Fiscal Policy:
Fiscal Policy: changes in government spending and taxation to influence aggregate
demand in an economy
Discretionary fiscal policy: a situation in which the government uses its discretion to
intervene in the economy in an attempt to stabilise it / influence the course of the economy
Austerity Policy: Policies attempting to curtain government spending in order to control
public-sector debt (contractionary fiscal policy)
The Government Budget:
Government budget: the balance between government receipts and outlays
Government current expenditure: spending by the government on goods and services
(includes transfer payments, wages on civil servants, NHS, education etc)
Government capital expenditure: spending by government on capital projects, includes
investment for future benefits such as Crossrail and HS2 (new zero,carbon high speed
railway)
Transfer payments: occur when the government provides benefits to poorer households.
Budget deficit: when expenditure exceeds tax revenue in a fiscal year
Budget surplus: when tax revenue exceeds expenditure in a fiscal year
Balanced budget: a situation in which government expenditure equals government revenue.
National debt: the total amount of the money which the government has borrowed and owes
the third-party members (regardless of the fiscal year).
Cyclical deficit: a temporary deficit that occurs during the downturn of the business cycle but
disappears in the upturn - during a recession the cyclical deficit will be high as governments
will increase spending and reduce taxation to stimulate the economy and spend more on
benefits/welfare
Structural deficit: a government budget deficit that persists even when the economy is at full
employment - does not depend on the stages of the economic cycle. This must be
addressed as it would not be sustainable in the long run - the deficit would need to be
financed through borrowing which would need to be repaid in the future alongside interest.
, Consequences of a budget deficit:
● As the budget deficit widens, governments will borrow excessively in order to spend -
high spending could lead to demand-pull inflation
● When the government borrows excessively this could signify a weak economy and
could lower the credit rating of the country giving investors insights to the level of risk
from investing in that country
Consequences of high national debt:
● There are long-run effects of policy on spending and borrowing. Sustainable
economic growth must take into account the needs of future generations who should
not have to meet the cost of consumption of the present population.
● UK currently experiencing high public sector net debt at 97.7% of GDP due to the
UK’s low productivity growth since the financial crash, higher energy prices, cost of
living crisis, ageing population.
Consequences of government borrowing:
● Higher debt interest payments - as borrowing increases the government must pay
more interest rate payments on those who hold bonds - these will have to be paid
with higher future taxes
● Pushes up interest rates: Higher borrowing can push up interest rates as markets are
nervous about government ability to repay and so demand higher bond yields in
return for perceived risk
● Crowding out: a classical argument that government borrowing reduces the supply of
loanable funds which pushes up interest rates and means that the private sector is
less able to undertake investment or take out loans.
○ However this is unlikely to apply in a recession as in a recession private
sector saving rises and there are surplus savings which the government is
simply making use of - government spending offsets the rise in private sector
saving. Government borrowing in a recession may actually help to maintain
AD and prevent a fall in spending.
Crowding out:
Crowding out: a process by which an increase in government expenditure reduces private
sector activity by raising the cost of borrowing. This means that government spending may
fail to increase overall AD because higher gov spending causes an equivalent fall in private
sector spending and investment.
● Increased taxes may be used to fund gov spending - higher corporation tax increases
COPs for firms reducing profits available for investment - may also cause a fall in
consumer expenditure if higher prices are passed onto consumers
● Increased borrowing - government sells bonds to private sector to finance borrowing
and if these are bought the private sector has reduced funds available for private
sector investment.
Financial crowding out: used to describe how government borrowing
can cause higher interest rates - if the government needs to seel more
securities it may have to increase interest rates on bonds to attract
buyers which increases interest rates elsewhere in the economy. If the
government demands more loanable funds, this also pushes up
interest rates in the loanable funds market.
Fiscal Policy: changes in government spending and taxation to influence aggregate
demand in an economy
Discretionary fiscal policy: a situation in which the government uses its discretion to
intervene in the economy in an attempt to stabilise it / influence the course of the economy
Austerity Policy: Policies attempting to curtain government spending in order to control
public-sector debt (contractionary fiscal policy)
The Government Budget:
Government budget: the balance between government receipts and outlays
Government current expenditure: spending by the government on goods and services
(includes transfer payments, wages on civil servants, NHS, education etc)
Government capital expenditure: spending by government on capital projects, includes
investment for future benefits such as Crossrail and HS2 (new zero,carbon high speed
railway)
Transfer payments: occur when the government provides benefits to poorer households.
Budget deficit: when expenditure exceeds tax revenue in a fiscal year
Budget surplus: when tax revenue exceeds expenditure in a fiscal year
Balanced budget: a situation in which government expenditure equals government revenue.
National debt: the total amount of the money which the government has borrowed and owes
the third-party members (regardless of the fiscal year).
Cyclical deficit: a temporary deficit that occurs during the downturn of the business cycle but
disappears in the upturn - during a recession the cyclical deficit will be high as governments
will increase spending and reduce taxation to stimulate the economy and spend more on
benefits/welfare
Structural deficit: a government budget deficit that persists even when the economy is at full
employment - does not depend on the stages of the economic cycle. This must be
addressed as it would not be sustainable in the long run - the deficit would need to be
financed through borrowing which would need to be repaid in the future alongside interest.
, Consequences of a budget deficit:
● As the budget deficit widens, governments will borrow excessively in order to spend -
high spending could lead to demand-pull inflation
● When the government borrows excessively this could signify a weak economy and
could lower the credit rating of the country giving investors insights to the level of risk
from investing in that country
Consequences of high national debt:
● There are long-run effects of policy on spending and borrowing. Sustainable
economic growth must take into account the needs of future generations who should
not have to meet the cost of consumption of the present population.
● UK currently experiencing high public sector net debt at 97.7% of GDP due to the
UK’s low productivity growth since the financial crash, higher energy prices, cost of
living crisis, ageing population.
Consequences of government borrowing:
● Higher debt interest payments - as borrowing increases the government must pay
more interest rate payments on those who hold bonds - these will have to be paid
with higher future taxes
● Pushes up interest rates: Higher borrowing can push up interest rates as markets are
nervous about government ability to repay and so demand higher bond yields in
return for perceived risk
● Crowding out: a classical argument that government borrowing reduces the supply of
loanable funds which pushes up interest rates and means that the private sector is
less able to undertake investment or take out loans.
○ However this is unlikely to apply in a recession as in a recession private
sector saving rises and there are surplus savings which the government is
simply making use of - government spending offsets the rise in private sector
saving. Government borrowing in a recession may actually help to maintain
AD and prevent a fall in spending.
Crowding out:
Crowding out: a process by which an increase in government expenditure reduces private
sector activity by raising the cost of borrowing. This means that government spending may
fail to increase overall AD because higher gov spending causes an equivalent fall in private
sector spending and investment.
● Increased taxes may be used to fund gov spending - higher corporation tax increases
COPs for firms reducing profits available for investment - may also cause a fall in
consumer expenditure if higher prices are passed onto consumers
● Increased borrowing - government sells bonds to private sector to finance borrowing
and if these are bought the private sector has reduced funds available for private
sector investment.
Financial crowding out: used to describe how government borrowing
can cause higher interest rates - if the government needs to seel more
securities it may have to increase interest rates on bonds to attract
buyers which increases interest rates elsewhere in the economy. If the
government demands more loanable funds, this also pushes up
interest rates in the loanable funds market.
