Public finances (G-T)

Government Spending

Government spending happens for three reasons:
to provide merit goods
to provide public goods
to meet government priorities

Given the flurry of data in recent years on the state of the Government's finances it is well worth ensuring you understand it. The following are useful links:

Note from the above the difference between Government expenditure as a percentage of Real GDP excluding benefits, the typical 20-25% of AD quoted in textbooks and the overall around 40% of Real GDP (including benefits - half of which are pension related) quoted in the media.

The ever helpful Economics help study notes: http://www.economicshelp.org/blog/5326/economics/government-spending/ 

Some interesting data blog graphics from the Guardian:

http://static.guim.co.uk/sys-images/Guardian/Pix/pictures/2013/3/20/1363800264587/Budget-spending-and-tax-r-001.jpg

http://www.theguardian.com/news/datablog/2010/apr/25/uk-public-spending-1963

Complete AS worksheet 60.

Fiscal Policy

Fiscal Policy concerns the manipulation of:
Government Spending
Taxation
the budgetary position e.g attempting to reduce the budget deficit

The Coalition Government have attempted to reduce the Budget Deficit (eighty percent through Government spending cuts and 20% through tax increases such as stopping tax avoidance and increasing VAT.) This is known as AUSTERITY MEASURES or tough/tightening fiscal policy or contractionary fiscal policy.

Discretionary Fiscal Policy - government decides to change government spending to achieve a priority e.g. increase it to achieve growth through the multiplier effect or cut it to reduce inflationary pressures and to reduce government borrowing allowing more loanable funds to be available to the private sector at a lower rate of interest.

Automatic Stabilisers - Germany is said to have had large automatic fiscal stabilisers. This means when the recession happened and people lost their jobs they did not suffer a large fall in disposable income. The reason for this is as benefits and income tax levels are high; so the fall in consumption was made up for by a rise in government spending and a fall in tax revenue so AD did not shift inwards substantially.

Cyclical Deficit - temporary budget deficit caused by recession. Increased spending on benefits given rising unemployment and falling tax revenue due to loss of wages, wage cuts or business paying less corporation tax as profits fall. Deficit may be replaced by a budget surplus in the boom years.

Structural Deficit - long term budget deficit problem caused by low trend growth generating insufficient tax revenue to cover government infrastructure expenditure on NHS, Education, transport etc. For the structural deficit to be removed Governments need to consider:
a) Cutting Government spending on NHS and Education
b) Increasing taxes
c) Increasing trend growth through supply side measures.

Crowding out - Government  Spending and Borrowing replaces private sector Investment. Key reason for this is government borrowing results in a lack of loanable funds for the private sector that then has to pay a higher rate of interest on these loans if they still wish to borrow. GOVERNMENT SPENDING REPLACES INVESTMENT, the private sector is more productively efficient.

Ricardian Equivalence - tax payers are rational and expect any government that is cutting income taxes or increasing government spending, by borrowing, before an election - after the election the government will reverse this fiscal policy to pay back the money borrowed. The consequence of this is that the fiscal stimulus is ineffective as tax payers save the income tax cut or public sector wages rather than spend it - so there is no multiplier effect. FISCAL POLICY DOES NOT WORK.



Complete A2 worksheet 87, 95 and 96.