The cumulative total of outstanding government borrowing is known as National Debt. Although the casual relationships are not now very well understood, countries with national debt levels above 90% of GDP, as opposed to those with a much lower debt are much more associated with
1. More frequent and severe financial crises,
2. Significantly slower economic growth, and
3. Higher rates of inflation.
Mention should also be made of the cost of servicing a high national or government debt. High debt, high interest charges and thus it prevents other uses of that money by government and can lead to higher taxes and significantly reduced current spending.
This refers to whether the government is increasing Aggregate Demand (AD) or decreasing AD In other words – the government has an Expansionary (or loose) Fiscal Policy.
• This involves increasing AD, therefore the government will increase spending (G) and cut taxes. Lower taxes will increase consumers spending because they have more disposable income(C). This could worsen the government budget deficit
Deflationary (or tight) Fiscal Policy
• This involves decreasing AD, therefore the government will cut government spending (G) and/or increase taxes. Higher taxes will reduce consumer spending (C). This will lead to an improvement in the government budget deficit
Fine Tuning: This involves maintaining a steady rate of economic growth through using fiscal policy. However this has proved quite difficult to achieve.
Automatic Fiscal Stabilisers
If the economy is growing, people will automatically pay more taxes (VAT and Income tax) and the Government will spend less on unemployment benefits. The increased T (tax) and lower G will act as a check on AD.
In a recession the opposite will occur with tax revenue falling but increased government spending on benefits, this will help stabilise AD
Discretionary Fiscal Stabilisers
This is a deliberate attempt by the government to affect AD and stabilise the economy, e.g. during a boom the government will increase taxes to reduce inflation
This is an increase of expenditure into the circular flow, it includes govt spending(G), Exports (X) and Investment (I)
This is leakage from the circular flow this is household income that is not spent in the circular flow. It includes:
Net savings (S) + Net Taxes (T) + Net Imports (M)
Note Fiscal Policy was particularly used in the 1950s and 1960s to stabilise economic cycles in Europe. These policies were broadly referred to as ‘Keynesian’.
In the 1970s and 1980s governments tended to prefer monetary policy for influencing the economy.
There are many factors which make successful implementation of fiscal Policy difficult.