Chapter 19 FISCAL POLICY GEORGE OSBORNE IS THE CHANCELLOR OF THE EXCHEQUER IN THE UK.

Chapter 19

FISCAL POLICY

GEORGE OSBORNE IS THE CHANCELLOR OF THE

EXCHEQUER IN THE UK

What is FISCAL Policy?

• FISCAL POLICY is the use of taxation and spending to influence the economy in a number of ways;– Controlled by the government– Policies are often politically motivated and therefore

can suffer from government failure– The Chancellor sets out THE BUDGET in March of

each year• http://www.hm-treasury.gov.uk/2011budget.htm

– In November or December the Pre Budget Report is issued which forecasts tax and spending

The 2011 Budget Video

Check out this great video

Where does the UK Government get revenue from?

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How does the UK Government spend our money?

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Deficit

• Based on Chart 1 and Chart 2 what is the predicted deficit for 2011-12 financial year?

• Where will they get that money from?

Fiscal Policy - Key Terms 1

• Current spending – Government spending on the day-to-day running of the public sector,

including raw materials and wages of public sector wages e.g. teachers• Capital spending

– Government spending to improve the productive capacity of the nation, including infrastructure, schools and hospitals

• Transfer payments– Government payments to individuals for which no service is given in

return, e.g. benefit payments• Balanced budget

– Government receipts equal government spending over the financial year (April 6th – April 5th in UK and October 1st to September 30th in US)

Fiscal Policy - Key Terms 2

• Budget deficit– Where government spending exceeds government receipts in a financial

year (PSNCR – Public Sector Net Cash Requirement)• Budget surplus

– Where government receipts exceeds government spending in a financial year (PSDR – Public Sector Debt Repayment)

• Demand side fiscal policy– Changes in the level or structure of government spending and taxation

aimed at influencing one or more of the components of AD• Discretionary fiscal policy

– The deliberate manipulation of government spending and taxation to influence the economy.

Fiscal Policy - Key Terms 3

• Expansionary fiscal policy– Increasing levels of government spending relative to

tax revenue, appropriate to stimulating AD during a downturn in economic activity

• Contractionary fiscal policy– Increasing levels of tax revenue relative to

government spending, appropriate during a boom in economic activity

Taxation and Fiscal Policy

• Direct Taxation (Taxes on Income)– Income tax– National insurance contributions– Corporation tax

• Indirect Taxation (Taxes on spending)– VAT – Excise duties e.g. tobacco and petrol

Spending and Fiscal Policy

• The government spends money on– Current spending: to cover it’s running costs

and pay wages– Capital spending: to improve the nation’s

productive capacity (LRAS to the right)– Transfer payments: payments such as

benefits to the unemployed or sick

Deficit and Surplus

• In the 2011-12 financial year the government is expected to spend in the region of £__________ more than it receives in revenue – A DEFICT – That’s £________ per person in the UK!– This is VERY high by historical figures and has been

caused due to the recession and increased speding by the previous government

– PSNCR (or PSBR) national debt increases– PSDR national debt falls

How big is the Govt?

How much does the UK owe?

Comment on the level of UK National Debt

Cuts warning as public debt grows

Figures published this month by the Office for National Statistics (ONS) indicate that Britain's national debt rose to £703.4bn in January, or 47.8% of gross domestic product. It is the biggest proportion since 1978, when net debt was 49.1% of GDP.

The ONS said that figure would increase sharply if the money being pumped into Britain's faltering banks was taken into account.

In an article for The Times on Thursday, Mr Bundred warned that if borrowing pushed above 65% of GDP, there was a "distinct possibility" Britain could face "the Armageddon scenario most feared by the Treasury: that there will be insufficient lenders to match the planned level of borrowing".

Source: http://news.bbc.co.uk/2/hi/business/7916356.stm | 28th Feb 2009

Recent Deficit / Surplus Performance in the UK

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The use of Fiscal Rules

• Gordon Brown as Chancellor introduced the GOLDEN RULE– The government would only borrow to fund

capital spending balanced over the course of the economic cycle

– In the later years of the Labour rule the government found it harder and harder to stick to this rule

Demand Side Fiscal Policy

• Discretionary fiscal policy– Deliberate changes in fiscal policy e.g. spending on schools or

roads or cuts in tax to encourage investment

• Expansionary fiscal policy– Aimed at increasing (or speeding up the increase in) AD

• Contractionary fiscal policy– Aimed at reducing (or slowing down the increase in) AD

• Keynes’ Multiplier– An initial £500 million increase leads to a greater later increase– Can lead to overshoots and therefore inflation

AS/AD Analysis of Fiscal Policy

The UK Economy: Expansionary Fiscal Policy

PriceLevel

Real GDP

AS/AD Analysis of Fiscal Policy

The UK Economy: Contractionary Fiscal Policy

PriceLevel

Real GDP

AS/AD Analysis of Fiscal Policy

The UK Economy: The Multiplier Following an Expansionary Fiscal Policy

PriceLevel

Real GDP

Supply Side Fiscal Policy

• Labour market incentives• Capital spending• Entrepreneurship• Research and development and innovation• Improvements in human capitalECONOMIC CONFLICT: Free market economists argue that government intervention is ineffective. The Institute of Economic Affairs (IEA) is one such group which believes that the government should reduce the size of government and therefore the tax burden on society. I AGREE but KEYNES wouldn’t!I AGREE but KEYNES wouldn’t!

AS/AD Analysis of Fiscal Policy

The UK Economy: Supply side policy e.g. reducing unemployment benefits

PriceLevel

Real GDP

AS/AD Analysis of Fiscal Policy

The UK Economy: Supply side policy e.g. increased spending on infrastructure

PriceLevel

Real GDP

AS/AD Analysis of Fiscal Policy

The UK Economy: Supply side policy e.g. making the education system more vocational

PriceLevel

Real GDP

Exam Style Questions - MCQ

Exam Style Questions - DR

Exam Style Questions - DR

Exam Style Questions - DR

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