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

Social protection**28% Other health and personal

social services5%

Education13%

Other expenditure*10%

Housing & environment3%

Law & order6%

Industry, agriculture & employment

4%

Debt interest5%

Defence6%

Transport3%

Health17%

GOVERNMENT SPENDING BY FUNCTION 2004-05 (Projections)

The growth of real government spending

Real leal of government final consumption at constant 2000 pricesGovernment final consumption expenditure

Source: EcoWin

Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q300 01 02 03 04 05 06

2001

GB

P (b

illio

ns)

180

185

190

195

200

205

210

215

220

225

Trends in Government Spending

During the Nineteenth Century was low (approx 10% of national income).

Big expansion during WW2

1945 – 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