Public Sector Finances (Edexcel A Level Economics A)

Public Sector Finance Terminology

Distinction between automatic stabilisers and 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 and taxation policy to influence aggregate demand (AD)

Distinction between a fiscal deficit and 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 and 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 and income fall - and 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 Fiscal Deficits

Factors Influencing the Size of National Debts

Factors Influencing the Size of National Debts

The Significance of the Size of Deficits & National Debts

• The size of the deficits and national debt can influence multiple factors in an economy

  • These factors tend to be more long-term in nature and 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 and 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 and 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 and 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