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--SYLLABUS CONTENT--
--DEFINITION--
--DEFINITION--
"FISCAL POLICY is called a 'DEMAND-SIDE POLICY' because it is aimed at influencing the level of AGGREGATE DEMAND in the economy, SHIFTING the AD curve either to the left or to the right."
--THE BUDGET--
--DEFINITION--
"A government budget is a document that outlines a government's PROJECTED REVENUES and PLANNED SPENDING for a fiscal year."
--REVENUES--
DIRECT TAXES: INCOME, PROFIT
INDIRECT: GST, EXCISE DUTIES
PRIVATISATION: BRITISH RAIL
--SPENDING--
CURRENT EXPENDITURE: WAGES OF PUBLIC SERVANTS, DAY-TO-DAY PURCHASES OF CONSUMER GOODS SUCH AS PUBLIC SCHOOL and HOSPITAL SUPPLIES.
CAPITAL EXPENDITURE: PUBLIC INVESTMENTS THAT ADD TO THE 'CAPITAL STOCK' OF THE COUNTRY SUCH AS ROADS AND NEW SCHOOLS etc
TRANSFER PAYMENTS: THESE ARE PAYMENTS MADE TO VULNERABLE GROUPS IN SOCIETY EXAMPLES INCLUDE UNEMPLOYMENT BENEFITS AND CHILD ALLOWANCES.
DEFICIT
GOV'T EXPENITURE
IS GREATER THAN
GOV'T REVENUE
= BUDGET DEFICIT.
BALANCED
GOV'T EXPENITURE
IS EQUAL TO
GOV'T REVENUE
= BALANCED BUDGET.
SURPLUS
GOV'T EXPENITURE
IS LESS THAN
GOV'T REVENUE
= BUDGET SURPLUS.
--DEFICITS, SURPLUSES, & NAT'L DEBT--
"NATIONAL/GOVERNMENT DEBT refers to the DEBT that a government has accumulated through its BORROWING TO FINANCE its overspending."
--TASK--
"Can you run a surplus and still be in debt?"
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--RWE BUDGET/SURPLUS AS A % OF GDP--
--RWE BUDGET/SURPLUS IN MILLIONS OF USD--
--PORTFOLIO CHECKPOINT--
--Use the mark scheme(s) below to construct the answer(s)--
--THE GOALS--
--THE GOALS--
--THE TOOLS--
--THE TOOLS--
EXPANSIONARY FISCAL POLICY: is aimed at INCREASING (AD) when a DEFLATIONARY GAP occurs through a combination of the following:
INCREASING GOVERNMENT SPENDING (G↑)
DECREASING PERSONAL INCOME TAXES (C↑)
DECREASING BUSINESS TAXES (I↑)
CONTRACTIONARY FISCAL POLICY: is aimed at DECREASING (AD) when an INFLATIONARY GAP occurs through a combination of the following:
DECREASING GOVERNMENT SPENDING (G↓)
INCREASING PERSONAL INCOME TAXES (C↓)
INCREASING BUSINESS TAXES (I↓)
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--TASK--
"Look at the diagram below and summarise the tools and their impacts of both expansionary and contractionary fiscal policy."
--EVALUATION--
--LIMITATIONS--
--LIMITATIONS--
--THINK AHEAD--
"Look at the image below. What limitation of fiscal policy do you think it's referring to?"
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"That's right."
--TIME LAGS EXIST--
"Firstly, it takes some time to RECOGNISE THE PROBLEM ('RECOGNITION LAG')
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"Secondly, it will take time to decide THE APPROPRIATE POLICIES..."
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"...and finally, the POLICIES WILL TAKE TIME TO TAKE EFFECT, especially if they're related to tax changes, which are reliant on the unpredictable nature of consumer and business confidence." ('ADMINISTRATION LAG')
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"If the time lag is severe, then the actual impact on AD may occur once the economy has already self-corrected, thus creating a problem it was designed to fix."
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--THINK AHEAD--
"Look at the images below. What limitation of fiscal policy do you think it's referring to?"
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"That's right."
--POLITICAL CONSTRAINTS--
"Governments cannot easily cut spending for many of their committed social services, such as health care and education, as well as public goods such as defence. Furthermore, tax increases are politically unpopular and may be avoided by the government even though they might be necessary."
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"Furthermore, tax decreases could also be inappropriately enacted because they are politically popular. The upshot is that political factors may sometimes lead to unsuitable fiscal policies.
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--THINK AHEAD--
"Look at the image below. What limitation of fiscal policy do you think it's referring to?"
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"That's right, it's related to the..."
--SUSTAINABLE DEBT LEVEL--
"Of course, if the expansionary government spending is financed by BORROWING, then this could become problematic for a government that is already facing a large deficit, as to do so would not only burden the economy with massive interest repayments which take away valuable revenue for other expenditures but also increase the risk of default, which in turn LOWERS THEIR CREDIT RATINGS meaning interest rates on future borrowing will be higher to mitigate this risk."
--TASK--
"Look at the diagram below and extract the relationship between the level of debt, the level of investor confidence, the credit rating, and the interest rate charged."
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--THINK AHEAD--
"Look at the image below. What limitation of fiscal policy do you think it's referring to?"
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"That's right..."
--TAX CUTS INEFFECTIVENESS--
"In a recessionary phase, a cut in income and profit taxes won't necessarily lead to a greater level of spending, as both consumer and business confidence are low, and both parties may prefer to save their extra disposable income."
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--THINK AHEAD--
"Look at the image below. What limitation of fiscal policy do you think it's referring to?"
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"That's right; one problem with expansionary fiscal policy is that it is extremely DIFFICULT TO FINE-TUNE the exact increase in AD needed to close a recessionary gap."
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"This is because the size of the multiplier is uncertain, while changes in consumer and business confidence make the response of consumption and investment difficult to predict."
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"As a result, the government may OVERSHOOT, increasing AD by MORE than is necessary to return the economy to potential GDP, and rather than simply eliminating the recessionary gap, the excessive increase in AD may create an INFLATIONARY GAP, resulting in DEMAND-PULL INFLATION."
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--THINK AHEAD--
"Look at the image below. What limitation of fiscal policy do you think it's referring to?" (Hint: It would appear he has to make a trade-off, but why?")
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"That's right, if the instability is caused by supply-side factors, where there is a FALL in REAL GDP and INFLATION simultaneously, FISCAL POLICY is unable to deal with it effectively and will have to trade unemployment for inflation or vice versa. In other words, it CAN'T FIX STAGFLATION."
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--TASK--
"Use the diagram below to explain how using fiscal policy during a state of stagflation forces governments to trade employment for price stability and vice versa."
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--THINK AHEAD--
"Look at the image below. What limitation of fiscal policy do you think it's referring to?" (Hint: "What happens to interest rates when more stakeholders demand loans?")
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"As mentioned above, a government running a deficit will have to BORROW to finance its GOVERNMENT SPENDING (so the 'G' component of AD rises) (this is called 'deficit spending'); however, this increase in demand for borrowed funds from banks will lead to a RISE IN INTEREST RATES."
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"This rise in interest rates (the price of borrowing) will likely result in FIRMS TAKING OUT FEWER LOANS TO INVEST (so the 'I' component of AD will decrease). In other words, INVESTMENT IS 'CROWDED OUT' and the overall expansionary effect of the fiscal policy is weakened since the greater government spending ('G') has been counteracted by the lower level of investment spending ('I')."
--TASK--
"We can see below that the crowding-out effect is less significant during a recession can you think why?"
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--THINK AHEAD--
"Look at the image below. What limitation of fiscal policy do you think it's referring to?" (Hint: "Short termism")
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"That's right, these policies have long-term impacts."
--IMPACT LONG-TERM GROWTH--
"If contractionary policy involves REDUCING GOVERNMENT SPENDING on MERIT GOODS such as EDUCATION & HEALTHCARE as well as INFRASTRUCTURE PROJECTS such as new roads and airports, then this can have a serious impact on the potential growth of the economy."
--STRENGTHS--
--STRENGTHS--
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--THINK AHEAD--
"Look at the image carousel below. What strength of fiscal policy do you think it's referring to?" (Hint: "Think directness")
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"That's right, in a deep recession, when consumer and business confidence is at an all-time low, reduced taxes and interest rates do nothing to stimulate spending; as such, the strength of fiscal policy and government spending in particular is that it can DIRECTLY KICK-START a stagnant economy and PULL AN ECONOMY OUT OF DEEP RECESSION as well as improve the long-term prospects of the economy."
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"What type of projects do they choose?"
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"Ideally the most useful projects tend to be labour-intensive, quick to start so spending can multiply, and capable of delivering long-term economic benefits such as spending on 'shovel-ready' repair and maintenance work or large infrastructure projects that can increase the economy's long-run productive capacity, shifting the LRAS, which CAN OFFSET INFLATIONARY PRESSURE. In other words, the increase in AD is countered by increases in LRAS, so in the long run prices remain stable. "
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"We saw in the last strength that government spending CAN TARGET SPECIFIC SECTORS and groups which they deem the most in need or the most appropriate for leading the economy out of a recession, e.g, specific infrastructure projects, merit good, and public good provision etc...
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--THINK AHEAD--
"Look at the image carousel below. What strength of fiscal policy do you think it's referring to?" (Hint: "Think directness")
--IMPACT LONG-TERM GROWTH--
EXPANSIONARY FISCAL POLICY can affect potential output and long-term economic growth DIRECTLY through investments in HUMAN CAPITAL and PHYSICAL CAPITAL (infrastructure) and through offering INCENTIVES to firms to invest in SUNRISE INDUSTRIES, which shift the LRAS to the right.
In addition, EXPANSIONARY FISCAL POLICY can affect potential output and long-term economic growth INDIRECTLY as when firms are confident that the government is committed to using FISCAL POLICY to control the average price level they are MORE CONFIDENT about, the real value of future earnings and thus are MUCH MORE LIKELY BORROW and SPEND for investment purposes. This should result in GREATER PRODUCTIVITY and OUTPUT hence the LRAS will shift to the right.
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--THINK AHEAD--
"During a 'RECESSION', imagine your work hours are heavily reduced. Apart from using your savings or borrowing money, can you think of anything that could AUTOMATICALLY STABILISE ('cushion') the loss, allowing you to maintain some of your previous spending levels?"
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"That's right; firstly, your lower income level may now make you 'automatically' eligible for unemployment benefits, which partially replace your lost income, helping maintain consumption.
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"...secondly, progressive income tax systems 'automatically' reduces your income tax payments, cushioning the reduction in ('after tax') disposable income.
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--TASK--
"Now imagine it's an INFLATIONARY GAP and your income has risen; explain how the size of your spending power has been 'automatically' reduced due to the above two automatic stabilisers,..."
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"...then using correct diagrams, comment on how these stabilisers impact the size and severity of the fall/rise in AD following both recessionary and inflationary gaps."
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"Use the diagram below to help you."
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--KEYNESIAN MULTIPLIER (HL)--
--KEYNESIAN MULTIPLIER (HL)--
--DEFINITION--
"THE KEYNESIAN MULTIPLIER refers to the SIZE of the MULTIPLE by which an initial increase in expenditure of one of the components of aggregate demand (Either C, I, G, or X), is multiplied by to arrive at the final change in REAL GDP."
MULTIPLIER = CHANGE IN REAL GDP / INITIAL CHANGE IN EXPENDITURE
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"So how much larger will the increase in real GDP be?"
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"Surely it's endless; after I spend my $100 and it becomes your income, you will spend your $100, and then your $100 will become someone else's income, and so on, forever and ever, right?"
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"Nope, as NOT ALL INCOME IS USED FOR DOMESTIC CONSUMPTION, as some of it is deducted, can you think why?"
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"That's right, some of it is WITHDRAWN/LEAKED after each round of spending to pay for TAX, for SAVINGS, as well as to pay for NON-DOMESTICALLY PRODUCED GOODS, aka IMPORTS. Therefore, the remaining money left for spending (to actually impact Real GDP) gets progressively smaller and smaller."
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"Now, if we know what proportion of every additional dollar of income is paid in taxes (MPT), saved (MPS), and spent on imports (MPM), we can calculate the marginal propensity to withdraw (MPW = MPT + MPS + MPM).
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"This also tells us what proportion of each additional dollar is spent on domestically produced goods and services (MPC) or (1 − MPW), generating further income for others in the economy."
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"From this, we can calculate the Keynesian multiplier:
(k = 1 ÷ MPW)
and ultimately the theoretical total increase in national income generated by the initial injection, assuming the marginal propensities remain constant and prices do not rise significantly."
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"Let's look at this process in action. Below you can see that by default the initial injected amount is $100m, the mpt = 20%, the mps = 10%, and the mpm = 10%, and from these settings the multiplier works out to be 2.5."
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"So does this mean that the $100m results in a 250m increase in the level of real GDP?"
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"If the government injects $100 million into an economy already operating at full employment, where will the additional workers, machinery and other resources needed to produce $250 million of extra output come from? What might happen to prices instead?"
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"Do you think households will spend or save the same proportion of every additional dollar of income during a deep recession as they would during an economic boom? How might unemployment fears, consumer confidence, debt and income levels influence their marginal propensity to consume (MPC) and marginal propensity to save (MPS)?"
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"So, even if the initial injection is identical, could both the theoretical multiplier and the actual increase in real GDP differ depending on the state of the economy? Why?"
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--PAPER 3 PRACTICE--
--END OF UNIT TASK--
In pairs/or alone, imagine you are two economic advisors DISCUSSING the use of FISCAL POLICY to solve a RECESSIONARY GAP, in your discussion, one of you must be FOR its use while the other is AGAINST it.
First, CREATE A SCRIPT of your conversation, then act out the discussion and record the audio/video into MP4 for upload.
Name the file: "NAME_Discuss_use_of_Fiscal_policy_in_recession.mp4" and upload to the homework site.
DON'T FORGET, in your script, you MUST explain the theory behind your viewpoint, and answer such questions as...
Why does fiscal policy 'automatically stabilizes' the economy?
Whether crowding out is a real worry?...
Why is a time lag a problem?
Why is knowledge of the multiplier important?
Will the multiplier effect always be fully exploited?
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