Focus on fiscal policy – balanced budget fiscal expansion
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Focus on fiscal policy – balanced budget fiscal expansion

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    Focus on fiscal policy – balanced budget fiscal expansion Focus on fiscal policy – balanced budget fiscal expansion Document Transcript

    • Focus  on  Fiscal  Policy  –  Balanced  Budget  Fiscal  Expansion     Extract     A  more  expansionary  fiscal  policy  should  be  considered  if  downside  risks   materialise  and  the  recovery  fails  to  take  off.  Balanced  budget  fiscal  expansion   should  be  pursued  to  increase  growth.  For  example,  cuts  in  spending  on  items  such  as   public  employee  wages  could  be  used  to  finance  higher  spending  on  items  such  as   infrastructure.   What  is  meant  by  a  “balanced  budget  fiscal  expansion?”   This  concept  has  become  a  major  topic  of  conversation  in  the  debate  over  the  economic   effects  of  fiscal  austerity  in  many  countries  in  the  European  Union  and  beyond.  Put   simply,  a  balanced  budget  fiscal  expansion  occurs  when  a  change  in  government   spending  is  matched  by  an  equal  change  in  taxation  so  that  there  is  a  neutral  effect  on   the  annual  fiscal  deficit  but  with  the  hope  that  real  national  income  will  expand.   Central  to  the  concept  is  that  the  fiscal  multiplier  effects  of  say  a  £10bn  rise  in   government  spending  are  higher  than  the  negative  multiplier  effects  of  an  equivalent   £10bn  rise  in  taxes   What  is  the  fiscal  multiplier?   The  fiscal  multiplier  measures  the  final  change  in  national  income  (GDP)  that  results   from  a  deliberate  change  in  either  government  spending  and/or  taxation.  Several  factors   affect  the  likely  size  of  the  fiscal  multiplier  effect   What  factors  affect  the  size  of  the  fiscal  multiplier  effect?   1. Design:  i.e.  the  important  choice  between  tax  cuts  or  higher  government   spending.  Evidence  from  the  OECD  is  that  multiplier  effects  of  increases  in   spending  are  higher  than  for  tax  cuts  or  increased  transfer  payments.     2. Who  gains  from  the  stimulus?  If  tax  reductions  are  targeted  on  the  low  paid,   the  chances  are  greater  that  they  will  spend  it  and  spend  it  on  UK  produced   goods  and  services.   3. Financial  Stress:  Uncertainty  about  job  prospects,  future  income  and  inflation   levels  might  make  people  save  their  tax  cuts.  On  the  other  hand  if  consumers  are   finding  it  hard  to  get  fresh  lines  of  credit,  they  may  decide  to  consume  a  high   percentage  of  the  boost  to  their  disposable  incomes   4. Temporary  or  permanent  fiscal  boost:  Expectations  of  the  future  drive   behaviour  today  ...  most  people  now  expect  taxes  to  rise  further  in  the  coming   years.  Will  this  prompt  a  higher  household  saving  and  a  paring  back  of  spending   and  private  sector  borrowing?   5. The  availability  of  credit:  If  fiscal  policy  works  in  injecting  fresh  demand,  we   still  need  the  banking  system  to  be  able  to  offer  sufficient  credit  to  businesses   who  may  need  to  borrow  to  fund  a  rise  in  production  (perhaps  for  export)  and   also  investment  in  fixed  capital  and  extra  stocks.  
    • 6. The  response  of  monetary  policy:  The  multiplier  effects  of  a  fiscal  stimulus   depend  in  part  on  what  happens  to  policy  interest  rates  and  the  exchange  rate   (we  cannot  look  at  fiscal  and  monetary  policy  in  isolation!).  Would  a  rise  in   government  spending  and  borrowing  lead  to  higher  interest  rates?  That  might   dampen  the  expansionary  effects.  Or  would  the  Monetary  Policy  Committee  be   prepared  to  keep  nominal  interest  rates  low  even  if  there  were  signs  of  stronger   economic  growth  and  recovery.   7. Openness  of  the  economy:  The  more  open  an  economy  is  (i.e.  the  higher  is  the   ratio  of  imports  and  exports  to  GDP)  the  greater  the  extent  to  which  higher   government  spending  or  tax  cuts  will  feed  into  rising  demand  for  imported   goods  and  services,  lowering  the  impact  on  domestic  GDP.     8. Fiscal  and  monetary  policy  decisions  in  other  countries:  Modern  economics   are  deeply  inter-­‐connected  with  each  other.  What  happens  to  government   borrowing  and  interest  rates  in  the  EU,  the  USA  and  in  emerging  market   countries  will  have  an  important  bearing  on  prospects  for  a  broadly  based   recovery  in  global  trade  and  output  which  then  affects  the  UK  economy.   Identify  some  examples  of  policies  that  use  the  concept  of  the  balanced  budget   fiscal  expansion     • Bring  forward  by  four  years  £20  billion  of  tax  increases  pencilled  in  for  after   2015,  and  using  that  money  for  temporary  infrastructure  spending  worth  £20bn   in  those  four  years   • Reduce  spending  on  pensions,  increase  spending  on  capital  investment   • A  £10bn  cut  in  government  spending  on  welfare  to  fund  a  £10bn  cut  in   employers'  national  insurance  contributions  when  they  employ  extra  workers   Analyse  how  infrastructure  spending  financed  by  temporary  tax  rises  might  cause   an  expansion  of  real  GDP  for  a  country  such  as  the  UK   The  British  government  recognises  the  importance  of  infrastructure  spending  and  has   already  published  several  National  Infrastructure  Plans  with  many  £  billions  of  pounds   earmarked  for  projects  although  few  have  yet  to  get  off  the  ground  or  reached   completion.  Keep  in  mind  too  that  for  many  of  the  projects  mentioned  below,  the   government  is  seeking  a  combination  of  public  and  private  investment  money.   • Examples  of  infrastructure  investment  include:   o 2 nd Forth Road Bridge   o Argyll wind farm array   o Cross Rail   o High Speed Rail project   o London Gateway Port   o London’s new super sewer   o Nuclear power plants e.g. the proposed one at Hinkley Point   The  hope  is  the  infrastructure  spending  creates  strong  multiplier  effects  leading  to  a   significant  effect  on  real  GDP,  employment  and  incomes.   • Many  projects  can  be  relatively  labour  intensive  such  as  road  widening,  housing   and  environmental  improvement  schemes  
    • • Supply-­‐chain  businesses  will  benefit  from  producing  and  selling  the  raw   materials  and  components  needed  to  deliver  big  projects   • There  ought  to  be  an  accelerator  effect  on  planned  investment  e.g.  an  increased   demand  for  capital  machinery  such  as  earth-­‐moving  equipment   Well  planned  targets  also  have  longer-­‐run  economic  benefits:   1. Improvements  in  the  capacity  of  our  transport  systems   2. Stronger  energy  security     3. Facilitates  improved  geographical  mobility  of  labour   4. Better  logistics  and  transport  systems  can  –  in  the  long  run  –  help  to  reduce   prices  for  consumers   5. Greater  resilience  to  the  effects  of  volatile  weather   6. Increased  labour  productivity  from  more  efficient  transport,   telecommunications  and  logistics   7. Infrastructure  makes  the  economy  more  attractive  to  future  flows  of  inward  FDI   8. We  need  better  infrastructure  to  cope  with  forecast  population  growth  -­‐  the   Office  for  National  Statistics  forecasts  that  the  UK  population  will  grow  to  over   73  million  people  by  2035.   According  to  the  UK  government:     “Infrastructure  equips  a  country  for  future  economic  growth  -­‐  Infrastructure  must   strengthen  and  drive  the  economy,  create  jobs  and  act  as  a  key  enabler  for  future  economic   development  and  rising  living  standards  across  the  whole  country.  That  is  why  the   government  is  taking  steps  to  address  the  legacy  of  historic  under-­‐investment  and  short-­‐ term  thinking  in  our  key  infrastructure  sectors.”   What  are  the  counter-­‐arguments  to  the  “balanced  budget  fiscal  expansion”  view?   Fiscal  conservatives  argue  that  strong  action  is  needed  to  lower  the  deficit  both  in   absolute  terms  and  also  as  a  share  of  GDP.  They  argue  that  the  economy  will  benefit  in   the  medium  term  if  government  finances  are  brought  under  control:   1. Lower  borrowing  means  that  the  UK  economy  will  retain  a  high  credit  rating  and   this  will  mean  lower  interest  rates  on  government  debt  and  newly-­‐issued   corporate  bonds.     2. Less  interest  paid  on  debt  frees  up  more  money  to  be  reinvested  in  key  public   services  such  as  health  or  education   3. Reducing  the  debt  opens  up  the  possibility  of  consumer  and  business  tax  cuts  –  a   strategy  that  free  market  economists  support  as  a  way  of  stimulating  fresh   growth  in  the  private  sector     4. Tighter  control  of  government  spending  /  a  lower  fiscal  deficit  makes  it  more   likely  that  the  Bank  of  England  will  be  able  to  keep  policy  interest  rates  lower,   again  helping  the  economy  to  recover  more  strongly   5. Some  economists  have  claimed  that  economic  growth  tends  to  be  lower  on   average  among  countries  with  government  debt/GDP  ratios  above  90%  
    • Chancellor  George  Osborne  has  talked  openly  about  an  expansionary  fiscal   contraction  –  a  stage  beyond  the  idea  of  the  balanced  budget  fiscal  expansion!  This   theory  argues  that  tightening  fiscal  policy  could,  through  exchange  rate  and  confidence   effects,  actually  increase  demand  and  growth.   Keynesian  economists  have  argued  that  this  is  economically  illiterate!  In  their  view,   fiscal  expansions  are  expansionary!  And  fiscal  austerity  is  contractionary!  Again  –  much   depends  on  the  size  of  the  estimated  fiscal  multiplier  effect.  We  are  told  in  the  case   study  introduction  (page  2)  that  fiscal  multipliers  are  estimated  to  be  in  the  range  of  0.9   to  1.7.  Keynesian  economists  would  support  the  larger  figure  -­‐  if  the  fiscal  multiplier  is   1,  then  a  reduction  in  the  budget  deficit  of  1%  of  GDP  reduces  output  by  1%.  But  a  figure   of  1.7  implies  that  fiscal  austerity  measures  that  cut  the  deficit  by  2%  or  more  could   bring  about  a  near  4%  reduction  in  output  in  the  short  term.        
    • Glossary  of  Key  Terms  in  Extract  1     Automatic  fiscal  stabilisers   Tax  revenues  that  rise  and  government  expenditure   that  falls  as  GDP  rises.  The  more  they  change  with   income,  the  bigger  the  stabilising  effect  on  national   income  e.g.  during  a  recession   Balanced  budget  fiscal   expansion   A  policy  to  increase  AD  /  GDP  through  changing   government  spending  and  taxation  levels,  whilst   leaving  the  overall  fiscal  budget  situation  the  same   Consumer  confidence   The  level  of  confidence  or  pessimism  among   consumers   Economic  rebalancing   Altering  the  balance  of  economic  activity  e.g.  away   from  debt-­‐fuelled  consumption  and  imports  towards   a  higher  level  of  business  investment  and  exports   Economic  recovery   An  upturn  in  demand,  real  national  output  and   employment   Financial  sector  stability   The  stability  of  institutions  that  are  part  of  the   financial  system  such  as  banks  and  other  lenders   Fiscal  consolidation   Policies  designed  to  reduce  the  size  of  a  country’s   fiscal  deficit   Hysteresis   When  a  sustained  period  of  low  aggregate  demand   can  lead  to  permanent  damage  to  the  supply  side  of   the  economy   Inflation   A  persistent  rise  in  the  general  price  level  for  goods   and  services   Inflation  expectations   The  rate  of  increase  of  consumer  prices  expected  by   consumers.  Expectations  can  influence  spending  and   saving  decisions.   Infrastructure   The  transport  links,  communications  networks,   sewage  systems,  energy  plants  and  other  facilities   essential  for  the  efficient  functioning  of  a  country  and   its  economy   Investor  confidence   The  state  of  confidence  or  pessimism  among   businesses  
    • Labour  market  performance   The  extents  to  which  a  country  can  achieve  a   sustained  fall  in  unemployment  and  avoid  under-­‐ employment  and  long  term  unemployment.   Monetary  stimulus   Changes  in  monetary  policy  designed  to  increase   aggregate  demand  including  lower  policy  interest   rates  and  measures  to  increase  the  supply  of  credit   Nominal  wage  growth   The  annual  growth  of  wages  unadjusted  for  inflation   Output  gap   Difference  between  actual  and  potential  national   output   Productive  capacity   The  ability  of  an  economy  to  supply  goods  and   services  –  determined  by  factors  that  affect  long  run   aggregate  supply   Quantitative  easing  (QE)     Central  banks  injecting  extra  cash  into  banking   system   Structural  deficit   The  size  of  a  fiscal  (budget)  deficit  adjusted  to  take   account  of  the  effects  of  changes  in  the  economic   cycle   Sustainable  budgetary  position   Extent  to  which  a  government  can  sustain  current   levels  of  spending  and  borrowing  –  affected  for   example  by  the  rate  of  interest  that  it  must  pay  on   new  issues  of  government  debt   Youth  unemployment   Lack  of  job  opportunities  for  people  aged  15–24   years  old