Aquinas College Economics Department

Fiscal Policy & Government Expenditure

ECON4

Aquinas College Economics Department

Fiscal Policy

• Manipulation of – Public Spending– Taxation– Borrowing

• To achieve macroeconomic objectives

• Fiscal Policy is going to have impacts on Individuals and Business

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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.

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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

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Budget Balance

• G = Government Spending• T = Taxation

𝐺=𝑇𝐺<𝑇𝐺>𝑇

Balanced Budgeti.e. Expenditure = Tax Revenue

Balanced Surplusi.e. Expenditure is less than Tax Revenue

Balanced Deficiti.e. Expenditure is greater than Tax Revenue

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UK Budget Balance

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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.

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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

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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

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G&T Graphs

Real GDP

Govern

me

nt

Spendin

g

& T

axati

on

Taxation

G

Balanced Budget G=T

Budget Deficit G>T

Y1 Y2 Y30

Budget Surplus G<T

Govt. Spending falls as GDP rises. Automatic Stabilisers take effect at this pointAt Y1 a deficit is being run as GDP is low – this is called Cyclical Budget Deficit

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Deficits and the Business Cycle

Cyclical Budget Deficit

Cyclical Budget Surplus

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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

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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

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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

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Pros and Cons of a DeficitProblems with a Deficit Benefits of a Deficit

Financing the deficit – interest payments cause a leakage on the circular flow of income

If spending is used in capital expenditure such as infrastructure and schools it can increase the long term growth prospects of an economy

Consistent deficits will cause the National Debt to increase

Avoids a large negative output gap

Fiscal Crowding out – Public sector deficit deters private sector investment and consumption

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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

AS Level Revision Site (ECON1, ECON2)• http://www.aquinaseconomicsas.co.uk

A2 Level Revision Site (ECON3, ECON4)• http://www.aquinaseconomicsa2.co.uk

Aquinas Economics on Twitter• http://www.twitter.com/aquinaseconomic

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