Macroeconomics: Cyclical vs. Structural Budget Deficit

Introduction

• Topic: Differences between cyclical and structural budget deficits.
• Relevance: Part of AQA and Edexcel syllabuses.

Budget Deficit Basics

• Definition: When government spending exceeds its tax revenue, necessitating borrowing.
• Causes:
  • Cyclical
  • Structural

Cyclical Budget Deficit

• Occurs during economic downturns (e.g., recessions).
• Characteristics:
  • Unemployment Increases: Leads to a reduced tax base.
  • Reduced Consumer Spending: Decreases VAT and corporation tax revenues.
  • Increased Welfare Needs: More out-of-work benefits.
• Government Actions:
  • Introduce fiscal stimulus (e.g., increase public sector wages, investment).
  • Borrow more due to increased debt interest payments.

Structural Budget Deficit

• Definition: Part of the deficit not related to the economic cycle.
• Characteristics:
  • Does not disappear with economic recovery.
  • Influenced by demographic factors (e.g., aging population, pension policies).
  • May be exacerbated by policies like the triple lock on pensions.

UK Context

• Historical Data:
  • 1999-2000: Budget surplus.
  • Post-2001: Persistent budget deficits.
  • 2008-2009: Increase in structural deficit due to recession.
• Recent Changes:
  • Economic recovery has reduced cyclical deficit.
  • Structural deficit remains around 2.5-3% of GDP.
  • Ongoing challenges with corporate tax avoidance and high government spending.

Key Points

• Cyclical Deficit:
  • Increases in downturns due to lower tax revenues and higher welfare spending.
  • Should turn into a surplus during economic booms.
• Structural Deficit:
  • Remains constant regardless of economic cycle.
  • Affects government's ability to increase spending.

Conclusion

• The UK faces a notable structural budget deficit that persists despite economic recovery.
• Understanding these concepts is crucial for fiscal policy and navigating current economic challenges, like Brexit.

Important Terms

• Fiscal Deficit: Shortfall in government finances.
• Cyclical Fiscal Balance: Budget balance affected by economic cycles.
• Structural Fiscal Balance: Budget balance unaffected by economic cycles.