1. Focus
on
Fiscal
Policy
–
Balanced
Budget
Fiscal
Expansion
Extract
A
more
expansionary
fiscal
policy
should
be
considered
if
downside
risks
materialise
and
the
recovery
fails
to
take
off.
Balanced
budget
fiscal
expansion
should
be
pursued
to
increase
growth.
For
example,
cuts
in
spending
on
items
such
as
public
employee
wages
could
be
used
to
finance
higher
spending
on
items
such
as
infrastructure.
What
is
meant
by
a
“balanced
budget
fiscal
expansion?”
This
concept
has
become
a
major
topic
of
conversation
in
the
debate
over
the
economic
effects
of
fiscal
austerity
in
many
countries
in
the
European
Union
and
beyond.
Put
simply,
a
balanced
budget
fiscal
expansion
occurs
when
a
change
in
government
spending
is
matched
by
an
equal
change
in
taxation
so
that
there
is
a
neutral
effect
on
the
annual
fiscal
deficit
but
with
the
hope
that
real
national
income
will
expand.
Central
to
the
concept
is
that
the
fiscal
multiplier
effects
of
say
a
£10bn
rise
in
government
spending
are
higher
than
the
negative
multiplier
effects
of
an
equivalent
£10bn
rise
in
taxes
What
is
the
fiscal
multiplier?
The
fiscal
multiplier
measures
the
final
change
in
national
income
(GDP)
that
results
from
a
deliberate
change
in
either
government
spending
and/or
taxation.
Several
factors
affect
the
likely
size
of
the
fiscal
multiplier
effect
What
factors
affect
the
size
of
the
fiscal
multiplier
effect?
1. Design:
i.e.
the
important
choice
between
tax
cuts
or
higher
government
spending.
Evidence
from
the
OECD
is
that
multiplier
effects
of
increases
in
spending
are
higher
than
for
tax
cuts
or
increased
transfer
payments.
2. Who
gains
from
the
stimulus?
If
tax
reductions
are
targeted
on
the
low
paid,
the
chances
are
greater
that
they
will
spend
it
and
spend
it
on
UK
produced
goods
and
services.
3. Financial
Stress:
Uncertainty
about
job
prospects,
future
income
and
inflation
levels
might
make
people
save
their
tax
cuts.
On
the
other
hand
if
consumers
are
finding
it
hard
to
get
fresh
lines
of
credit,
they
may
decide
to
consume
a
high
percentage
of
the
boost
to
their
disposable
incomes
4. Temporary
or
permanent
fiscal
boost:
Expectations
of
the
future
drive
behaviour
today
...
most
people
now
expect
taxes
to
rise
further
in
the
coming
years.
Will
this
prompt
a
higher
household
saving
and
a
paring
back
of
spending
and
private
sector
borrowing?
5. The
availability
of
credit:
If
fiscal
policy
works
in
injecting
fresh
demand,
we
still
need
the
banking
system
to
be
able
to
offer
sufficient
credit
to
businesses
who
may
need
to
borrow
to
fund
a
rise
in
production
(perhaps
for
export)
and
also
investment
in
fixed
capital
and
extra
stocks.

2. 6. The
response
of
monetary
policy:
The
multiplier
effects
of
a
fiscal
stimulus
depend
in
part
on
what
happens
to
policy
interest
rates
and
the
exchange
rate
(we
cannot
look
at
fiscal
and
monetary
policy
in
isolation!).
Would
a
rise
in
government
spending
and
borrowing
lead
to
higher
interest
rates?
That
might
dampen
the
expansionary
effects.
Or
would
the
Monetary
Policy
Committee
be
prepared
to
keep
nominal
interest
rates
low
even
if
there
were
signs
of
stronger
economic
growth
and
recovery.
7. Openness
of
the
economy:
The
more
open
an
economy
is
(i.e.
the
higher
is
the
ratio
of
imports
and
exports
to
GDP)
the
greater
the
extent
to
which
higher
government
spending
or
tax
cuts
will
feed
into
rising
demand
for
imported
goods
and
services,
lowering
the
impact
on
domestic
GDP.
8. Fiscal
and
monetary
policy
decisions
in
other
countries:
Modern
economics
are
deeply
inter-­‐connected
with
each
other.
What
happens
to
government
borrowing
and
interest
rates
in
the
EU,
the
USA
and
in
emerging
market
countries
will
have
an
important
bearing
on
prospects
for
a
broadly
based
recovery
in
global
trade
and
output
which
then
affects
the
UK
economy.
Identify
some
examples
of
policies
that
use
the
concept
of
the
balanced
budget
fiscal
expansion
• Bring
forward
by
four
years
£20
billion
of
tax
increases
pencilled
in
for
after
2015,
and
using
that
money
for
temporary
infrastructure
spending
worth
£20bn
in
those
four
years
• Reduce
spending
on
pensions,
increase
spending
on
capital
investment
• A
£10bn
cut
in
government
spending
on
welfare
to
fund
a
£10bn
cut
in
employers'
national
insurance
contributions
when
they
employ
extra
workers
Analyse
how
infrastructure
spending
financed
by
temporary
tax
rises
might
cause
an
expansion
of
real
GDP
for
a
country
such
as
the
UK
The
British
government
recognises
the
importance
of
infrastructure
spending
and
has
already
published
several
National
Infrastructure
Plans
with
many
£
billions
of
pounds
earmarked
for
projects
although
few
have
yet
to
get
off
the
ground
or
reached
completion.
Keep
in
mind
too
that
for
many
of
the
projects
mentioned
below,
the
government
is
seeking
a
combination
of
public
and
private
investment
money.
• Examples
of
infrastructure
investment
include:
o 2
nd
Forth Road Bridge
o Argyll wind farm array
o Cross Rail
o High Speed Rail project
o London Gateway Port
o London’s new super sewer
o Nuclear power plants e.g. the proposed one at Hinkley Point
The
hope
is
the
infrastructure
spending
creates
strong
multiplier
effects
leading
to
a
significant
effect
on
real
GDP,
employment
and
incomes.
• Many
projects
can
be
relatively
labour
intensive
such
as
road
widening,
housing
and
environmental
improvement
schemes

3. • Supply-­‐chain
businesses
will
benefit
from
producing
and
selling
the
raw
materials
and
components
needed
to
deliver
big
projects
• There
ought
to
be
an
accelerator
effect
on
planned
investment
e.g.
an
increased
demand
for
capital
machinery
such
as
earth-­‐moving
equipment
Well
planned
targets
also
have
longer-­‐run
economic
benefits:
1. Improvements
in
the
capacity
of
our
transport
systems
2. Stronger
energy
security
3. Facilitates
improved
geographical
mobility
of
labour
4. Better
logistics
and
transport
systems
can
–
in
the
long
run
–
help
to
reduce
prices
for
consumers
5. Greater
resilience
to
the
effects
of
volatile
weather
6. Increased
labour
productivity
from
more
efficient
transport,
telecommunications
and
logistics
7. Infrastructure
makes
the
economy
more
attractive
to
future
flows
of
inward
FDI
8. We
need
better
infrastructure
to
cope
with
forecast
population
growth
-­‐
the
Office
for
National
Statistics
forecasts
that
the
UK
population
will
grow
to
over
73
million
people
by
2035.
According
to
the
UK
government:
“Infrastructure
equips
a
country
for
future
economic
growth
-­‐
Infrastructure
must
strengthen
and
drive
the
economy,
create
jobs
and
act
as
a
key
enabler
for
future
economic
development
and
rising
living
standards
across
the
whole
country.
That
is
why
the
government
is
taking
steps
to
address
the
legacy
of
historic
under-­‐investment
and
short-­‐
term
thinking
in
our
key
infrastructure
sectors.”
What
are
the
counter-­‐arguments
to
the
“balanced
budget
fiscal
expansion”
view?
Fiscal
conservatives
argue
that
strong
action
is
needed
to
lower
the
deficit
both
in
absolute
terms
and
also
as
a
share
of
GDP.
They
argue
that
the
economy
will
benefit
in
the
medium
term
if
government
finances
are
brought
under
control:
1. Lower
borrowing
means
that
the
UK
economy
will
retain
a
high
credit
rating
and
this
will
mean
lower
interest
rates
on
government
debt
and
newly-­‐issued
corporate
bonds.
2. Less
interest
paid
on
debt
frees
up
more
money
to
be
reinvested
in
key
public
services
such
as
health
or
education
3. Reducing
the
debt
opens
up
the
possibility
of
consumer
and
business
tax
cuts
–
a
strategy
that
free
market
economists
support
as
a
way
of
stimulating
fresh
growth
in
the
private
sector
4. Tighter
control
of
government
spending
/
a
lower
fiscal
deficit
makes
it
more
likely
that
the
Bank
of
England
will
be
able
to
keep
policy
interest
rates
lower,
again
helping
the
economy
to
recover
more
strongly
5. Some
economists
have
claimed
that
economic
growth
tends
to
be
lower
on
average
among
countries
with
government
debt/GDP
ratios
above
90%

4. Chancellor
George
Osborne
has
talked
openly
about
an
expansionary
fiscal
contraction
–
a
stage
beyond
the
idea
of
the
balanced
budget
fiscal
expansion!
This
theory
argues
that
tightening
fiscal
policy
could,
through
exchange
rate
and
confidence
effects,
actually
increase
demand
and
growth.
Keynesian
economists
have
argued
that
this
is
economically
illiterate!
In
their
view,
fiscal
expansions
are
expansionary!
And
fiscal
austerity
is
contractionary!
Again
–
much
depends
on
the
size
of
the
estimated
fiscal
multiplier
effect.
We
are
told
in
the
case
study
introduction
(page
2)
that
fiscal
multipliers
are
estimated
to
be
in
the
range
of
0.9
to
1.7.
Keynesian
economists
would
support
the
larger
figure
-­‐
if
the
fiscal
multiplier
is
1,
then
a
reduction
in
the
budget
deficit
of
1%
of
GDP
reduces
output
by
1%.
But
a
figure
of
1.7
implies
that
fiscal
austerity
measures
that
cut
the
deficit
by
2%
or
more
could
bring
about
a
near
4%
reduction
in
output
in
the
short
term.

5. Glossary
of
Key
Terms
in
Extract
1
Automatic
fiscal
stabilisers
Tax
revenues
that
rise
and
government
expenditure
that
falls
as
GDP
rises.
The
more
they
change
with
income,
the
bigger
the
stabilising
effect
on
national
income
e.g.
during
a
recession
Balanced
budget
fiscal
expansion
A
policy
to
increase
AD
/
GDP
through
changing
government
spending
and
taxation
levels,
whilst
leaving
the
overall
fiscal
budget
situation
the
same
Consumer
confidence
The
level
of
confidence
or
pessimism
among
consumers
Economic
rebalancing
Altering
the
balance
of
economic
activity
e.g.
away
from
debt-­‐fuelled
consumption
and
imports
towards
a
higher
level
of
business
investment
and
exports
Economic
recovery
An
upturn
in
demand,
real
national
output
and
employment
Financial
sector
stability
The
stability
of
institutions
that
are
part
of
the
financial
system
such
as
banks
and
other
lenders
Fiscal
consolidation
Policies
designed
to
reduce
the
size
of
a
country’s
fiscal
deficit
Hysteresis
When
a
sustained
period
of
low
aggregate
demand
can
lead
to
permanent
damage
to
the
supply
side
of
the
economy
Inflation
A
persistent
rise
in
the
general
price
level
for
goods
and
services
Inflation
expectations
The
rate
of
increase
of
consumer
prices
expected
by
consumers.
Expectations
can
influence
spending
and
saving
decisions.
Infrastructure
The
transport
links,
communications
networks,
sewage
systems,
energy
plants
and
other
facilities
essential
for
the
efficient
functioning
of
a
country
and
its
economy
Investor
confidence
The
state
of
confidence
or
pessimism
among
businesses

6. Labour
market
performance
The
extents
to
which
a
country
can
achieve
a
sustained
fall
in
unemployment
and
avoid
under-­‐
employment
and
long
term
unemployment.
Monetary
stimulus
Changes
in
monetary
policy
designed
to
increase
aggregate
demand
including
lower
policy
interest
rates
and
measures
to
increase
the
supply
of
credit
Nominal
wage
growth
The
annual
growth
of
wages
unadjusted
for
inflation
Output
gap
Difference
between
actual
and
potential
national
output
Productive
capacity
The
ability
of
an
economy
to
supply
goods
and
services
–
determined
by
factors
that
affect
long
run
aggregate
supply
Quantitative
easing
(QE)
Central
banks
injecting
extra
cash
into
banking
system
Structural
deficit
The
size
of
a
fiscal
(budget)
deficit
adjusted
to
take
account
of
the
effects
of
changes
in
the
economic
cycle
Sustainable
budgetary
position
Extent
to
which
a
government
can
sustain
current
levels
of
spending
and
borrowing
–
affected
for
example
by
the
rate
of
interest
that
it
must
pay
on
new
issues
of
government
debt
Youth
unemployment
Lack
of
job
opportunities
for
people
aged
15–24
years
old