2.6

Question 1

Name the four main macroeconomic objectives of government

Answer 1

• low and stable inflation
• low unemployment
• balance of payments equilibrium
• high and stable economic growth

Question 2

name three extra objectives the government might have

Answer 2

• fiscal/budget balance
• greater income equality
• improvements to the environment

Question 3

what is meant by fiscal policy?

Answer 3

• government spending and taxation

- aims to manipulate predominantly AD and not LRAS

Question 4

give three examples of fiscal policies

Answer 4

• increasing indirect taxes on cigarettes
• reducing spending by local councils
• decreasing personal independent payments

Question 5

what is meant by a budget surplus?

Answer 5

when government taxation is greater than spending. also known as a fiscal surplus, or contractionary fiscal policy

Question 6

what is meant by a budget deficit

Answer 6

when government spending is greater than taxation

Question 7

is having a budget deficit a problem for the economy?

Answer 7

it is when the economy is shrinking and tax revenues are falling.

Question 8

what is meant by a direct tax and give examples

Answer 8

direct taxes cannot be passed on to third parties, such as income tax, corporation tax and council tax

Question 9

what is meant by an indirect tax and give examples

Answer 9

a tax on consumption that can be passed on to third parties, such as VAT and excise duty, also known as a specific tax

Question 10

what is meant by monetary policy

Answer 10

a policy that is set by the Bank of England and aims to manipulate AD in the economy by using monetary tools such as interest rates

Question 11

give three examples of monetary policy

Answer 11

• increasing/decreasing interest rates
• increasing/decreasing money supply
• manipulating exchange rates by buying and selling foreign reserves

Question 12

what is meant by quantitative easing and how does it work?

Answer 12

QE is when the government purchase financial assets such as government bonds from institutions such as banks.
The money to purchase these assets is made by the Bank of England. This would create hyperinflation, but because the government must settle the bond at some point in the future, the Bank of England can remove this money from circulation when the goverment pay their bond. By buying assets from the banks, this improve their liquidity, and allows them to lend more money. when consumers and producers borrow more money, this can lead to increased consumption and production and thus stimulates the economy.

Question 13

what are the advantages and disadvantages of QE?

Answer 13

ADVANTAGES:

• it is free (doesnt need any tax revenue)
• it can ease a credit crunch and get people spending again, boosting the economy
• can raise inflation when it is too low
• any inflationary pressure that builds up can be removed in the future when the government pays its bonds

DISADVANTAGES:

• it is inflationary
• brings about a fall in the interest rates in the short run. However, in the long run it leads to inflation which causes the interest rates to rise causing the exact opposite of financial stability. Therefore, critics of quantitative easing believe that it is a disruptive policy that creates negative effects in the economy.
• makes employment rise in the short run, but decrease in the long run

Question 14

how can interest rates be used to achieve inflation targets?

Answer 14

when inflation is too low, they can reduce the interest rate, which reduces the reward of saving and reduces the reward for the cost of borrowing. Existing debt can be paid back, and overall these things can increase consumption and investment in the economy, and boosts AD. when the economy is close to full capacity, this puts upward pressure on prices so that inflation targets can be met.

when inflation is too high, they can increase the interest rate which increased the reward for saving. the cost of borrowing is increased and the payment on existing debt is increased. this all reduces consumption and investment, thus lowering AD and the price level. this is contractionary monetary policy

Question 15

what are the advantages and disadvantages of using interest rates

Answer 15

ADVANTAGES:
- doesnt cost anything
- very effective
DISADVANTAGES:
- they are only effective if consumers and producers respond to changes in incentives (e.g interest rates decrease, investment and consumption may not increase as banks dont want to lend/confidence is low, so consumers/businesses may not want to borrow
- the base rate is already at 0.5%, so there is little scope to reduce it further.

Question 16

show the impact of monetary and fiscal policy on AD, the price level and real output.

Answer 16

Expansionary monetary or fiscal policy increases AD:
- two demand curves, one AS (curved)
- AD1 rises to AD2
- P1 rises to P2
- Y1 rises to Y2
Decreases AD:
- Y1 decreases to Y2
- AD2 decreases to AD2
- P1 decreases to P2

Question 17

what is the role of the Bank of England?

Answer 17

maintaining financial stability in the UK.

Question 18

What does the monetary policy committee of the Bank of England do?

Answer 18

• ensure inflation is kept to 2% ± 1 % by using interest rates and QE as their main policy tools
• there are 9 members who meet monthly to decide on QE and interest rates

Question 19

what factors do the monetary policy committee consider when making interest rate decisions?

Answer 19

• they look at what they think inflation will be like in 2 years. this is because of the time lag between the monetary policy tools and their effect on the economy.
• spare capacity in the economy, as shown by unemployment rate
• wage growth indicates that firms costs are rising and may lead to prices rising
• consumer confidence
• retail sales and spending

Question 20

describe the UK and the US economy during the great depression

Answer 20

• a depression is a period of sustained recession where output is falling and unemployment is high.
• in the UK the recession lasted from 1930-1932
• in the USA it was 1929-1939
• the great depression was caused by a build up of credit in the USA, and the stock market crash (‘black thursday’)
• unemployment was high during this period and there was an increase in poverty

Question 21

what policies were used to help the economy recover from the great depression?

Answer 21

• in the UK the currency was devalued, helping to boost exports. the interest rates were cut from 9% in 1931 to 0.6% in 1933 and the government set a target of higher inflation

Question 22

describe the UK and US economy during the Global Financial Crisis of 2008

Answer 22

• a credit bubble was created in the US economy which was caused by selling sub-prime mortgages. when people defaulted on these loans, large banks started to go bankrupt, and caused banks around the world to fail. the housing market crashed as the banking crisis was transferred to the economy. consumption therefore fell due to a reverse wealth effect. in the UK, the Royal Bank of Scotland was nationalised to prevent it going bankrupt.
• a recession lasted in the UK from 2008 to 2012 (longer than the great depression) and the economy did not grow till 2013.
• unemployment reached 10% in the US in late 2009, and in the UK it was 8.4%

Question 23

what policies were used to help the economy recover from the GFC 2008?

Answer 23

Bank base rate in the UK fell from 5% to 0.5% in less than six months. QE was also started soon after the crash. an extremely loose monetary policy was adopted to help the economy recover.

Question 24

what are the advantages and disadvantages of demand-side policies?

Answer 24

ADVANTAGES:
- fast to take effect, especially government spending
- can have multiplier effects to make them even more effective at stimulating AD
- monetary policy does not have a monetary cost.
DISADVANTAGES:
- fiscal policy involved opportunity cost
- monetary policy has a time lag of up to 2 years.
- can cause government failure if not designed/targeted correctly.

Question 25

define supply side policies

Answer 25

a policy aimed at increasing LRAS

Question 26

distinguish between market based and interventionist policies

Answer 26

market based policies - where the size of the state is reduced, and where the policy helps free market work more effectively (e.g increasing incentives in the labour market by increasing the tax free threshold).
- an interventionist policy is a policy that increases the size of the state or reduces the need for free markets such as nationalisation

Question 27

give 5 examples of supply side policies

Answer 27

• investment into health and education
• investment into infrastructure
• privatisation
• deregulation
• increasing minimum wage

Question 28

explain how investment into health and education increases the productive potential of an economy

Answer 28

a subsidy to education increases the quality of the labour force, which improves skills. an investment into health decreases the days lost because of illness. productivity increases and LRAS increases

Question 29

what are the advantages and disadvantages of using supply side policies?

Answer 29

ADVANTAGES:
- all goverrnment objectives can be achieved at once without having trade-offs.
DISADVANTAGES:
- can be expensive - opportunity cost
- time lag
- difficult to see if they have been effective because of the time lag.

Question 30

show the impact of these policies on LRAS, the price level and real output

Answer 30

• two LRAS (straight vertical lines)
• one AD
• P1 decreases to P2
• Y1 increases to Y2

Question 31

What does the Phillips curve show?

Answer 31

It shows the relationship between inflation and unemployment, generally there is an inverse relationship.

Question 32

Explain the phillips curve

Answer 32

as an economy reaches full employment, labour starts to become relatively scarce, and in order to attract good quality labour, wages start to increase which adds to the costs of production and a wage-price spiral can start. hence low unemployment is associated with higher inflation.

Question 33

Draw a phillips curve

Answer 33

look in notes.

• inflation y axis unemployment x axis
• curved (inwards) AD curve
• point A on curve has 5% unemployment and 2% inflation
• point B on curve has 3% unemployment and 6% inflation

Question 34

does low unemployment have to conflict with inflation?

Answer 34

when there are low inflationary expectations, meaning that workers are not expecting large wage rises to move jobs, or where there is downward pressure on prices caused by other factors, such as low AD in the economy or low energy and commodity prices

Question 35

does economic growth have to conflict with environmental or sustainability goals?

Answer 35

it does conflict often, as in order to increase real GDP, more goods are consumed, using more resources, using more energy and more waste/packaging. however if goods are produced sustainably and responsibly then there can be an increase in output without having an impact on the environment.

Question 36

does economic growth have to conflict with a current account balance

Answer 36

often yes, when there is an increase in output, there is an increase in income, some of which is spent on imports. if an economy’s marginal propensity to import is high and income increases then imports will rise and there will be a current account deficit. however, if the economic growth is export-led growth, then output can increase without an effect on current account balance

Question 37

what is meant by a trade-off and give examples

Answer 37

when a consumer/producer/government has to prioritise their objectives as all cannot be achieved at once (e.g.a government may prioritise reducing the budget deficit, but the trade-off is that they may not be able to achieve economic growth). there is a conflict between two objectives that may be mutually exclusive. another example is when the government has to sacrifice the distribution of income in order to achieve economic growth

Question 38

give three examples of where policy instruments might interfere with each other

Answer 38

monetary and fiscal policies can often interfere with each other:

• low interest rates to boost the economy, whilst government cuts budget deficit, so decrease in growth
• decrease in spending on health and education to cut the budget deficit, but reduces long run economic growth and employment
• looser monetary policy to encourage borrowing e.g low interest rates and QE, but high regulations on banks which restrict lending

Question 39

what difficulties are there in prioritising which instrument to use?

Answer 39

need to choose the policy instruments that support each other rather than conflicting, and which achieve as many objectives simultaneously as possible without causing conflicts between objectives.

Question 40

how are policy instruments linked indirectly?

Answer 40

when implementing one policy has impacts on the use or effectiveness of another policy. for example, if the BofE increases interest rates in order to control inflation, this would decrease AD, and increase unemployment, which would affect the fiscal policy of Job Seekers Allowance and mean more would have to be paid in unemployment benefits as there are more claimants.