Fiscal Policy 25 Markers
1. To what extent should government borrowing be a cause for concern? (25 marks)
Introduction
National debt is the total debt outstanding for a nation: the total amount borrowed minus
the total amount repaid over time.
Yes
The longer deficits persist without appropriate action, the bigger and more painful the
needed actions will be down the road in theory
Higher interest payments
o As borrowing increases the government has to pay more interest rate payments on
those who hold bonds
o Leads to greater percentage of tax revenue going to debt interest payments
Future tax rises and spending cuts
o If debt to GDP rises rapidly the government may need to reduce debt levels in the
future
o Means future budgets will need to increase taxes and or limit spending
o If they don’t raise taxes, markets may be alarmed at the size of borrowing
Crowding out of the private sector
o The government borrow from the private sector by selling bonds
o Because the private sector lends money to the government they have less money to
spend and invest
o Although government spending increases, private sector spending falls
o Government spending may be more inefficient than the private sector so there is a
decline in output
Higher interest rates
o Markets are nervous about governments ability to repay and they demand higher
bond yields in return for perceived risk
o Problem in countries in the Eurozone in 2011/12
o High inflation – investors demand higher bond yields – 1970s
o Higher interest rates on government bonds push up other interest rates and reduce
spending and investment
No
Most tax and spending charges are political rather than economic in nature
Depends on the state of the economy
o In a recession borrowing can be beneficial in creating economic stimulus and
shortening the recession
Depends on the levels of domestic saving
o If there is a strong domestic demand for buying government borrowing then bond
yields will be low
o 2016 – national debt over 225% of GDP
Depends on levels of government debt
, o If bond yields are low and borrowing is relatively low a government can finance debt
by a relatively small share of tax revenues
o The debt is manageable
o Higher public sector debt could lead to lower interest rates
2. To what extent do you agree, if at all, that the implementation of a budget deficit
reduction programme will improve the UK’s long-term economic prospects? Justify your
answer. [25 marks]
Agree
Increase in national debt
Higher debt interest payments
Crowding out
Inflation
Higher bond yields
Lack of confidence
Long term negative effects if the budget deficit proceeds to increase
Disagree
Increases aggregate demand and economic growth
Makes use of surplus saving in a recession
Automatic stabilisers
Finance public sector investment
If government borrowed to invest in improving infrastructure it might be able to overcome
market failure and improve the productive capacity of the economy
o Economy benefits in the long term
Evaluation
Key factor is the timing of deficit reduction plans
If the country is already in recession it is more difficult to reduce the deficit because fiscal
consolidation worsens the economic situation leading to lower tax revenues
o Austerity can be self defeating
Best way to reduce deficit is to aim for positive economic growth
Long term evaluate government spending commitments and reduce spending to sustainable
levels
3. Evaluate whether achieving a budget surplus is a desirable objective of economic policy.
(25)
Yes
A budget surplus occurs when government revenue is higher than government spending
plus transfer payments
Additional money to spend at the end of the financial year
Extra money can pay off debts or be reinvested into other projects
It can be returned to the public in the form of price or tax cuts
1. To what extent should government borrowing be a cause for concern? (25 marks)
Introduction
National debt is the total debt outstanding for a nation: the total amount borrowed minus
the total amount repaid over time.
Yes
The longer deficits persist without appropriate action, the bigger and more painful the
needed actions will be down the road in theory
Higher interest payments
o As borrowing increases the government has to pay more interest rate payments on
those who hold bonds
o Leads to greater percentage of tax revenue going to debt interest payments
Future tax rises and spending cuts
o If debt to GDP rises rapidly the government may need to reduce debt levels in the
future
o Means future budgets will need to increase taxes and or limit spending
o If they don’t raise taxes, markets may be alarmed at the size of borrowing
Crowding out of the private sector
o The government borrow from the private sector by selling bonds
o Because the private sector lends money to the government they have less money to
spend and invest
o Although government spending increases, private sector spending falls
o Government spending may be more inefficient than the private sector so there is a
decline in output
Higher interest rates
o Markets are nervous about governments ability to repay and they demand higher
bond yields in return for perceived risk
o Problem in countries in the Eurozone in 2011/12
o High inflation – investors demand higher bond yields – 1970s
o Higher interest rates on government bonds push up other interest rates and reduce
spending and investment
No
Most tax and spending charges are political rather than economic in nature
Depends on the state of the economy
o In a recession borrowing can be beneficial in creating economic stimulus and
shortening the recession
Depends on the levels of domestic saving
o If there is a strong domestic demand for buying government borrowing then bond
yields will be low
o 2016 – national debt over 225% of GDP
Depends on levels of government debt
, o If bond yields are low and borrowing is relatively low a government can finance debt
by a relatively small share of tax revenues
o The debt is manageable
o Higher public sector debt could lead to lower interest rates
2. To what extent do you agree, if at all, that the implementation of a budget deficit
reduction programme will improve the UK’s long-term economic prospects? Justify your
answer. [25 marks]
Agree
Increase in national debt
Higher debt interest payments
Crowding out
Inflation
Higher bond yields
Lack of confidence
Long term negative effects if the budget deficit proceeds to increase
Disagree
Increases aggregate demand and economic growth
Makes use of surplus saving in a recession
Automatic stabilisers
Finance public sector investment
If government borrowed to invest in improving infrastructure it might be able to overcome
market failure and improve the productive capacity of the economy
o Economy benefits in the long term
Evaluation
Key factor is the timing of deficit reduction plans
If the country is already in recession it is more difficult to reduce the deficit because fiscal
consolidation worsens the economic situation leading to lower tax revenues
o Austerity can be self defeating
Best way to reduce deficit is to aim for positive economic growth
Long term evaluate government spending commitments and reduce spending to sustainable
levels
3. Evaluate whether achieving a budget surplus is a desirable objective of economic policy.
(25)
Yes
A budget surplus occurs when government revenue is higher than government spending
plus transfer payments
Additional money to spend at the end of the financial year
Extra money can pay off debts or be reinvested into other projects
It can be returned to the public in the form of price or tax cuts
