
A
Indirect Effects
- increased confidence/certainty for businesses -> invest in capital -> long-term economic growth (increase LRAS)
Direct Effects
- directly increase gov spending on infrastructure, education, etc.
- directly lower business taxes to encourage private investments
8
Q
Outline the strengths of fiscal policy.
A
- Gov spending directly affects AD, pull the economy out of deep recession
- Ability to target specific sectors of the economy (e.g. merit goods)
- Affects potential output (LRAS), leading to long-term economic growth
9
Q
Outline the weaknesses of fiscal policy.
A
- Time lags (time to realize the problem, time to implement policies, time to wait for the effects to take place)
- Political constraints
- Inability to deal with supply-side causes of instability (e.g. stagflation, unemployment)
- Tax cuts may not lead to more spending/investment (marginal propensity to spend and save, low confidence or certainty, deep recession: expectation that product prices will continue to fall)
- Marginal propensity to import: rising disposable incomes may feed through to increasing demand for imports, widening the net trade deficit (imports > exports)
- May lead to an acceleration in the rate of price inflation which then cuts real incomes and spending by households
- Crowding-out effect: increased gov spending will lead to decreased private sector spending → may lead to higher market interest rates, reduces private sector demand for loans → lowers the incentive for borrowing, discourages spending → reduce AD
10
Q
Define automatic stabilizers.
A
- Fiscal policy tools, automatic mechanisms without any deliberate action from the gov which help to reduce fluctuations in the economic cycle
- e.g. unemployment benefits, progressive taxation
11
Q
How does fiscal policy affect unemployment?
A
- gov spending on specific areas can open up job opportunities, e.g. Clinton’s Deficit Reduction Act (1993) implemented new spending on infrastructure and training programs, opening up 500,000 jobs
- mainly targets cyclical unemployment only and unable to combat natural unemployment
12
Q
USA Unemployment Benefits in 2019
A
- support and protect households during an economic slump due to COVID-19 pandemic
- up to $600 USD of benefits per week
- led to low incentive to work as individuals could sustain a high standard of living without jobs
- unemployment rate tripled from 3.6% in 2019 to 13.0% in 2020
13
Q
The U.S. Fiscal Response to COVID-19 expansionary fiscal policy
A
- $5.2 trillion USD spent in total
- $599 billion spent to pay for public health measures
- $748 billion was spent to expand unemployment insurance (direct payments of up to $1,200 per person followed by $600 and $1,400)
- $808 billion spent on loans to small businesses
- will push the U.S. debt-to-GDP ratio from 79 percent to 110 percent
Positive Impacts
- economists agree that the money spent helped local governments shoulder significant pandemic-related costs, and avoided deep budget cuts
- accelerated the deployment of vaccines, advanced COVID-19 treatment plans, protected health providers
- Personal consumption expenditures (PCE) rose by 7.6% in 2021 and by 3.9% in 2022
Negative Impacts
- some of the funds were unfairly distributed since smaller, poorer hospitals received less federal aid in comparison
- unemployment benefits of up to $600 USD per week lowered the incentive to work, causing the unemployment rate to triple from 3.6% in 2019 to 13.0% in 2020
14
Q
Evaluate expansionary fiscal policy.
A
Cons
- Higher demand-pull inflationary pressure (conflicts economic objectives)
- More spending on imports, widen current account deficit
- Gov. finances worsen, budget deficit, national debt increases
- Crowding out effects: highly debt-fueled gov spending increases demand for loanable funds, pushes up equilibrium interest rates, more expensive for firms to invest, reduces private sector investment
- Time lags in realizing the issue, implementing the issue, and allowing effects to take place in the economy
Evaluation
- Size of the output gap
- Consumer/business confidence
- State of gov finances
- Long-run tax returns to the gov overtime (long-term economic activity)
15
Q
Explain how automatic stabilizers work.
A
Boom (cushion demand)
- Progressive taxation
- Growth leads to rising incomes
- Workers pushed into higher income tax bands
- Increases the average rate of tax (amount of income tax paid as a proportion of total income)
- Less disposable income
- Slow down increases in C
- Slow down increases in AD
Recession (support output)
- Progressive taxation
- Negative growth, incomes fall
- Workers fall into lower income tax bands
- Reduce average rates of tax
- Prevents large decreases in consumption
- Prevents deep recession
Recession (support output)
- Unemployment benefits
- Negative growth, firms lay off workers to retain profits, more individuals eligible for u benefits
- Increase in disposable income
- Prevents large decreases in consumption
- Prevents deep recession
