Policy Instruments

• The objectives of Fiscal Policy

  1. To affect AD (Aggregate Demand)
  2. To reduce the national debt
  3. To redistribute income
• When does the Fiscal Policy affect AD

  Increases in times of unemployment ( expansionary fiscal policy ).

  Reduces it in times of high inflation and full employment ( deflationary fiscal policy ).
• How does the Fiscal Policy reduce the national debt

  A policy of austerity - the attempt to reduce government spending so that it is lower than tax revenue
• How does the Fiscal Policy redistribute income

  By taxing those on higher incomes and giving benefits to those on lower incomes
• What are the two types of Fiscal Policy

  Automatic stabilisers , discretionary Fiscal Policy
• Automatic stabilisers are institutional features of the economy which - without direct government intervention - will automatically change the level of government spending & taxation with the economic cycle to dampen its effects
• Discretionary Fiscal Policy is direct intervention by the government in order to deliberately manipulate government spending and/or taxation to achieve specific policy objectives
• How do automatic stabilisers boost AD in times of recession

  Less money is taken in tax and more money is given out in benefits as fewer people have jobs
• How do automatic stabilisers reduce AD in a boom

  More money is taken in tax as more people are working, if spending or prices rise then more money will be taken as VAT and duty. Less money will be spent on unemployment benefits so government spending falls
• The two main ways in which fiscal policy can affect AD is through changing taxes ( C & I ) and through changing the level of government spending ( G )
• Define progressive taxation

  A tax system that takes proportionately more from those that can afford it
• Define proportional taxation

  A tax system that takes the same proportion of income from everyone irrespective of the size of their income
• Define regressive taxation

  A tax system that takes proportionately more from those who can least afford it
• Define tax base

  The total value of income / sales / wealth upon which taxes can be imposed
• Define tax rates

  The percentage of income / sales / wealth that is taken in tax
• What shape is the Laffer Curve

  A bell shaped curve (More likely to be asymmetrical)
• Describe the shape of the Laffer Curve

  1. As tax rates rise tax revenue also rises (at a diminishing rate)
  2. Beyond a certain rate of tax (usually t*) tax revenues begin to decline
• Why does the Laffer Curve decline after a certain rate

  1. Income tax revenues fall as higher tax rates acts as a disincentive to work
  2. Corporation tax revenues fall as firms move into economies with lower tax rates
  3. Indirect tax revenues fall as black market activity rises
  4. All tax revenues fall as it becomes worthwhile to avoid or evade taxes
• Evaluation points for the Laffer Curve

  1. Size of the tax rate change
  2. Where the tax rate was originally
• Current spending is spending on the provision of goods and services by the government that are used on a day to day basis
• Current spending is short term and is renewed each year
• Capital spending by the government is spending on physical assets like roads or schools (a.k.a social capital/infrastructure)
• Capital spending is long term and is not renewed each year
• The Budget

  The government’s spending and taxation plans for the coming year
• Government expenditure = Current Spending + Capital Spending
• Budget Deficit

  G > T
• Budget Surplus

  G < T
• How does the government cover a Budget Deficit

  Borrows money from the private sector - known as the PSNCR (Public Sector Net Cash Requirement)
• To borrow money, the government issues bonds, which are financial assets for a fixed amount of money at a stated rate of interest (paid yearly to the bond-holder) and with an expiry date of repayment
• What does the government borrowing money lead to

  Adding to the national debt
• How can the government use surplus cash while in a Budget Surplus

  1. Build up their reserves (can be used if in an economic crisis occurs rather than borrowing money)
  2. Repay outstanding debt by buying back bonds
• A loose Fiscal Stance is intended to increase AD by increasing government spending and reducing taxation. This may lead to a budget deficit
• A tight Fiscal Stance is intended to reduce AD by reducing government spending and increasing taxation. This may lead to a budget surplus
• A neutral Fiscal Stance is intended to keep AD the same. This doesn’t necessarily mean G & T are the same as changes can offset eachother
• What is Fiscal Policy

  The manipulation of the government’s budget though spending, taxation and borrowing
• What is the Monetary Policy

  The attempt by government or a central bank to manipulate the money supply, supply of credit and interest rates to achieve its policy objectives
• What is the UK‘s central bank

  The Bank of England
• What are the functions of a central bank

  1. Issue of notes and coin
  2. Supervise the financial system - regulate financial institutions to ensure they are behaving correctly
  3. Manage a country’s gold and foreign currency reserves
  4. Act as a banker to the government - manage the national debt
  5. Act as a banker to the banking system and Lender of Last Resort to the UK banks
• What is the Bank of England’s mission statement

  “Promoting the good of the people of the UK by maintaining monetary and financial stability”
• What is the goal of the Bank of England

  To maintain consumer & business confidence (animal spirits) for sustained economic growth