Download Fiscal policy and demand management unit 4 File

Fiscal policy
and demand
management
• Fiscal policy: decisions about taxation, borrowing and
spending which affect aggregate demand in the economy.
• Current Spending
• Capital Spending
• Transfer payments
Government Spending
• 1. Current spending – salaries of teachers, policemen’s
salaries.
• 2. Capital spending – long term investment projects.
• 3. Transfer payments – payments (through the fiscal
system) for which there is no corresponding output.
Government
spending
• AD and LRAS curves can/must be used in Unit 4 when
addressing increases and decreases in government
spending.
• Reductions in capital spending may be politically easier
in the short run (no strikes by teachers, for example), but
damaging in the long run. The country loses its
competitive advantage.
Analysis of government
spending
• Cutting transfer payments may in some respects also
politically be easier – children and unemployed people
cannot go on strike. But, it does worsen the relative
poverty of the poorest/most dependent people.
Analysis of government
spending
• Increases in capital projects are popular among the
business community, however they tend to be only
effective in the long run and they produce significant
negative externalities.
• Crowding out occurs when an extra dollar of government
spending results in reduction of one dollar of private
sector spending.
Crowding Out
• 1. for example, the UK govt spends £40bn on high speed
trains. This draws resources such as skilled engineers to
this project reducing the number of engineers available
for other projects that the private sector may have
undertaken.
Crowding Out – how
does this happen?
• 2. The government borrows from private banks to fund
the high speed rail, then the private banks have no more
liquidity to lend to would be private sector investors.
Crowding Out – how
does this happen?
• Automatic or built in
stabilisers:
• A feature of the fiscal
budgets that limit
economic fluctuations
through routine
behaviour without the
need for decision
making.
Automatic or
deliberate
• Active/discretionary
fiscal policy –
• The deliberate
manipulation of
government
expenditure and
taxation to influence
the economy.
Say what?
• Automatic stabiliser:
• For example 100 people become unemployed in a
recession. They receive the transfer payment of $100 a
week in JSA. So, the government automatically increases
their expenditure by $10,000 per week in this recession.
• Active fiscal policy.
• The government sees that 100 people have become
unemployed and they deliberately inject $787bn in a
typical Keynesian stimulus to improve the prospects of
the unemployed people.
• An economy is growing at full capacity with full
employment and high consumer confidence – but with a
risk of inflation.
• As there is high consumer confidence and full
employment, people will spend more on luxury goods
and the government automatically collects more money in
VAT – helping to cool down the economy.
The budget surplus enjoyed by the USA from 1999-2001 wasn’t a result of tight
fiscal policy or austerity as such – it was instead the automatic stabilisers of Sales
Tax and other forms of tax extracting more and more from the economy as the
economy enjoyed full employment and high confidence.
• Considering any one of the three previous slides, offer
reasons why the UK’s fiscal position worsened?
• Large debt to GDP ratio and/or significant budget deficit.
• To what extent are these problems?
• Yes a serious problem – debt interest repayments climb.
• Unlike choosing to host the Olympics – this is not an
optional repayment.
• High debt/deficit makes investment less likely.
• High debt/deficit makes investment less likely.
• So many other factors – interest rates, corporation tax,
labour productivity and infrastructure.
• No shortage of investment in some highly indebted
countries – the USA, Japan, Ireland.
• If the debt is foreign owned – it adds another dimension
to it.
• In extreme cases the country may need a bailout from the
IMF/EU/ECB or some other int’l body.
• http://www.dw.de/cyprus-becomes-fifth-country-to-seekbailout/a-16049277
• According to Reinhard Rogoff – debt of over 90% of
GDP is a permanent and significant drag on growth.
• The methodology of R and R has been criticised – but
there is an element of truth to it.
• Countries can get downgraded by the rating agencies.
• When compared to other macroeconomic problems such
as high unemployment, a large national debt (you could
argue) is not that serious.
• It worries professional economists and opinion writers in
newspapers – but unemployment can affect the very
fabric of society.
However….
• Also – ________ debt can be eaten away by
___________.
• A high debt/GDP ratio can be solved by high growth –
without deliberately following a policy of austerity.
• And, in the case of the USA – the country is simply too
big to fail – too big to bail. So, it can never go down the
path of Greece
•Structural and
Cyclical
Fiscal deficits
• Cyclical deficits refer to deficits that are caused by
economic downturns. Structural deficits refer to deficits
that are ongoing and not caused by any short term
macroeconomic fluctuation.
Structural and Cyclical
• A country with a balanced budget that runs a deficit for a
couple years after a financial crisis before returning to a
balanced budget would have a cyclical deficit. A country
running continuous 5% deficits in normal times has a
structural deficit.
Greece