Fiscal Policy - Budget Deficits & Surpluses

What is the fiscal balance

What is a budget/fiscal deficit

When government spending is greater than tax revenue in a year

What is budget/fiscal surplus

When tax revenue is greater than government spending in a year

What are the implications of a budget deficit

Government may need to borrow more money by issuing bonds which can increase overall debt level

What are the implications of a budget surplus

Allows government to save or pay down debt, invest in infrastructure or reduce taxes

What is a structural budget deficit

Budget deficit when the economy is at full employment/capacity

What is a structural budget surplus

A budget surplus being run at full employment

What is a cyclical budget deficit

Budget deficit during recession

What is a cyclical budget surplus

Budget surplus during a boom

What is the national debt

Total stock of government debt over time

What does national debt imply

Implies an increase in government spending and/or decrease in taxation. Expansionary policies

How is a budget deficit financed?

• Issuing government bonds to raise funds

• International borrowing

• Central Bank Financing - they purchase bonds or provide loans

What are the effects of a budget deficit on AD

• Increase in government spending and therefore AD

• Lower taxes and incentives of lower tax

• Lower unemployment

• Multiplier effect for increased consumption and therefore higher growth

• Crowding in

What are the negative effect of a budget deficit on AD

• Deterioration of government finances - lower credit rating on bond therefore higher coupon (interest) rates need to be provided = extra cost

• Increased borrowing

• Inflation trade off - demand pull

• Crowding out

Explain crowding out theory

Increased government borrowing leads to higher demand for loanable funds and causing interest rates to rise and therefore borrowing costs for private sector businesses. This reduces profit, capital investment and employment in private sector

Evaluate crowding out

• Likelihood is very limited if country is operating below full capacity

• Well timed and targeted gov spending can absorb under-utilised capacity and provide multiplier effect

What is crowd in theory

An increase in government spending/investment causes an expansion in economic activity (GDP) which incentivises private sector firms yo raise their levels of investment and employment

What is contractionary fiscal policy

Government aiming to decrease AD by reducing spending and/or increasing taxes

Define austerity

Cuts in government spending

What are the microeconomic effects to austerity

• Effects of real income

• Effects of demand for goods and services

• Cuts in pension may delay people’s retirement

What are the macroeconomic effects of austerity

• Multiplier effect in public sector and employment

• Lower fiscal deficit may help investor confidence

• Risk of deflationary pressures due to excess capacity

• Likely to have low interest rates

What are benefits of austerity

• Confidence in government finance and credit rating - they can issue lower coupon rates so it is cheaper to borrow and fund public services. Can also attract FDI

• Flexibility for fiscal policy when needed in future

• Less crowding out

• Lower inflation

What are risks of austerity

• Demand side shock with recessionary outcomes

• Effects of reduced spending on services e.g. healthcare/education

• Impacts of higher taxes

• Risk of income inequality