• Assess the impact of an increase in Government spending on education and health care.

1. Government spending G is a component of AD. Therefore there will be an increase in AD and potentially economic growth.

2. There will be an increase in government borrowing, to fund the increased expenditure.

3. Higher AD may cause inflation.

4. In the long term higher spending on education, and to a lesser extent health care, may cause an increase in labour productivity and therefore AS. Over time AS may increase at a faster rate and lead to an increase in the underlying trend rate of economic growth.

EVALUATION

5. Other components of AD. The effect of higher G depends on other components of AD. For example, if consumer spending was low due to lower house price, then AD may not increase at all. If the government increased taxes to pay for the higher spending then AD would not increase.

6. Multiplier Effect. Higher G may lead to a multiplier effect. This means the initial increase in government spending causes a bigger final increase in GDP. E.g. nurses and teachers have more to spend so others benefit.

7. Side Effects. To spend more the government need to borrow. However, this could cause crowding out. This means the government spends more, but because the private sector lend money to the government they have less to spend themselves; therefore AD doesn't actually increase.

8. Efficiency of spending. It depends on how efficient the government spending is. Spending on education may not increase labour productivity

9. State of Economy. The effect of higher spending government spending depends on the state of the economy. For example, if the economy is in recession then an increase in AD will help to increase growth without causing inflation, but if the economy is at full capacity it will cause inflation.

10. Time Lags. The effects of higher government spending will take a long time to have an effect.

Labels: fiscal policy

The Golden Rule states that over the economic cycle, the Government will borrow only to invest and not to fund current spending.

Therefore, over the economic cycle the current budget (ie, net of investment) must balance or be brought into surplus.

The argument is that government borrowing has many disadvantages.

See: Problems of Government borrowing

The golden rule means that basically, borrowing is justified for 2 reasons:

1. In a recession to increase AD (expansionary fiscal policy)
2. To finance public sector investment, which can increase economic growth in the long term.

See: Advantages of Government borrowing

In practise, the golden rule open to manipulation and different interpretations. For example, by changing the start of the economic cycle to 2 years earlier, Gordon Brown was able to justify an extra £12 billion in borrowing

The chancellor Gordon Brown also has a sustainable investment rule. This states national debt should always be less than 40% of GDP.

Related:

• Economic Record of Gordon Brown
  
• Meeting the golden rule
  
• Fiscal Policy
  
• A black hole in the Golden rule at Economics UK
  

Labels: fiscal policy

government borrowing is when spending is higher than taxation revenue.

Problems from Government Borrowing.

1. Expansionary Fiscal Policy may cause Inflation

A Government deficit means Injections (government spending) are higher than withdrawals (taxations) Therefore, this has the effect of increasing AD. If the economy is close to full capacity and growing at the long run trend rate, higher AD may lead to inflationary growth. If the economy is in recession or growing below trend rate, higher borrowing may increase growth, without causing inflation.

2. Higher Taxes in the Future.

High borrowing now leads to higher taxes in the future; this is a burden on future generations. Higher income taxes may reduce productivity in the future.

3. Crowding Out.

This is an argument to say that higher government borrowing may lead to a fall in private sector spending and investment. This is because government borrowing means that they need to borrow from the private sector. If the government are borrowing from the private sector (selling bonds) it means they have less to spend. Therefore, there may not be any increase in AD. Furthermore, it is argued that government spending is more inefficient than private sector spending. Therefore government borrowing may cause greater inefficiency.
However, it depends on why the government are borrowing, if they are borrowing to finance investment in education, this may lead to an increase in productivity in the long term. Also, Keynesians argue government borrowing will not cause crowding out, if the economy is in recession the government is merely helping to use resources that are currently idle.

4. Financial Crowding out.

It is argued that high levels of government borrowing can put upward pressure on interest rates. This is because if the government need to borrow large sums of money, they may have to increase interest rates to attract enough investors. Higher interest rates will lead to lower growth and lower investment in the long term.

5. Demographic Factors will Exacerbate the problem in the future.

In many western economies, demographic factors will worsen government's fiscal positions in the future. This is because of the aging population. The baby boomer generation is about to retire, therefore, the government will have higher spending requirements and lower taxes.
Basically any problems in government problems will be exacerbated in the future.

Related essays and revision notes

• Fiscal Policy
• Government Deficits
• Advantages of Budget Deficits
  

Labels: fiscal policy