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Fiscal and monetary policy

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Para educadores: diapositivas de la lección, apuntes de repaso listos para usar sobre Fiscal and monetary policy (Economics, The National Economy) — úsalos en tu lección, o presenta el tema como una actividad interactiva de clase que tus aprendices juegan como un juego en vivo.
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Apuntes de la lección

Fiscal policy

  • Fiscal policy uses taxation and public spending to influence activity, distribution and other aims. Expansionary measures seek to support demand; contractionary ones restrain it. Composition, capacity, financing and private responses determine the net effect; spending on productive assets can also affect future supply.
  • A deficit is spending above receipts over the same period and accounting basis; a surplus is the reverse. Public debt is a stock under a specified gross or net measure. Borrowing contributes to debt changes, but financial transactions, valuation and classification adjustments matter. A deficit is not automatically harmful or proof of a new stimulus.

Separate fiscal flows and stocks

Separate fiscal flows and stocksConceptMeaningFiscalpolicySpending and taxation decisionsDeficitSpending above receipts in a periodSurplusReceipts above spending in a periodDebtOutstanding stock under a specifiedmeasureBudgetchangeCan reflect policy and the economic cycle

Taxes

  • Income tax, corporation tax and the teaching classification of National Insurance are direct, while VAT and product duties are indirect. NI includes relevant employee, self-employed and employer contributions and helps determine entitlement to certain benefits and State Pension. Actual rates and thresholds require current official rules, which are not calculated here.
  • Progressive, regressive and proportional describe the average burden relative to a stated income or base. Marginal tax on the next slice differs from the average rate. VAT may be regressive against current income when lower-income households spend a larger share on taxed consumption, but exemptions, saving, lifetime resources and the wider tax-benefit system affect the assessment.

Classify two different tax dimensions

Classify two different tax dimensionsDimensionExamples or meaningDirect /indirectIncome tax / VAT in the teachingclassificationProgressiveAverage share rises with the relevantbaseRegressiveAverage share falls with the relevantbaseProportionalAverage share stays constantMarginal rateRate on the next slice, not all income

Monetary policy

  • The UK MPC sets Bank Rate to pursue price stability under the government’s 2% CPI inflation target. This target differs from current inflation and current Bank Rate. Changes in relevant market rates can alter borrowing, saving, asset prices, expectations and exchange rates, affecting demand and price pressure with lags.
  • Higher borrowing costs may restrain spending, while savers may gain income. Fixed loans may respond later at reset and lending depends on credit conditions. QE purchases assets with newly created reserves, seeking to influence yields and broader conditions; it is not a household cash handout or a guarantee of new bank loans. Monetary policy does not directly create scarce energy or productive capacity.

A possible interest-rate channel

A possible interest-rate channelBank Rate risesBorrowing costsmay riseSaving returnsmay riseSpending mayslowDemand pressureeasesInflation mayfall

Evaluating policy

  • Evaluate recognition, decision, implementation and transmission lags; policy can arrive after conditions have changed. Fiscal effects depend on recipients’ spending, imports, capacity and funding; monetary effects depend on pass-through, credit and expectations.
  • Distribution and trade-offs matter: some borrowers lose while some savers gain from rate rises; demand restraint may lower inflation pressure but reduce output or employment. Deficit finance can stabilise activity or support useful investment while adding future financing exposure. Lower inflation is not necessarily falling prices.

Evaluate the policy chain

Evaluate the policy chainConditionWhy it mattersSparecapacityReal output versus price pressurePass-throughPolicy rate versus actual contractsTime lagsResponse may arrive after conditions changeDistributionBorrowers, savers and recipients differProblem’scauseDemand policy does not directly fix everysupply loss

Worked deficit and debt example

  • Fictional opening debt £1,000bn; Year 1 spending £950bn less receipts £900bn gives deficit £50bn and closing debt £1,050bn if other adjustments are ignored. Year 2 spending £940bn less receipts £900bn gives deficit £40bn and closing debt £1,090bn.
  • The deficit falls but remains positive, so the simplified debt stock keeps rising. Keep flows and stocks, periods and accounting bases distinct. In official data, debt changes can differ from borrowing because financial and valuation adjustments also occur.

Fictional deficit and debt, £bn

Fictional deficit and debt, £bnMeasureYear 1 / Year 2Receipts900 / 900Spending950 / 940Period deficit50 / 40Opening debt1,000 / 1,050Closing debt1,050 / 1,090

Asset purchases and financial conditions

  • In QE the central bank creates reserves to buy assets, mainly bonds in the UK programme. Purchases can raise bond prices and lower yields, encourage portfolio changes and influence broader financing and spending conditions. Effects depend on the circumstances and other market forces.
  • The reserves are central-bank liabilities held by eligible institutions, not simply banknotes handed to households. QE does not guarantee more bank credit or directly equate to tax-funded public spending. Quantitative tightening reduces asset holdings through relevant arrangements; its effects are also conditional.

QE: mechanism and limits

QE: mechanism and limitsStep or questionWhat it involvesFundingNew central-bank reservesTransactionCentral bank purchases assetsFinancial channelPrices, yields and portfolio choicesIntended widereffectSupport financing, spending andinflationImportant limitNo guarantee of new bank loans

Worked average-tax comparisons

  • Fictional supplied totals: £3,000 tax on £30,000 income is 10%; £12,000 on £60,000 is 20%, illustrating a progressive average burden. A proportional 10% tax would take £3,000 and £6,000 respectively. These are not actual UK tax liabilities.
  • A fixed £1,000 charge is 10% of £10,000 income but 2% of £50,000, regressive relative to these annual incomes. The label depends on the comparison base and period. It does not mean the lower-income person necessarily pays more pounds than the higher-income person.

Fictional average tax burdens

Fictional average tax burdensSupplied caseAverage income shareIncome £30,000; tax £3,00010%Income £60,000; tax £12,00020%: progressivecomparisonFixed £1,000 on £10,000income10%Fixed £1,000 on £50,000income2%: regressive comparison

Automatic stabilisers and contracts

  • When activity falls, existing rules may generate lower receipts and higher eligibility-based benefit payments. These automatic stabilisers cushion disposable income without a new discretionary policy decision, although they cannot prevent every downturn.
  • Contract timing also matters. Fictional interest-only £10,000 at 4% costs £400 interest per year; a reset to 6% costs £600, up £200. An existing fixed-rate contract may not change immediately. Principal repayments and fees are excluded from this example.

Automatic or discretionary?

Automatic or discretionary?ChangeClassificationReceipts fall as income fallsAutomatic underunchanged rulesBenefit eligibility rises indownturnAutomatic underunchanged rulesNew government purchaseprogrammeDiscretionary spendingdecisionNew legislated tax reductionDiscretionary taxdecisionMPC changes Bank RateMonetary-policy decision

Diapositivas

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Preguntas de práctica

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  1. 1.What is fiscal policy?

    Easy
    • Ausing spending and taxes to influence the economy
    • Busing interest rates
    • Cusing trade
    • Dusing prices

  2. 2.What is monetary policy?

    Easy
    • Ausing taxes
    • Busing spending
    • Cusing trade
    • Dusing interest rates and the money supply

  3. 3.What is a budget deficit?

    Easy
    • Ano spending
    • Bno tax
    • Cgovernment spending exceeds receipts over the stated period
    • Drevenue exceeds spending

  4. 4.What is a budget surplus?

    Easy
    • Ano spending
    • Bgovernment receipts exceed spending over the stated period
    • Cspending exceeds revenue
    • Dno tax

  5. 5.What is the national debt?

    Easy
    • Athe outstanding stock of public liabilities under a specified measure
    • Byearly deficit
    • Ctax revenue
    • Dinterest rate

  6. 6.Which is a direct tax?

    Easy
    • AVAT
    • Bfuel duty
    • Calcohol duty
    • Dincome tax

  7. 7.Which is an indirect tax?

    Easy
    • Acorporation tax
    • BNational Insurance
    • CVAT
    • Dincome tax

  8. 8.What is a progressive tax?

    Easy
    • Ano tax
    • Bthe average tax share rises as the relevant income or base rises
    • Cpoorer pay more
    • Dsame rate for all

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