Distinction between automatic stabilisers & discretionary fiscal policy

• Automatic stabilisers:?these are?automatic fiscal changes?as the economy moves through stages of the business/trade cycle
  • E.g. A?fall in tax revenues?during a recession or an increase in state?welfare benefits paid out?when unemployment is rising
  • They do not require active intervention from the government but happen?automatically?in the background
• Discretionary fiscal policy:?a demand-side policy that uses government spending & taxation policy to influence aggregate demand (AD)

Distinction between a fiscal deficit & the national debt

• A fiscal deficit?occurs when the level of government spending is greater than the government tax revenue in any given year
• The national debt?is the accumulation of all previous deficits. The deficit in one year adds to the national debt from previous years

Distinction between structural & cyclical deficits

• Cyclical?deficits?occur due to downturns in the business/trade cycle, usually as a result of a recession
  • Governments receive?less tax revenue?as profits & income fall - &?government spending?increases
  • These deficits tend to?self-correct?as the economy starts to grow again
• Structural deficits?are present even when an economy may be operating at the?full employment level of output
  • These deficits are difficult to correct
  • These deficits may be caused by a widespread?tax avoidance culture, or poor governance

Factors Influencing the Size of Fiscal Deficits

Factors Influencing the Size of National Debts

• The size of the?deficits & national debt?can influence multiple factors in an economy
  • These factors tend to be more long-term in nature & can have?significant repercussions?should the level of national debt become unsustainable

1. Interest rates:?The higher the level of UK Government debt as a?proportion of GDP, the more concerned global lenders will be to?continue lending?to fund future deficits. This may require the UK to?raise interest rates?to entice lenders to make their money available to the UK government
2. Debt servicing:?there is an?opportunity cost?to paying back debt & debt interest. The higher the debt, the greater the opportunity cost e.g. every ￡ spent on paying back interest could have been spent on?education improvements?instead
3. Inter-generational equity:?today's borrowing has to be paid back from tax revenue received from future generations. The greater the debt, the greater the burden on the next generation of tax payers
4. Rate of inflation:?Inflation?reduces purchasing power (which is bad) but at the same time it allows the UK Government to pay back lenders with money worth less than when it was originally borrowed
5. Nation's credit rating:?Standard & Poor's is a?credit rating agency?based in the USA who provides credit ratings for different Nations. Investors use this to guide their lending. Countries with a good credit rating will be able to borrow funds at a lower interest rate
6. Foreign direct investment (FDI):?the higher the level of?external debt, the more foreign currency is required by the Government to pay it (e.g. UK borrowing from the USA in US$ needs to be repaid in US$). Countries may?run short of foreign currency?& one way to obtain more is to make foreign direct investment more attractive. This means more assets are?being sold?but it does bring in?more foreign currency?which can be used to facilitate repayments