Fiscal Policy (Government Spending) Fiscal Policy and Government Spending

The Main Goals of Fiscal Policy –Equity concerns –Funding government spending I.e without getting into too much debt –The Benefit Principle To ensure that those who benefit from public services also meet as far as possible the costs of the services they consume –Macroeconomic Stability Fiscal policy can support monetary policy in ‘smoothing the path of aggregate demand over the economic cycle’

Main areas of public spending Welfare benefits Education Health Defence Law and Order Transport Environment Local Government Housing Industry, agriculture and the environment

Distribution of Public Spending

The growth of real government spending

Trends in Government Spending During the Nineteenth Century was low (approx 10% of national income). Big expansion during WW – 1951 saw the introduction of the Welfare State and a big expansion. Size of pubic sector continued to grow until 1970’s

Composition of Government Spending 1. Transfer Payments –Social security payments –Over £150 billion including Income support Jobseekers’ Allowance State Pensions Housing benefit / Council Tax Benefit –Some benefits are means tested –Others are universal or are based on national insurance contributions 2. Current spending on goods & services 3. Capital Spending –Infrastructural spending by the public sector –Spending that results in the acquisition of assets

Why Do We Have Government Spending? The provision of public and merit goods The redistribution of income and wealth Influencing regional resource allocation and industrial efficiency Influencing the level of economic activity

Government Spending – An Optimal Level? One debate is about how high public spending should be relative to national output (GDP) In the United States and many Asian countries, government spending is less than 30% of GDP In European countries, such as Germany and Sweden, it has been as high as 40-50%

Benefits from higher public spending Microeconomic benefits Improved funding for public services Wider access of public and merit goods Reduction in relative poverty Reduction in income inequality if there is a rise in the real value of welfare benefits Externality effects Macroeconomic benefits injection of aggregate demand Helpful as a boost to AD when the economy may be in a slowdown Regional employment effects from public sector investment projects Improvement in AS

Financing Government Spending 2006 – 2007 Predictions: Expenditure - £555bn Income - £518bn Most years the government runs a BUDGET DEFICIT. Government borrowing takes two main forms: 1. Borrowing from the Bank of England 2. Selling securities (bonds) If the govt borrows too much it increases the national debt, borrowing from the Bank of England increases the money supply which can be inflationary.

Concerns about rising public sector spending Doubts about the efficiency of the public sector –Waste – not all funding improves front-line services –Increased costs of administration –Higher wage inflation in the public sector Higher government spending has to be paid for –Prospect of rising taxation –Increased budget deficit –May crowd out the private sector of the economy