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Unformatted text preview: FISCAL POLICY 2010 Macroeconomics: Mo Tanweer; Harriet Thompson; Andrew Ellams [email protected] Key objectives of the topic You should understand: Fiscal policy What it is… why its important What are the current (UK) trends in fiscal variables What has been causing this Evaluate the problems of running fiscal deficits Key terminology What is “fiscal policy”? Automatic stabilisers Budget deficit National Debt Golden Rule Expansionary vs Contractionary fiscal policy Direct taxes vs Indirect taxes PSBR vs PSNCR Cyclical vs Structural deficit Capital vs Current G Budget 2009 (T) Budget 2009 (G) Budget position £676 bn (G) - £498 bn (T) = -£178 bn i.e. a budget deficit What is the relationship between this number and the national debt? What does this mean in context? £178 billion new borrowing this year works out as: £487,671,000 a day in extra borrowing £20,319,600 an hour in extra borrowing £338,660 a minute in extra borrowing £5,643 a second in extra borrowing Compared to revenues of…: The average person earns about £25,000 per annum They get a personal tax allowance of £6,475 in 2009/10 Their taxable income is there £18,525 They will pay the BASIC INCOME TAX RATE of 20% on this That is £3,705 However they will also pay National Insurance at about 9.4% That is another £1,741.35 Making their DIRECT TAX BILL = £5,146.35 in 2009/10 The Government is borrowing more in ONE second, than one (average) person’s entire direct tax bill for a year. What has happened to the deficit? Keynesian stimulus Bank bailouts Consumption down Corporation tax receipts Recession Ratchet Effect Financing two wars Unemployment Net debt At the end of January 2010, net debt was £848.5 billion, equivalent to 59.5% of GDP. This is predicted to rise to almost 80% of GDP by 2013/2014. Print money to finance it? Inflation… higher interest rates… crowding out Don’t Panic Alistair Darling has already leaked that the March 2009 Budget GROWTH FORECASTS were overoptimistic at -3.75% for 2009 and revised it to -4.75% in this PBR Explain the trend in the two variables between 2015-2018 Evaluating a (£178bn) deficit The interest burden. What happens when Inflation Global coordinated fiscal rates rise? expansion Greece Mark II? Fiscal expansion necessary % of GDP (fiscal drag) Monetary policy weak Compared to other countries? Credit ratings Breaches Golden Rule Bond yields / exchange rates /equity markets / Economists’ letter Can we finance it? (When QE ends?) Mervyn King; Breaches Sustainable Investment Rule Euro membership? Capital G? Crowding out (in?) Credibility Intergenerational Ricardian Equivalence issues “Today’s borrowing is tomorrow’s taxes”. International competitiveness …as a % of GDP Explain the gap between the red and blue lines …structural deficit comparison: Why has the deficit increased? The primary balance is government net borrowing excluding interest payments on government liabilities. The tax burden is the ratio of tax receipts to GDP. Structural balances among the EU member states What does the UK spend comparatively more or less on than other EU members? EU comparisons …International comparison: PIIGS contagion …Greece Mark II? The UK could be the next Greece! Last month an OECD list of the countries with the most vulnerable public finances put Britain in fourth place behind Ireland, Greece and Portugal - the 'PIIGS‘ because of their hefty government debt burdens and uncompetitive economies. FISCAL RULES FRAMEWORK 1998 (The Code for Fiscal Stability) Golden Rule Over the economic cycle, the government will borrow only to invest and not to fund current government spending. Sustainable Investment Rule Government net debt as a percentage of GDP will be held over the economic cycle at a stable and prudent level (around 40% of GDP). A Budget Deficit spent building the CAPITAL STOCK of the nation be that in PHYSICAL CAPITAL such as new infrastructure, new hospitals, new schools, better classrooms, more medical scanning equipment, more tanks… or in improving the HUMAN CAPITAL of the nation through better training and education will NOT be a problem. It will raise the capacity of our economy and subsequently bring in more tax revenue through the growth that it causes and may be more than self-financing. E.g. real terms p.a. increases in the NHS budget of 7.2% every year between 2002 and 2007 Gordon Brown’s prudent rules broken But “extraordinary times require extraordinary measures”… The Temporary Operating Rule “to set policies to improve the cyclically adjusted current budget each year once the economy has emerged from the downturn, so it reaches balance and debt is falling as a proportion of GDP once the global shocks have worked through the economy in full.” TRANSLATED as: fiscal deficit to be back below 3% by 2015/16 National Debt to start falling as a proportion of GDP as per the new Rule in 2015/16 Get the Queen to say it maybe they’ll believe her …% change in recent years: …as a % of real GDP UK bondholders in 2008/09 according to Debt Management Office The Maastricht criteria In addition to these five self-imposed criteria, the UK would also have to meet the EU's economic convergence criteria ("Maastricht criteria") before being allowed to adopt the euro. These are: 1. Inflation rate No more than 1.5 percentage points higher than the three lowest inflation member states of the EU. 2. Government finance (the Stability and Growth Pact) Annual government deficit: The ratio of the annual government deficit to GDP must not exceed 3% at the end of the preceding fiscal year. If not, it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases. Government debt: The ratio of national debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace. 3. Exchange rate Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for two consecutive years and should not have devaluated its currency during the period. 4. Long-term interest rates The nominal long-term interest rate must not be more than two percentage points higher than in the three lowest inflation member states. The Maastricht criteria How is the UK doing if we update the charts below? The Stability and Growth Pact Given recent economic conditions, EU leaders have agreed that the flexibility provided for in the Stability and Growth Pact should be used, so that fiscal consolidation is only undertaken in line with economic recovery. Under the excessive deficit procedure, to which 20 (of the 27) EU member states are now subject, the EU’s Economic and Financial Affairs Council has recommended that the UK brings its budget deficit below the 3% reference value by 2014-15. •Is the UK on track to do this? UK SAYS NO!! •Will other EU countries achieve the target? And if you are still worried… There have already been political clashes over the speed of reduction of the budget deficit. Cameron Government spending will have to grow less than the UK economy for the next 5-6 years. ALL PARTIES AGREE ON THIS! (but disagree on where and how fast to do it) Tax revenues will have to rise faster than growth of the economy. ...
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This note was uploaded on 02/08/2012 for the course ECO 51844 taught by Professor Sabet during the Spring '11 term at FIU.

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