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Fiscal Policy and Government Expenditure


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Fiscal Policy and Government Expenditure

  1. 1. ECON4Fiscal Policy & Government Expenditure Aquinas College Economics Department
  2. 2. Fiscal Policy• Manipulation of – Public Spending – Taxation – Borrowing• To achieve macroeconomic objectives• Fiscal Policy is going to have impacts on Individuals and Business Aquinas College Economics Department
  3. 3. Government Expenditure• Includes both Central and Local Government Spending• Three Main Areas – Capital Expenditure • Schools, Hospitals, Roads etc. – Current Expenditure • Day to Day running of public services e.g. Pay teachers – Transfer Payments • Money transferred from tax payers to benefit claimants or pensioners etc. Aquinas College Economics Department
  4. 4. Budget Balance• ECON2 Recap: – Main announcements of spending come in the Budget usually in March, and the Autumn Statement in October/November. – Autumn Statement used to be called the Pre Budget Report – Budget is delivered to the Commons – Governments must pass budgets every year – If a budget fails to pass, the government crumbles Aquinas College Economics Department
  5. 5. Budget Balance Balanced Budget i.e. Expenditure = Tax Revenue Balanced Surplus i.e. Expenditure is less than Tax Revenue Balanced Deficit i.e. Expenditure is greater than Tax Revenue• G = Government Spending• T = Taxation Aquinas College Economics Department
  6. 6. UK Budget Balance Aquinas College Economics Department
  7. 7. Fiscal Stance “whether the government is seeking to increase or decrease AD through fiscal policy”• A neutral fiscal stance is where G=T, so a balanced budget course is being followed• A neutral stance should have very little impact on the economy as a whole. Aquinas College Economics Department
  8. 8. Expansionary Fiscal Policy• Sometimes known as Keynesian Economics• Governments will run a large budget deficit and spend on capital projects to boost AD and general economic activity• Government may well try and reduce spending after the economy picks up Aquinas College Economics Department
  9. 9. Contractionary Fiscal Policy• This occurs when the government runs a large surplus in it’s budget.• G<T• It can be called deflationary fiscal policy• It seeks to depress or reduce AD in an economy.• Typically it avoids over heating the economy Aquinas College Economics Department
  10. 10. G&T Graphs Govt. Spending falls as GDP rises. Automatic Stabilisers take effect at this pointGovernmentSpending & At Y1 a deficit is being run as GDP is low – Taxation Taxation this is called Cyclical Budget Deficit Balanced Budget G=T Budget Deficit G>T Budget Surplus G<T G 0 Y1 Y2 Y3 Real GDP Aquinas College Economics Department
  11. 11. Deficits and the Business Cycle Cyclical Budget Surplus Cyclical Budget Deficit Aquinas College Economics Department
  12. 12. Deficits• With ceteris paribus a deficit will follow the business cycle with recessions causing a deficit and a boom causing a surplus in the budget.• These are called cyclical budget deficits and cyclical budget surpluses• Automatic Stabilisers help to minimise the changes in the economy during the cycle Aquinas College Economics Department
  13. 13. Structural Deficit• However these occur when the economy under goes structural changes – Deindustrialisation – Rise in benefit claimants as a result of a rise in single parent families• This means that a government may run deficits when they would not typically have to Aquinas College Economics Department
  14. 14. PSNCR• Public Sector Net Cash Requirement• This is the amount of money required to cover the difference between government spending and taxation• Money often comes from selling Bonds on the Bond Market• A Negative PSNCR indicates a budget surplus and will allow a government to pay off national debt Aquinas College Economics Department
  15. 15. Pros and Cons of a DeficitProblems with a Deficit Benefits of a DeficitFinancing the deficit – interest If spending is used in capitalpayments cause a leakage on the expenditure such as infrastructurecircular flow of income and schools it can increase the long term growth prospects of an economyConsistent deficits will cause the Avoids a large negative output gapNational Debt to increaseFiscal Crowding out – Public sectordeficit deters private sectorinvestment and consumption Aquinas College Economics Department
  16. 16. UK Fiscal Rules• Fiscal policy now tends to influence supply side policies more than anything else• 1998 – Government establishes the Code for Fiscal Stability – GOLDEN RULE: Govt. should only borrow to invest in new social capital e.g. schools and hospitals – Any increase in borrowing as a result of increased welfare payments in a recession must be repaid in a boom Aquinas College Economics Department
  17. 17. Useful LinksAS Level Revision Site (ECON1, ECON2) • Level Revision Site (ECON3, ECON4) • Economics on Twitter • Aquinas College Economics Department