2.2.4 Government Expenditure

What is the trade cycle?

The trade cycle (business cycle) is the fluctuations in economic activity over time, typically moving through boom, slowdown, recession, and recovery.

How does the trade cycle influence government expenditure?

Government expenditure tends to rise in recessions and fall or grow more slowly in booms due to changes in automatic stabilisers and policy responses.

Why does government spending increase during a recession?

Because unemployment rises, leading to higher spending on welfare benefits (e.g. unemployment benefits) and lower tax revenues, increasing the budget deficit.

What are automatic stabilisers?

Government spending and taxation changes that occur automatically without new policy decisions, helping to reduce the impact of economic fluctuations.

Give examples of automatic stabilisers affecting government expenditure.

• Unemployment benefits increase in recessions
• Welfare payments rise
• Tax revenues fall, increasing borrowing needs

How does a boom affect government expenditure?

In a boom, unemployment falls, welfare spending decreases, and tax revenues increase, which can reduce government borrowing.

Why might discretionary government spending change during different phases of the trade cycle?

Governments may actively adjust spending to stabilise the economy, increasing spending in recessions (expansionary policy) and reducing it in booms (contractionary policy).

What is fiscal policy?

Fiscal policy refers to government use of taxation and public spending to influence the level of economic activity.

How does fiscal policy influence government expenditure?

Governments can deliberately increase or decrease spending to manage demand, reduce inflation, or stimulate growth.

What is expansionary fiscal policy?

A policy that increases government spending and/or reduces taxes to increase aggregate demand and stimulate economic growth.

What is contractionary fiscal policy?

A policy that reduces government spending and/or increases taxes to decrease aggregate demand and control inflation.

When is expansionary fiscal policy usually used?

During recessions or periods of low economic growth and high unemployment.

When is contractionary fiscal policy used?

During periods of high inflation or when the economy is overheating.

How does fiscal policy affect government borrowing?

Expansionary fiscal policy often increases borrowing (budget deficit), while contractionary policy may reduce borrowing or create a surplus.

What is discretionary fiscal policy?

Active changes in government spending or taxation made by policymakers in response to economic conditions.

What is the difference between fiscal policy and automatic stabilisers?

Fiscal policy involves deliberate government action, while automatic stabilisers work automatically without new government decisions.

How can fiscal policy be used to stabilise the economy?

By increasing spending in downturns to boost demand and reducing spending or increasing taxes in booms to prevent overheating.