OCR A Level Economics: Fiscal policy 2: deficits, debt, stabilisers and rules (H460) – Revision Notes

These notes condense the second half of Fiscal policy in the OCR A Level Economics (H460) specification, version 3.0 (June 2026), for first assessment in 2021. Full explanations are in the study guide. Then try the practice questions, the OCR Economics hub, the checklist and the free 10-minute diagnostics. The multiplier is revised in the multiplier and output gaps guide. All figures are invented and illustrative.

Key definitions

Term	Meaning
Budget deficit	Government spending exceeds revenue in a year (a flow)
National debt	Stock of outstanding government borrowing on one date
Primary deficit	Deficit before interest payments on debt
Debt-to-GDP ratio	Debt divided by GDP, the usual measure of the burden
Automatic stabiliser	Part of the budget that offsets output swings with no new decision
Discretionary policy	Deliberate change in government spending or taxes
Crowding out	Government borrowing or spending that reduces private spending
Crowding in	Government spending that raises private spending
Fiscal rule	A commitment that limits borrowing, the deficit or debt

Deficit and debt: must-know distinction

• Deficit = this year. Debt = everything owed. Deficit adds to debt; a surplus can repay it.
• Debt can rise in money terms while the ratio to GDP is flat or falling, if GDP grows fast enough.
• The national debt is held by domestic and overseas lenders, and may be quoted gross or net of financial assets.

Financing a deficit

Method	Effect	Risk
Sell bonds and bills to the public	Adds to debt, pays interest	May push up interest rates
Borrow from the central bank	Money creation	Inflation if money grows faster than output
Sell state assets	One-off cash, no new debt	Loses future income
Draw on cash balances or reserves	Quick	Cannot last

Overseas buyers: interest leaves the country. Short-term bills: refinancing risk if rates rise.

Correcting a deficit or surplus

Methods: raise taxes, cut spending, or rely on growth. Surplus: cut taxes, raise spending, repay debt.

Evaluation chain: tighten policy, GDP falls through the multiplier, tax revenue falls, benefits rise, so the deficit shrinks by less than the cut.

Method in steps (cut in spending).

1. Multiplier = 1 / (marginal propensity to save + marginal tax rate + marginal propensity to import).
2. Fall in GDP = cut x multiplier.
3. Fall in tax = marginal tax rate x fall in GDP. Add any rise in benefits.
4. Net deficit reduction = cut - fall in tax - rise in benefits.

Worked reminder. Leakages 0.1 + 0.25 + 0.15 = 0.5, multiplier 2. Cut spending by 20. GDP falls 40. Tax falls 10. Benefits rise 2. Deficit falls 8, which is 40% of the cut.

Judge by: timing in the cycle, composition (capital cuts hurt growth, benefit cuts hit the poor, tax rises hit incentives), size of the multiplier, and the size of the deficit.

Consequences of government debt

Costs	Benefits or offsets
Interest payments: opportunity cost	Funds investment that raises growth and revenue
Higher future taxes: burden on later generations	Supports demand in a recession
Crowding out of private investment	Can be small if debt is domestic and in own currency
Loss of lender confidence, higher yields, lower rating	Manageable if growth exceeds the interest rate
Interest leaving the country
Inflation risk if money is created

Judgement depends on the ratio to GDP, use of the borrowing (capital or current), who holds it, currency, and interest rate relative to growth.

Debt rule of thumb. New ratio = old ratio x (1 + r) / (1 + g) + primary deficit as a share of GDP. With r = 2.5%, g = 5%, ratio 0.80 and primary deficit 1.90% of GDP: 0.7810 + 0.0190 = 0.8000. With r = 4.5%: 0.8152. When r is above g, a primary surplus is needed to hold the ratio.

Automatic stabilisers

• Boom: tax receipts rise faster than income, benefits fall, budget moves to surplus, demand cools.
• Recession: receipts fall, benefits rise, deficit widens, demand supported.
• Stronger with progressive tax and generous benefits. No time lag in decisions. They soften the cycle but do not remove it.

Worked reminder. Leakages without tax 0.25, multiplier 4. With tax 0.5, multiplier 2. A shock of -10 gives -40 without tax and -20 with it. If GDP falls 20, tax falls 5, benefits rise 1, so the deficit widens by 6.

Discretionary fiscal policy

• Expansionary: more spending or lower taxes, AD shifts right, for a negative output gap or high unemployment.
• Contractionary: AD shifts left, for a positive output gap or inflation pressure.
• Capital and education spending can also raise long-run aggregate supply.
• Limits: time lags (recognition, decision, implementation, impact), uncertain multiplier, political motives, debt.

Worked reminder. Spending +12, multiplier 2: GDP +24, tax +6, net cost 6.

Crowding out and crowding in

Crowding out	Crowding in
More bonds raise interest rates, private investment falls	Higher demand and sales lift confidence
Resource squeeze near full capacity	Accelerator effect raises investment
Higher rate may raise the exchange rate and cut net exports	Public infrastructure raises returns on private projects
Weak with spare capacity, high saving, or low central bank rates	Needs a recovering economy and credible policy

Worked reminder. Spending +12 raises the interest rate by 0.5 points; investment falls by 8 per point, so 4. Net injection 8, GDP +16 instead of +24. One third crowded out. If crowding in adds 3, the net injection is 11, so GDP +22.

Effectiveness of fiscal policy

• Strengths: direct effect on demand, targeted, known multiplier effect.
• Weaknesses: lags, crowding out, uncertain multiplier, debt limits room, expectations of future tax rises, conflicts between objectives.
• Judge using spare capacity, the multiplier, type of spending, and the time frame.

Fiscal rules

• Types: deficit limit, debt ceiling, golden rule (borrow only to invest).
• Influence behaviour: governments must prioritise, lenders may charge less, firms and households may be more certain of future taxes.
• Strengths: credibility, discipline, protection against short-term politics.
• Weaknesses: rigid in a recession, escape clauses, accounting tricks, capital spending easily cut, rules can conflict with each other.

Worked reminder. Current spending 430, capital 30, revenue 400, GDP 1,500, debt 1,200. Current deficit 30. Total deficit 60 (4.0% of GDP). Borrowing 60 is above capital spending of 30, so the golden rule fails. A 3% limit allows 45, so 15 of correction. Debt of 80% breaks a 60% ceiling.

Quick self-test

1. State the difference between a budget deficit and the national debt.
2. A government spends 330 and raises 300, and pays 20 of that spending as debt interest. What are the deficit and the primary deficit?
3. Name two ways to finance a deficit.
4. Marginal propensity to save 0.1, marginal tax rate 0.3, marginal propensity to import 0.1. Find the multiplier.
5. Using that multiplier, spending is cut by 10. Find the fall in GDP and the fall in tax revenue.
6. Why can a spending cut leave the deficit falling by less than the cut?
7. Give one example of an automatic stabiliser and say how it works in a boom.
8. Explain crowding out in one sentence.
9. Name one condition under which crowding in is more likely.
10. Opening debt is 500, GDP 1,000 and the deficit 40. If GDP grows to 1,050, what is the closing debt ratio?
11. Give one strength and one weakness of a fiscal rule.

Answers

1. The deficit is a flow in one year; the national debt is the accumulated stock of borrowing.
2. Deficit 30; primary deficit 10.
3. Selling bonds or bills; borrowing from the central bank; selling state assets (any two).
4. Leakages 0.5; multiplier 2.
5. GDP falls 20; tax falls 6.
6. The fall in GDP reduces tax receipts and raises benefit payments, offsetting part of the saving.
7. Progressive income tax: receipts rise faster than income in a boom, which reduces disposable income growth and cools demand.
8. Government borrowing pushes up interest rates and reduces private investment.
9. Spare capacity, rising confidence or public investment that raises private returns (any one).
10. Closing debt 540; 540 / 1,050 = 51.4%.
11. Strength: credibility with lenders. Weakness: rigidity in a recession (other answers possible).

Where marks are usually lost

• Mixing up deficit and debt, especially in definitions.
• Calculating the effect of a spending cut without allowing for the tax and benefit response.
• Describing an automatic stabiliser as a government decision.
• Stating that crowding out always happens, without mentioning spare capacity.
• Listing consequences of debt without judging which matter most and why.
• Drawing or describing AD shifts without saying why aggregate demand moves.
• Evaluating fiscal rules with only generalities such as “they can be broken”.
• Forgetting to link a conclusion to the question’s context or time frame.

Official syllabus

OCR A Level in Economics (H460) specification, version 3.0 (June 2026), for first assessment in 2021, published by OCR.