2.6 Macroeconomic Objectives and Policies

Question 1

What are the four macroeconomic objectives?

Answer 1

Stable economic growth - 2.5%

Low Unemployment - aim to have full employment, accounting for frictional unemployment by aiming for an unemployment rate of 3%

Low and stable rate of inflation - 2% plus or minus 1% as measured by CPI

Balance of payments equilibrium of the current account - Governments aim for the current account to be satisfactory

Question 2

What is monetary policy?

Answer 2

Monetary policy is used by the government to control the money flow of the economy. This is done with interest rates and quantitative easing. This is conducted by the BoE and the Monetary Policy Committee which are independent from the government.

Question 3

What is fiscal policy?

Answer 3

Fiscal policy is the use of government spending and revenues from taxation to influence aggregate demand, this is conducted by the government.

Question 4

Interest rates

Answer 4

In the UK the MPC alters interest rates to control the supply of money. They are independent from the government, and the nine members meets each month to discuss what the rate of interest should be. Interest rates are used to help meet the governments target of price stability, since it alters the cost of borrowing and the reward for saving.

The BoE controls the base rate which ultimately controls the interest rates across the economy.

Question 5

How does a reduction in the base rate lead to an increase in AD?

Answer 5

Consumption and investment increase due to lower costs of borrowing

Higher consumption, due to lower borrowing, will mean that asset prices increase. This will lead to a positive wealth effect

Saving becomes less attractive, as a lower rate of return is offered, so consumption and investment both increase. Mortgage interest repayments are lower and so therefore consumers have more income left to spend, which also increases consumption.

Lower interest rates reduce the incentive for investors to hold their money in British banks, so demand for the pound will fall. The pound will be weaker, so exports will be cheaper and imports will be more expensive, thus increasing the net trade.

Question 6

What is Quantitative Easing?

Answer 6

QE is a method to pump money directly into the economy. It is when the BoE purchases illiquid assets, in the form of government bonds, from commercial banks using the money they have created

Question 7

Limitations of monetary policy

Answer 7

Commercial banks may not pass the base rate onto consumers, which means that even if the BoE changes the interest rate, it might not have the intended effect

Even thought interest rates may be low consumers and businesses may be unable to get loans as banks might be unwilling to give out loans after the 2008 financial crisis as banks have become more risk averse.

Interest rates will be more effective at stimulating spending and investment when consumer and business confidence is high. If consumers think the economy is still risky, they are less likely to spend, even if interest rates are low.