4.5.3 Public sector finances Quiz: Pearson Edexcel Economics A, Unit 4

The 20 questions

1. What is the difference between automatic stabilisers and discretionary fiscal policy?

   • Automatic stabilisers only operate in booms, while discretionary policy only operates in recessions, in every case
   • Automatic stabilisers and discretionary policy are the same thing, because both involve changes in the level of tax
   • Automatic stabilisers are set by the central bank, while discretionary policy is set by the government in its budget
   • Stabilisers respond to the cycle without new decisions, while discretionary policy involves deliberate changes to tax or spending

2. Which is an example of an automatic stabiliser?

   • A cut in income tax rates announced in the budget to boost consumer spending in a recession that year
   • Higher spending on unemployment benefits when the economy falls into recession, without any new policy decision
   • A decision by the government to build a new railway line to stimulate growth in a depressed region
   • A change in the central bank's interest rate to influence the level of demand in the economy

3. Which is the difference between a fiscal deficit and national debt?

   • National debt is the annual shortfall of spending over revenue, while a fiscal deficit is the total of all past borrowing
   • A fiscal deficit and national debt are the same measure, both recorded as the total sum of all taxes collected
   • A fiscal deficit is the total debt owed to foreign creditors, while national debt is the annual flow of tax revenue
   • A fiscal deficit is the annual shortfall of spending over revenue, while national debt is the accumulated stock of past borrowing

4. A government runs a fiscal deficit of £100bn in a year. What happens to the national debt?

   • It is unchanged, because deficits are cancelled out by the interest the government earns on its reserves
   • It falls by £100bn, since a deficit is the amount the government saves in each year of the budget
   • It rises by roughly £100bn, all else equal, since the deficit adds to the stock of borrowing
   • It rises by £200bn, since a deficit is always counted twice, once as a loan and once as spending

5. What is a structural deficit?

   • The part of the deficit that is paid by foreign investors who hold government bonds in the economy
   • The part of the deficit that would remain even if the economy were operating at full employment
   • The part of the deficit that is caused by the central bank's interest rate decisions in the economy each year
   • The part of the deficit that arises only because the economy is in a recession and tax revenues have fallen

6. What is a cyclical deficit?

   • The part of the deficit that depends on the position of the economic cycle, rising in recessions and falling in booms
   • The part of the deficit caused by government decisions to cut taxes permanently, regardless of the state of the economy
   • The part of the deficit that comes from fixed long-term commitments such as public sector pension payments each year
   • The part of the deficit that remains constant over the business cycle regardless of the level of output in the economy

7. A government's total deficit is £120bn. Its estimated structural deficit is £70bn. What is its cyclical deficit?

   • £70bn, since the cyclical deficit always equals the structural deficit in every year of the cycle
   • £50bn, since the cyclical part is the total deficit minus the structural part, 120 - 70
   • £120bn, since the total deficit is always the same as the cyclical deficit by definition in the accounts
   • £190bn, since the cyclical part is found by adding the structural and total deficits together

8. Which of these is a factor influencing the size of a fiscal deficit?

   • The number of public holidays in a year, which determines how much tax is collected from workers each year
   • The colour of government bonds, which determines how much investors are willing to lend to the government
   • The state of the economic cycle, since recessions lower tax revenue and raise spending on benefits
   • The size of the country's population, which by itself always determines whether the deficit is high or low

9. Which factor is most likely to increase the size of a country's national debt over time?

   • Persistent fiscal deficits, since each year's deficit adds to the stock of borrowing that must be repaid
   • A period of rapid economic growth with a balanced budget, since growth always requires new borrowing by government
   • Persistent fiscal surpluses, since surpluses increase the government's borrowing each year to fund its reserves
   • A fall in interest rates on government debt, which always raises the cost of servicing the national debt

10. Why might a higher interest rate on government debt increase the size of the national debt?

    • Higher interest rates always cancel out the national debt, since the central bank holds all government bonds
    • Higher interest rates reduce the cost of borrowing, so the government borrows less and the debt falls each year
    • Interest rates have no effect on government debt, because bonds always pay a fixed return regardless of the market
    • Higher interest payments add to the government's spending, so the deficit and the borrowing needed rise

11. Why is the size of a national debt relative to GDP important?

    • It has no significance, because debt relative to GDP is always the same for all countries in the world economy
    • It indicates whether the debt is manageable, since a rising ratio can signal growing risk of unsustainable borrowing
    • It shows the number of taxpayers, since the debt ratio is calculated from the population rather than output
    • It shows only the value of the currency, since the debt ratio is the exchange rate measured in terms of output

12. A country has national debt of £1.6tn and GDP of £2.0tn. What is its debt-to-GDP ratio?

    • 125 per cent, since 2.0 / 1.6 is approximately 1.25 and that is the debt-to-GDP ratio
    • 20 per cent, since the debt-to-GDP ratio is the difference between GDP and debt as a share of the total
    • 80 per cent, since 1.6 / 2.0 = 0.8
    • 3.6 per cent, since 1.6 plus 2.0 gives 3.6 and that figure is then taken as a percentage

13. What is a significant risk of a large and rising national debt?

    • It guarantees faster economic growth, since government borrowing always raises demand and productive investment
    • It always lowers interest rates for private borrowers, since the government absorbs all available savings each year
    • It removes the need for taxation in future years, since the debt is always repaid by the central bank without cost
    • Higher debt interest payments can crowd out other spending and raise the risk of a loss of confidence in government bonds

14. Why might the government's deficit be considered to affect future generations?

    • Debt always benefits future generations, because it funds investment that is paid for entirely by those who borrow
    • Debt has no effect on future generations, since all debts are cancelled automatically when a new government is elected
    • Debt built up today must be serviced and repaid from future tax revenue, so future taxpayers bear part of the cost
    • Future generations are unaffected, since debt is always owed by the government and never by the taxpayers of the future

15. Which statement best evaluates the view that a fiscal deficit is always harmful?

    • Deficits are never harmful, since governments can always borrow without limit and without any risk to the economy
    • Deficits have no effect on the economy, because all government borrowing is cancelled out by private saving each year
    • It depends on the context: deficits can be appropriate in recessions and productive investment, but persistent deficits raise debt risks
    • Deficits are always harmful in every case, since any borrowing by government reduces economic growth in all circumstances

16. A government spends £800bn and receives £750bn in revenue in a year. What is its fiscal deficit for that year?

    • £1,550bn, since 800 plus 750 gives the total of spending and revenue for the year
    • £800bn, since the deficit is always equal to total government spending in the year
    • £50bn, since 800 minus 750 gives the shortfall of spending over revenue
    • £750bn, since the deficit is always equal to total government revenue in the year

17. Which factor would reduce the debt-to-GDP ratio without any change in the stock of debt?

    • A rise in the government's spending, which raises the stock of debt without any change in GDP
    • A fall in nominal GDP, which reduces the economy's capacity to produce and so lowers tax revenues
    • A rise in the level of interest rates on government bonds, which increases the value of debt held by investors
    • Faster nominal GDP growth, which increases the denominator of the ratio

18. Why might a structural deficit be a greater concern than a cyclical deficit?

    • It persists when the economy recovers, so it signals a long-run imbalance between spending and tax revenue
    • It is always smaller than the cyclical deficit, so it can be ignored in most budget discussions each year
    • It disappears automatically when the economy recovers, so it never needs any policy response at all
    • It depends only on the central bank's interest rates, so the government cannot influence it through its budget

19. A government raises taxes by 2 per cent of GDP to reduce its deficit. How is this best described?

    • Expansionary automatic stabiliser, since tax rises automatically increase demand in the economy
    • Monetary policy, since changes in taxes are always carried out by the central bank through interest rates
    • Contractionary discretionary fiscal policy, since a deliberate tax rise reduces aggregate demand
    • Supply-side policy, since higher taxes always raise productivity and so improve the economy's long-run growth

20. Which change would most directly widen a fiscal deficit without any change in government policy?

    • A rise in the price of government bonds, which reduces the amount the government needs to borrow each year
    • A fall in the number of public sector workers, which reduces wage spending on public services each year
    • A rise in employment, which raises tax revenue and reduces benefit spending automatically in the economy
    • A rise in unemployment, which lowers tax revenue and raises spending on benefits automatically

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