2.6 Macroeconomic Objectives and Policies

Question 1

Define fiscal policy

Answer 1

Decisions made by the government on its expenditure, taxation and borrowing

Question 2

What is an example of expansionary fiscal policy?

What effect does it have on macroeconomic equilibrium?

Answer 2

Increase in government spending or reduction in taxes.

AD would shift to the right, leading to an increase in the general price level and an increase in real output.

Question 3

What reinforces the effects of expansionary fiscal policy?

Answer 3

The multiplier effect

Question 4

In what scenarios would expansionary fiscal policies be ineffective and why?

Answer 4

When the economy is at full employment because real output would remain constant, however prices would rise.

Question 5

What side-effects can there be of increased government spending?

What is the name given to this process?

Answer 5

In order to finance G, the government may need to increase borrowing, which may have an upwards pressure on interest rates, leading to a decline in private sector activity, and thus weakening AD.

Crowding out

Question 6

What effects are there of a budget deficit on the balance of payments?

Answer 6

Part of an increase in AD is likely to be spent on imports, leading to a short-run increase in current account deficit on the BoP.

Question 7

What is a government budget deficit/ surplus?

Answer 7

The balance between government spending and revenue.

Question 8

What are automatic stabilisers?

Answer 8

Effects by which government expenditure adjusts to offset the effects of a recession or boom without the need for active intervention.

Question 9

Why might the government choose to increase direct taxes over indirect taxes (2)?

Answer 9

They are progressive

More even distribution of income

Question 10

Why might the government choose to increase indirect taxes over direct taxes?

Answer 10

To address market failures.

Question 11

Define monetary policy

Answer 11

Manipulation of monetary variables, such as interests rates and quantitative easing, in order to increase AD

Question 12

What is created when firms and households choose to hold money?

Answer 12

An opportunity cost- they could be earning interest by purchasing financial assets

Question 13

Vaguely, how do interest rates affect AD in an economy?

Answer 13

When interest rates are high, firms and households undertake less investment and expenditure.

Question 14

Why is investment low when interest rates are high?

Answer 14

Because the cost of borrowing is high

Question 15

What reinforces the effects of a high interest rate?

Answer 15

The exchange rate may rise leading to a reduction in the competitiveness of UK goods, and an inflow of financial capital.

Question 16

When the economy is close to full employment and is in danger of overheating, what can the government do?

Answer 16

Raise interest rates in order to reduce AD

Question 17

When was the responsibility of monetary policy handed over to the Bank of England, and by who?

Answer 17

1997, after Tony Blair was first elected.

Question 18

What targets were the Bank of England set?

Answer 18

2% inflation +/-1%

Question 19

If inflation landed outside the targets, what was then done?

Answer 19

The Bank of England would have to write an open letter to the Chancellor of the exchequer to explain why the target has not been met.

Question 20

Who are the monetary policy committee?

Answer 20

The body within the Bank of England responsible for the conduct of monetary policy

Question 21

What is the bank rate?

Answer 21

The interest rate set by the Monetary Policy Committee in order to influence inflation.

This interest rate is paid on commercial bank reserves.

Question 22

How do commercial banks set interest rates for borrowers?

Answer 22

They adjust their base rates according to the bank rates.

The interest rates however depend on the riskiness of the loans.

Question 23

Define the transmission mechanism of monetary policy

Answer 23

The process by which a change in the bank rate affects inflation

Question 24

What is the first effect of a change in the official bank rate?

Answer 24

Market interest rates will change

The exchange rate will change

Question 25

How will the exchange rate go on to affect inflation?

Answer 25

It will affect import prices, thus affecting inflation.

Question 26

Why was the role of monetary policy given to the Bank of England?

Answer 26

It increases the credibility of the policy (not politically driven) and allows firms and households to realise the government are serious about controlling inflation, therefore increased confidence with future expectations.

Question 27

What happened in 2008, and how did the MPC react?

What was the next step after this?

Answer 27

Inflation accelerated, however the MPC considered this to be a temporary surge.
Commercial banks began to find themselves in trouble and many were bailed out, so there was hardly any availability of credit.
Thus the MPC reduced bank rates to 0.5% by early 2009.

Quantitative easing

Question 28

Define quantitative easing

Answer 28

A process by which liquidity in the economy is increased when the Bank of England purchases assets from the bank.

Question 29

What was the aim of quantitative easing during the financial crisis?

Answer 29

To encourage lending by banks, which had previously dried up since the credit crunch. In doing this, AD would be boosted.

Question 30

How did the US respond to the financial crisis?

Answer 30

The federal reserve expanded the amount of credit provided to the bank system by purchasing long-term securities, which increased the money supply.

Question 31

Where did the financial crisis begin?

Answer 31

In the housing market

Question 32

When was the great depression and what happened with it?

Answer 32

Between the two world wars.
In 1929 a stock market crash in New York spread rapidly to the UK, as unemployment rose to 3 million, and world trade contracted.

Question 33

What UK policies were implemented during the Great Depression?

Answer 33

Government cut spending to maintain a balanced budget.

They encouraged workers to take wage cuts, so that firms would be prepared to employ more workers.

Question 34

What were the results of these government policies during The Great depression?

Answer 34

The economy fell into a deeper recession.

This was the context behind Keynes general theory, which pointed out the multiplier effects of autonomous spending, which could have aided the recovery.

Question 35

What are supply-side policies?

Answer 35

Policies that intend to increase aggregate supply and the productive potential of the economy.

Question 36

What type of supply-side policies do classical economists recommend and define this policy?

Answer 36

Market-based policies, which are policies that rely on allowing markets to work more freely and providing incentives for enterprise and initiative.

Question 37

What is the other type of supply-side policy?

Answer 37

Interventionist policies, which are policies by which the government intervenes to stimulate AS.

Question 38

What are the 4 overarching supply-side policies?

Answer 38

• Education and Training
• Flexibility of markets
• Unemployment benefits
• Promotion of competition

Question 39

Why is education and training important?

Answer 39

To improve skills and quantity of the labour force, which will improve human capital productivity