2.6 Macroeconomic Objectives and Policies Flashcards
Main Macroeconomic Objectives
Economic Growth
Low Unemployment
Low and Stable Inflation
Balance of Payments Equilibrium on the Current Account
Macroeconomic Objectives
Economic Growth
In the UK, the long run trend of economic growth is around 2.5%
Governments aim to have sustainable economic growth for the long run
In emerging and developing economies, governments might aim to increase economic development before economic growth, increasing living standards, life expectancy and literacy rates
Macroeconomic Objectives
Low Unemployment
Governments aim to have as near to full employment as possible
They account for frictional unemployed by aiming for an unemployment rate of around 3%
Labour force should also be employed in productive work
Macroeconomic Objectives
Low and Stable Inflation
Government inflation target is 2% in the UK measured by CPI
Aims to provide price stability for firms and consumers and will help them make decisions for the long run
Macroeconomic Objectives
Balance of Payments Equilibrium on the Current Account
Important to allow the country to sustainably finance the current account which is important for long term growth
Other Macroeconomic Objectives
Balance Government Budget
Protection of the Environment
Greater Income Equality
Macroeconomic Objectives
Balance Government Budget
Ensures the government keeps control of state borrowing so national debt does not escalate
Allows governments to borrow cheaply in the future should they need to and mark repayments easier
Macroeconomic Objectives
Protection of the Environment
Aims to provide long run environmental stability
Ensures resources used are not exploited and that they are used sustainably so future generations can access them
Means there is no excessive pollution
Macroeconomic Objectives
Greater Income Equality
Minimises the gap between the rich and poor
Generally associated with a fairer society
Achieving Macroeconomic Objectives
Governments are able to manage demand through monetary or fiscal policy
In times of recession, they often increase AD to increase employment and economic growth
In times of boom, they will decrease AD to decrease inflationary pressures
May also use supply side policies which aim to bring long-term growth
Demand Side Policies
Policies designed to manipulate consumer demand
Expansionary policy is aimed to increase AD to bring about growth
Deflationary policy attempts to decrease AD to control inflation
Types of Demand Side Policies
Monetary Policy
Where the central bank or regulatory authority attempts to control the level of AD by altering base interest rates or the amount of money in the economy
Fiscal Policy
Use of borrowing, government spending and taxation to manipulate the level of aggregate demand and improve macroeconomic performance
Monetary Policies
Interest Rates
Monetary Supply
Role of the Bank of England
Monetary Policy
Interest Rates
Interest rate is the price of money and the MPC (Monetary Policy Committee) are able to change the official base rate in order to tackle inflation
Change in repo rate affects mark rates offered by banks as Bank of England is the lender of last resort
If banks are short of money, they borrow from the Bank of England at the repo rate and therefore they need to make sure their own interest rates are based on the repo rate so they can make a reasonable return
Monetary Policy
Rise in Interest Rates Mechanisms
Increase the cost of borrowing
Fall in prices for these assets
Less confident
Value of the pound will rise
Monetary Policy
Rise in Interest Rates Mechanisms
Increase the cost of borrowing
Rise in interest rates will increase the cost of borrowing for firms and consumers
Leads to a fall in investment and consumption reducing AD
Two particular areas of consumption that decrease are consumer durables and houses
Higher interest rates require higher rates of return for investment
Also makes savings more attractive as interest earned on them is higher
Monetary Policy
Rise in Interest Rates Mechanisms
Fall in prices for these assets
Since people are borrowing and more are saving, there is a fall in demand for assets such as stocks, shares and government bonds
Leads to a fall in prices for these assets
Therefore, consumers experience a negative wealth effect since the value of their assets fall leading to a fall in consumption
Moreover, investment is less attractive since firms are likely to see lower profits if prices fall.
AD falls because of the fall in consumption and investment
Monetary Policy
Rise in Interest Rates Mechanisms
Less Confident
People become less confident about borrowing and spending if interest rates rise
Fall in consumer and business confidence leads to a fall in consumption and investment causing a fall in AD
Other loans will become more expensive to repay and so consumers have to dedicate more of their income to pay back these debts
This means they have less income to spend on goods and services so consumption will fall causing AD to fall
Monetary Policy
Rise in Interest Rates Mechanisms
Value of the pound will rise
Higher rates increase incentives for foreigners to hold their money in British banks as they can see a higher rate of return
As a result, there will be increased demands for pounds and the value of the pound will rise
Means that imports will be cheaper and exports dear
Decreases net trade and therefore AD
Monetary Policy
Interest Rates Problems
Exchange rate may be affected so much that exports fall significantly and imports rise causing a BOP deficit
Changes in interest rates take up to 2 years to have full effect and small changes in interest rates may not affect people’s decisions
Interests rates can be so low that they cannot be decreased any further to stimulate demand
Range of different interest rates and not all of them are affected by the Bank of England base rate
Lack of confidence may mean consumers and borrowers do not want to borrow or banks do not lend
High interests rates discourage investment and decrease LRAS
Monetary Supply
Quantative Easing
This is when Bank of England (BofE) buys assets in exchange for money to increase money supply and move money around economy during times of low demand
Set amount of money is created to reduce pressure on banks
Prevents liquidity trap where low interest rates cannot stimulate AD
BofE increases size of banks’ account at BofE (reserve) encouraging to lend more money
Monetary Supply
Asset Prices
Since bank is buying assets, demand increases, increasing asset prices
Positice welath effect increasing consumption
Cost of borrowing decreases as higher asset prices mean lower yield making it cheaper for households and businesses to finance spending
Monetary Supply
Money Supply
Money supply increases
Private sector receives more leading to more spending on goods and services or other financial assets increasing investment or consumption => AD rises
Also push asset prices further up
Banks have higher reseves so lending increases thus further increasing consumption and investment due to credit
Monetary Supply
Interest Rates
Banks may lower interest rates as they receive so much from BofE so they can offer low deals
Increases money supply thus price of money falls
Encourages borrowing thereforce increase investment and consumption increasing AD
Monetary Supply
Quantative Easing Problems
Risky and could lead to hyperinflation if not controlled
Only increases demand for second hand goods
No guarantee that higher asset prices lead to higher consumption
Rising effect on housing market and share prices
Economies may become too depedent on quantative easing
Role of Bank of England
Monetary policy is controlled by BofE rather than goverment
Monetary Policy Committee (MPC) make most decisions
Aim is to keep inflation at 2%
If inflation drops below 1% or higher than 3% then governor of BofE writes letter to Chancellor of Exchequer explaining and ways to bring to 2%
Fiscal Policy
Increased income tax causes fall in disposable income
Leads to reduction in consumption thus AD
Rise in corporation tax decreases post-tax profits leading to reduction in investment thus AD
Rise in goverment spending increases AD (component)
Government Budgets
Government’s fiscal plans are outlined in budget
Budget deficit is when government spends more than they receive
Budget surplus is when government receives more than they spend
Direct and Indirect Taxation
Direct taxes are paid directly to the government by the individual taxpayer
Indirect tax is where person charged with paying money passes cost to someone else
Income tax, national insurance, VAT, corporation tax