2.6 Flashcards
key macro objectives
- low and stable inflation
- sustained growth of real gdp
- low unemployment
- higher mean living standards
- balance trade on the current account of payments
- achieve more equitable distribution of income/ wealth
- protection of the environment
3 broad categories of macroeconomic policy:
- Fiscal policy: policies that involve government spending, taxation, and/or borrowing to affect AD
- Monetary policy: policies relating to interest rates, the money supply, and/or the exchange rate
- Supply side policy: policies that increase the productive potential of an economy; usually in relation to increases in the quantity and/or quality of an economy’s factors of production
Budget (Fiscal) Deficit
The difference between what the government receives in revenue and what it spends
Cyclical Fiscal Deficit
The size of the deficit is influenced by the state of the economy: in a boom, tax receipts are relatively high and spending on unemployment benefit is low
What is fiscal policy?
- fiscal policy is use of govt spending, direct/indirect taxation to affect level and growth of AD, output and jobs
- used to change pattern of spending on goods and services
what are three justifications for government spending?
- provide socially efficient level of public goods and overcome one or more market failures
- infrastructure provision
- manage level and growth of AD
direct taxes vs indirect taxes
direct - levied on wealth, income and profit
indirect - taxes on spending
Changes in employers’ national insurance affect the cost of
employing extra workers
- Changes in VAT affect business
- Changes in direct taxes can influence work
- Changes in business taxes might affect the level of foreign
- taxes can affect the incentive to start
costs
incentives
direct investment
a business
fiscal surplus =
gov spending< tax revenues
fiscal deficit =
tax revenues< govt spending
What is government borrowing?
- Public sector borrowing is the amount the government must borrow each year to finance their spending.
- Usually this borrowing is achieved by the sale of government debt, known as bonds.
What is national debt?
• Public sector (government) debt is a measure of the accumulated debt owed by the government sector.
Causes of a budget (fiscal deficit)
anything that results in less tax paid or increase in welfare benefit spending
eg, recession, decrease consumer spending, increase in economic inactivity
Keynesian economists believe that fiscal policy is the most
effective form of managing demand, output and confidence at times of economic instability.
Discretionary fiscal changes
deliberate changes in direct and indirect taxation and govt spending
Automatic stabilisers
changes in tax revenues and government spending that come about automatically as
an economy moves through the business cycle
What is fiscal austerity?
Austerity is when the Government uses contractionary fiscal policy to decrease their budget deficit. The primary aim is not to decrease AD but to slow the rate of growth of the national debt.
Policies to reduce the size of a budget (fiscal) deficit
- cuts in government spending
- higher taxes
- supply side policies to encourage growth
What is Monetary Policy?
- Monetary policy involves changes in interest rates, the supply of money & credit, and exchange rates.
- The Monetary Policy Committee (MPC) of the Bank of England has full operational independence.
- In the UK, tools of monetary policy are changes in interest rate and supply of money.
what is the exchange rate of £ determined by
entirely by demand and supply in international foreign exchange
markets
MPC only sets
base rate, other little banks set own interest. rates on products, but these often follow changes in bank of Englands base rate
Monetary Stability
- Monetary stability means stable prices and confidence in the currency.
• Stable prices are defined by the UK Government’s inflation target
Expansionary Monetary Policy
o Fall in nominal and real level of interest rates.
o Measures to expand / increase the supply of credit from the commercial banking system.
o Depreciation of the external value of the exchange rate
Deflationary Monetary Policy:
o Higher interest rates on both loans and savings.
o Tightening of credit supply (i.e. loans become harder to get).
o Appreciation of the exchange rate.
Nominal and Real Interest Rates
The real rate of return on savings is the money rate of interest minus the rate of inflation.
interest rates falling mean?
- borrowing costs fall
- more spending and investment
- higher AD
= increases real GDP and employment levels in the labour market
interest rates rising means?
- slows down consumption = lower AD
- more saving
- mortgagers have less disposable income
key roles for central banks (4)
- setting interest rates
- financial regulation
- lender of last resort
- debt management
Debt management
Handling the issue (sale) and repayment of issues of government debt such as bonds.
Policy operation functions:
o “Lender of last resort” to the commercial banking system to provide stability.
o Managing levels of liquidity in the commercial banking system e.g. in the immediate aftermath of an economic shock such as the Global Financial Crisis.
Financial stability & regulatory function:
o Prudential policies designed to maintain financial stability of banks & other lenders.
Monetary policy function
o Setting of the main monetary policy interest rate (i.e. the base rate or bank rate).
o Quantitative easing (QE) – this policy creates extra credit within the financial (banking) system.
o Exchange rate intervention (only with managed/fixed currency systems)
what are the factors considered when setting policy interest rates in UK context?
- GDP growth
- consumer confidence
- equity market
- international data
What is quantitative easing?
• Quantitative easing (QE) is the introduction of new money into the national money supply by a central bank.
four key channels through which QE operates
- Wealth effect - lower yields (interest rates) lead to higher share and bond prices.
- Borrowing cost effect - QE lowers the interest rate on long term debt such as government bonds and
mortgages. - Lending effect - QE increases the liquidity of banks and increased lending from banks lifts incomes and
spending in the economy. - Currency effect - lower interest rates has the side effect of causing the exchange rate to weaken (a
depreciation) which helps exports.
difference between monetary financing and quantitative easing?
MF - direct transfer of permanent central bank money to govt
QE - central bank makes bond purchases
currency appreciation =
exports more expensive = lower/inward shift AD
imports cheaper = outward shift AS