Public Sector Finances

Question 1

Automatic stabilisers and discretionary fiscal policy

Answer 1

Automatic stabilisers and discretionary fiscal policy:
• Automatic stabilisers are mechanisms which reduce the impact of changes in the economy on national income; government spending and taxation are automatic stabilisers.
• Discretionary fiscal policy is the deliberate manipulation of government expenditure and taxes to influence the economy; expansionary and deflationary policies.

Question 2

Example of an automatic stabiliser

Answer 2

Example of an automatic stabiliser:
• In a recession, benefits increase as more people are unemployed and so the benefits are a stabiliser as it means that the overall fall in AD is reduced, preventing too much change in the economy. On the other hand, during a boom, tax increases as people have more jobs and higher incomes, and this tax reduces disposable income so decreases consumption and AD, meaning that demand doesn’t grow too high.

Question 3

Fiscal deficit and national debt

Answer 3

Fiscal deficit and National debt:
The national debt is the sum of all government debts built up over many years whilst a fiscal deficit is when the government spends more than it receives that year.

Question 4

Distinction between structural and cyclical deficit

Answer 4

Distinction between structural and cyclical deficits:
•A cyclical deficit is the part of the deficit that occurs because government spending and tax fluctuates around the trade cycle. When the economy is in recession, tax revenues are low and spending is high creating a larger deficit.
• At the peak of the boom, there is no cyclical deficit, any deficit at this point is a structural deficit. The structural deficit is the fiscal deficit which occurs when the cyclical deficit is zero;
it is long term and not related to the state of the economy.
• The actual deficit is the structural deficit plus the fiscal deficit.

Question 5

Factors influencing the size of fiscal deficits

Answer 5

Factors influencing the size of fiscal deficits:
• Trade cycle - during a downturn, government revenue decreases, whilst govemment spending increases - therefore deficit increases.
• Unforeseen events - natural disasters or recessions
• Interest rates - increase in interest rates on government debt will impact citizens
• Privatisation - one off payments to the government - decrease deficit in the short term
• Government aims - austerity aims to reduce size of deficit but increasing AD will increase spending
• High revenues - like from oil, OPEC countries - run a budget surplus
• Number of dependents

Question 6

Factors influencing the size of national debts

Answer 6

Factors influencing the size of national debts:
• If the government is continuously running a deficit, then the national debt will increase overtime. It is only when the government runs a budget surplus that the size of the national debt decreases.
• Ageing populations tend to contribute to a high national debt since the government runs a structural deficit in order to fund their pensions and care and this leads to a high national debt.

Question 7

The significance of fiscal deficits and national debts

Answer 7

The significance of fiscal deficits and national debts:
• High levels of borrowing may raise interest rates in the economy since an increase in the demand for money will increase the price of money
Countries have to spend a large amount of money on servicing their national debt through interest repayments, which has a high opportunity cost
Some economists argue that high fiscal deficits and national debts benefit citizens today at the expense of future generations and can cause intergenerational inequality.
• High fiscal deficits can cause inflation. If the government increases their spending and there is no similar fall in private sector spending, AD will rise and this can be inflationary.
• High levels of debt tend to result in a reduced credit rating for the government.
• If a govemment has borrowed from abroad, it may have difficulties getting enough foreign currency to make repayments on its debt.
• On the other hand, government borrowing can benefit growth if it is used for capital spending since this will improve the supply side of the economy and thus reduce the deficit in the long term.