4.5.3 Public Sector Finances

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

State of the economy	Housing Market
Government revenue often increases in a boom & decreases in a recession. Government spending often decreases in a boom & increases in a recession. Fiscal deficits tend to increase as the state of the economy worsens	The government receives an indirect tax from property sales (stamp duty). This revenue increases when an economy is doing well & helps to reduce fiscal deficits
Political priorities	Unforeseen events
If political priorities change then the size of the fiscal deficit can change e.g. after the UK Government has spent billions in rescuing the economy after the Global Financial Crisis of 2008 they prioritised austerity with the focus of eliminating the deficit	Many unforeseen events occur each year which require government support e.g. The Russian war on Ukraine started in February 2022 & by June 2022 the UK Government had spent £2.8 bn. in providing assistance (it is worth noting that much of this went to the UK military industry to pay for weapons which were donated to the Ukraine. This increased UK GDP)

Factors Influencing the Size of National Debts

Factor	Explanation
Size of fiscal deficits	As national debt is the accumulation of annual fiscal deficits, the size of the fiscal deficit each year will grow by the size of the deficit If the UK were to run a budget surplus in any year, this additional revenue could be used to pay back some of the debt - or it may be used to fund government spending or investment in the following year
Government policies	These directly impact tax revenue & government spending which can change the level of the fiscal deficit leading to a change in the national debt level E.g. Reducing corporation tax during a boom in the economy will reduce government revenue & possibly increase the deficit & national debt at a time when the deficit would naturally be decreasing due to the automatic stabilisers

• 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