Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Macro Economics > 2.6 Macroeconomic objectives and policies > Flashcards

2.6 Macroeconomic objectives and policies Flashcards

1
Q

What are the main macroeconomic objectives ?

A
  • low and stable inflation (2% UK target)
  • sustained growth of real GDP (national output)
  • low unemployment/rising employment
  • higher average living standards (national income per capita)
  • balanced trade on the current account of balance of payments
  • achieve a more equitable distribution of income and wealth
  • balancing the budget and reducing the national debt
  • improving economic well being
  • better regional balance
  • improved access to key public services
  • improved global competitiveness
  • environmental sustainability
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is meant by fiscal policy ?

A
  • policies that involve govt spending, taxation and/or borrowing to affect AD, output and jobs
  • also used to change the pattern of spending on goods and services + a means by which redistribution of wealth and income can be achieved
  • instrument of govt intervention to correct market failures eg. pollution or under provision of a good
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What is meant by monetary policy ?

A
  • policies relating to interest rates, the money supply and/or the exchange rate
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What is meant by supply side policy ?

A
  • 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
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What is meant by crowding out ?

A
  • when higher govt spending causes an equivalent fall in private sector spending and investment
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is meant by an expansionary fiscal policy ?

A
  • the govt seeking to increase AD, through higher govt spending and/or lower tax
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What is meant by discretionary fiscal policy ?

A
  • refers to policies which decided and implemented by one off policy changes made by the govt
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What is meant by automatic fiscal policy ?

A
  • refers to the changes in fiscal policy that occur naturally as a result of changes to AD eg. when AD fall, govt spending on unemployment increases
  • tax and spending stabilisers that slow down the fall in AD when the economy enters a recession and restraining AD when the economy speeds up
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What are the three fiscal stances ?

A
  • neutral: shown if the govt runs with a balanced budget (no money in or out overall)
  • reflationary: happens when the govt is running a budget deficit
  • deflationary: happens when the govt runs a budget surplus
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What does the govt need to consider when deciding on fiscal policy ?

A
  • financing govt spending
  • changing the distribution of final income and wealth
  • providing a welfare state safety net
  • managing the economic cycle
  • improving long run competitiveness
  • tackle important market failures
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What is the fiscal multiplier ?

A
  • refers to when initial spending by the govt causes further spending through out an economy (extra AD caused by ripple effect)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What are the justifications for govt spending ?

A
  1. Provides a socially efficient level of public and merit goods + overcome market failure
  2. Provides a safety net system of welfare benefits to supplement the incomes of the poorest in society (redistributing income and wealth + controlling poverty)
  3. Provides necessary infrastructure via capital spending on transport, education and health facilities (important component for LRAS)
  4. Govt spending can be used to manage the level and growth of AD to meet macroeconomic policy objectives eg. low inflation
  5. Govt spending can be justified as a way of promoting equity
  6. Public spending can also be a catalyst for improving economic efficiency and competitiveness if well targeted
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

How can govt spending affect incomes/inequality ?

A
  • welfare state transfers eg. universal child benefits, state pensions, conditional welfare transfers, targeted welfare payments
  • state provided services eg. education (reduces inequality of market incomes), health care, social housing provided by local authorities, employment training
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

What are direct taxes ?

A
  • levied on income, wealth and profit
  • eg. income tax, inheritance tax, national insurance contributions, capital gains tax, corporation tax
  • the burden of direct tax can not be passed on
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What are indirect taxes ?

A
  • taxes on spending
  • eg. excise duties on fuel, cigarettes and alcohol, VAT
  • producers may be able to pass on an indirect tax (depending on price elasticity of demand/supply)
  • often added to demerit goods or goods with negative externalities to deter demand
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What is the UK tax revenue as a % of GDP ?

A
  • the bulk of tax revenues for the UK govt come from income tax, national insurance contributions and VAT
  • most tax revenues are cyclical meaning they rise when the economy is doing well but fall in a slowdown or recession ➡️ this happens automatically w/o any changes in tax rates
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

How does income tax in the UK work ?

A
  • charged at three rates: basic rate, the higher rate and the additional rate
  • basic rate (20%) up to £37,500
  • higher rate (40%) between £37,500 and £150,000
  • additional rate (45%) on incomes over £150,000
  • personal allowance in £12,500
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

How does VAT in the UK work ?

A
  • standard rate 20%
  • reduced rate of 5%: domestic fuel, power, women’s sanitary products, children’s car seats, contraceptives and some residential conversions and renovations
  • zero rated VAT: food, construction of new dwellings, domestic passenger transport, books, newspapers and magazines, children clothing, water, drugs and supplies on prescription, supplies to charities, cycle helmets
  • exempt from VAT: private education, health service, postal service, burial and cremation, small traders below the turn over limit for VAT registration, rent in domestic dwellings
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

What taxes have an affect on AD ?

A
  • income tax ➡️ disposable income
  • corporation taxes ➡️ investment
  • taxation of imports ➡️ affects trade flows
  • national insurance ➡️ labour demand
  • VAT ➡️ affects levels of consumer spending
  • taxation ➡️ business R&D spending
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

How can taxation affect LRAS ?

A
  • work incentives/active labour supply
  • inward migration of key skilled workers
  • capital investment eg. FDI projects
  • enterprise/entrepreneurship (affects incentive to start businesses or spend money on R&D)
  • taxation and incentives to study
  • import tariffs affected import costs
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

What is meant by a budget surplus ?

A
  • total govt spending is less than total tax revenue
    ie. govt spending < taxation
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

What is meant by budget deficit ?

A
  • total govt spending is greater than total tax revenue
    ie. govt spending > taxation
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

What is govt borrowing ?

A
  • public sector borrowing is the amount the govt much borrow each year to finance their spending ➡️ usually achieved by the sale of govt debt (bonds)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

What is national debt ?

A
  • public sector/govt debt is a measure of the accumulated debt owed by the govt sector
25
Q

What are the causes of a budget deficit ?

A
  • recession ➡️ rising unemployment + less tax paid
  • decrease in consumer spending and profits ➡️ less tax revenue
  • increase in inactivity ➡️ rise in welfare benefit spending
  • use of fiscal stimulus by a govt to lift AD
  • increase interest rates on debt ➡️ rise in debt service costs
  • demographic factors ➡️ state pensions rise
26
Q

What is meant by fiscal austerity ?

A
  • when the govt uses contractionary fiscal policy to decrease their budget deficit
  • primary aim is not to decrease AD but to slow the rate of growth of national debt
27
Q

What policies are there to reduce the size of budget/fiscal debt ?

A
  • cuts in govt spending: controlling public sector pay, limiting welfare entitlement + privatisation
  • higher taxes: higher indirect taxes eg. VAT, cutting tax allowances + bringing in new taxes
  • supply side policies to encourage growth: stronger growth increases tax revenues, growth cuts a deficit as a % of GPD
28
Q

What is meant by monetary policy ?

A
  • involves changes in interest rates, the supply of money and credit, and exchange rates to influence the economy
  • the Bank of England has full operational independence to set monetary policy
  • exchange rate of the £ is determined by demand and supply in international foreign exchange markets and not directly influenced by the BofE
  • the BofE only sets the base/bank rate and high street banks can set their own interest rates but these often follow changes in the BofE’s base rate
29
Q

What role does the Bank of England play in monetary policy ?

A
  • the Bank of England has full operational independence to set monetary policy (MPC department)
  • exchange rate of the £ is determined by demand and supply in international foreign exchange markets and not directly influenced by the BofE
  • the BofE only sets the base/bank rate and high street banks can set their own interest rates on savings/mortgages/loans etc but these often follow changes in the BofE’s base rate
30
Q

What is meant bu monetary stability ?

A
  • refers to stable prices and confidence in the currency
  • stable prices are defined by the Government’s inflation target, which the Bank seeks to meet through the decisions taken by the Monetary Policy Committee (MPC).
  • according to the government: “Low and stable inflation supports living standards and provides certainty for households and businesses. This helps households and businesses make efficient decisions about saving, investment and spending.”
31
Q

What is expansionary monetary policy ?

A
  • fall in nominal and real interest rates
  • measures to expand the supply of credit from the commercial banking system
  • depreciation of the exchange rate
  • leads to an increase in AD
  • can also leads to an increase in LRAS (id lower interest rates stimulate investment + business growth)
32
Q

What is deflationary monetary policy ?

A
  • higher interest rates on both loans and savings
  • tightening of credit supply (ie. loans harder to get)
  • appreciation of the exchange rate
  • leads to a decrease in AD
33
Q

What are interest rates ?

A
  • the reward for saving and the cost of borrowing (expressed as a % of money saved/borrowed), two types:
    1. interest rates on savings in banks and other accounts
    2. borrowing interest rates eg. mortgage/credit cards/pay day loans/interest rates on govt and corporate bonds
34
Q

What is meant by nominal and real interest rates ?

A
  • real rate of return on savings is the money rate of interest - rate of inflation ie. if a saver is receiving a money rate of interest of 6% but price inflation is running at 3% per year, the real rate of return on these savings is only 3%
  • real interest rates become negative when the m=nominal rate of interest in less than inflation
  • price deflation can lead to an increaser in real interest rates
35
Q

What is the transmission mechanism of monetary policy ?

A
  • explains how changes in interest rates feed through to affecting AD, output and prices
    1. Changes in market interest rates: BofE changes base rates ➡️ impacts saving/borrowing rates
    2. Impact in AD: AD shifts due to changes in spending, investments and exports
    3. Effect on output, jobs and investment: multiplier impact in consumption, jobs and investment (expansion of production and employment?)
    4. Real GDP and price inflation: output and prices will change depending on AS (can take 12-24 months for full effects after changing policy interest rates)
36
Q

What happens when interest rates rise ?

A
  • example of contractionary monetary policy
  • higher interest rates (contractionary monetary policy) ➡️ slow down the rate of growth of demand incl. consumption
  • increased incentive to save
  • mortgage interest rates likely to rise ➡️ fall in disposable income
  • borrowing becomes more expensive (credit cards and loans)
  • increased interest rates may dampen consumer optimism ➡️ more saving and less spending
  • may cause a currency appreciation ➡️ makes UK exports more expensive in overseas markets
37
Q

What happens when interest rates fall ?

A
  • reduction in interest rates or increase in supply of money or credit = expansionary monetary policy (🔔designed to lift consumer confidence and demand during a turn down)
    1. cost of service loans/debt is reduced ➡️ increased spending power
    2. increased consumer confidence ➡️ more spending
    3. disposable income rises (lower mortgage costs)
    4. increased business investment eg. prospect of rising demand
    5. house market effected ➡️ more demand and higher property prices
    6. exchange rates and exports ➡️ cheaper currency = increased exports
38
Q

What are the key roles for central banks ?

A
  • Monetary policy function: setting interest rates (base or bank rate) + quantitive easing (create extra credit) + exchange rate intervention
  • Financial stability & regulatory function: prudential policies designed to maintain financial stability of banks & other lenders
  • Policy operation functions: “Lender of last resort” to the commercial banking system to provide stability + 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 infrastructure function: overseeing the payments systems used by banks / retailers / credit card companies including
    financial innovations such as contactless payments
  • Debt management (acting as a banker to the government): handling the issue (sale) and repayment of issues of government debt
39
Q

??? What is the role of the Bank of England in monetary policy ?

A
  • BofE’s Monetary Policy Committee (MPC) does a thorough assessment of the economy every month
  • free floating currency
  • 2% inflation target
  • quantitative easing (planned QE = £445bn)
  • capital/liquidity requirements for banks
40
Q

What factors should be considered when setting policy interest rates ?

A
  • GDP growth + spare capacity
  • bank lending, consumer credit figures, retail sales data
  • equity markets (share prices) + trend in house prices
  • consumer and business confidence
  • growth of wages/average earnings/labour productivity etc
  • unemployment and employment data + unfilled vacancies
  • trends in foreign exchange markets
  • international data eg. GDP growth rate of major trading partners such as USA
41
Q

What is quantitative easing ?

A
  • a process whereby a central bank eg. BofE purchases existing bonds (gilts) in order to pump money directly into the financial system
  • regarded as a last resort to stimulate spending when interest rates are so low they no longer stimulate the economy
  • used to increase the supply in the banking system and encourage cheaper/lower interest rates
42
Q

What are exchange rates ?

A
  • the rate or price at which one country’s currency can be exchanged for other currencies (no such thing as “the” exchange rate – so if £ depreciates against the $, it could still be
    appreciating against the €)
  • the price of the currency is determined in the global currency markets
43
Q

What is the economic impact of a currency appreciation ?

A
  • REMEMBER SPICEE (strong pound imports cheaper, exports expensive)
  • rising demand for imports and less demand for exports ie. worsening trade deficit
  • inward shift of AD
  • outward shift of AS
44
Q

What is the economic impact of a currency depreciation ?

A
  • inflation: rise in import prices causing cost push inflation
  • export demand and trade balance: exports cheaper ➡️ rising exports sales + stronger trade balance
  • rise in exports and fall in imports will increase AD ➡️ increase in real GDP and jobs ?
45
Q

What were the key origins of the 2007-2009 financial crisis ?

A
  1. Sub-prime lending: lending to high risk home-buyers
  2. Financial innovation: e.g. credit default swaps and collateralised debt obligations
  3. Asset price bubble, especially in housing ➡️ banks lent out too much
  4. Regulatory capture: e.g. failure of the credit ratings agencies
46
Q

What policy responses did central banks and national govt have to the financial crisis ?

A
  • central banks around the world cut interest rates sharply (rates have stayed at historic lows since then, close to or below 0% (zero) in most developed economies)
  • huge fiscal stimulus (govt spending and decrease taxation) ➡️ especially in China and USA
  • backstop and bailout of the private sector (financial system, households, corporations): including bail-outs and nationalisation of some banks such as Royal Bank of Scotland and Northern Rock
47
Q

Arguments in favour of stimulus (i.e. expansionary) policies in the aftermath of the crisis ?

A
  1. Prevent depression: provide strong monetary & fiscal stimulus ➡️ public sector spending needed when private sector demand is weak
  2. Create jobs: labour-intensive infrastructure projects may have a large and positive fiscal multiplier effect
  3. Avoid price deflation: demand side stimulus after a financial shock is needed to stop prices and real wages falling
  4. Support confidence: if confidence is stabilised, businesses more likely to invest
48
Q

Weaknesses/limits to stimulus (i.e. expansionary) policies ?

A
  1. Keynesian liquidity trap: when ultra-low interest rates fail to stimulate consumption and investment because of low
    confidence and high debt
  2. Moral hazard: bailing-out banks might encourage riskier behaviour in the future leading to another financial crisis
  3. Impact on savers: negative real interest rates hit living standards of savers especially older people reliant on savings
  4. Rising property prices: QE and low interest rates contributed to a surge in property prices and housing rents ➡️ damaging the geographical mobility of labour by making housing less affordable especially for younger people
49
Q

What are supply side policies ?

A
  • policies that improve the productive potential of an economy (illustrated by an outward shift of LRAS)
  • different approaches to supply side reforms: market led policies OR government led policies/intervention
  • supply side reforms affect both short run and long run AS but focus usually on LRAS
50
Q

What is meant by market led policies ?

A
  • designed to make markets works better and give the private sector more freedom ➡️ focuses on reducing the size of the state and boosting the role of market focrces
51
Q

Examples of market led policies ?

A
  • cut govt spending and borrowing ➡️ allows private sector to borrow £ instead
  • lower business taxes ➡️ stimulates capital investment
  • lower income taxes ➡️ improve work incentives
  • reduced red tape ➡️ cut costs of doing business
  • improving flexibility of labour market
  • competition policies eg. deregulation and anti-cartel laws
  • privatisation of state assets ➡️ transferred to private sector
  • opening up an economy to overseas trade, investment and skilled labour migration
52
Q

What is meant by government led policies ?

A
  • overcome different types of market failures + design to improve efficiency and productivity
53
Q

Examples of govt led policies ?

A
  • state investment in public services + critical infrastructure
  • minimum wage/living wage ➡️ improve work incentives and productivity in labour markets
  • higher taxes on wealthy ➡️ fund public and merit goods
  • active regional policy ➡️ inject extra demand into under performing areas g. northern powerhouse project
  • selective import controls ➡️ allow for domestic industries to expand
  • management of the exchange rate ➡️ improve competitiveness
  • nationalisation of and/or tougher regulations of key industries
54
Q

What are the main objectives of supply side policies ?

A

🔔 INCREASE PRODUCTION IN THE UK
- improve incentives to look for work and invest in people’s skills
- increase labour and capital productivity
- increase occupational and geographical mobility of labour to help reduce the rate of unemployment
- increase investment and R&D spending
- promote more competition and stimulate invention and innovation to improve competitiveness
- provide a strong platform for sustained non-inflationary growth
- encourage the start-up and expansion of new businesses/ enterprises especially those with export potential
- improve the trend growth of real GDP to help improve living standards and regional economic balance

55
Q

What is production and productivity ?

A
  • production: the value of output of goods/services eg. measured by GDP etc
  • productivity: a measure of the efficiency of factors of production (measured by output per person employed or per person per hour)
56
Q

What are the causes of the productivity gap ?

A
  • low rate of new capital investment in the UK
  • banking crisis affecting lending to businesses
  • possible slowing rates of innovation
  • persistent skill shortages in key industries
  • relative slow levels of market competition
  • low AD and higher spare capacity
57
Q

What are the advantages of higher productivity ?

A
  1. lower unit costs: cost savings for businesses ➡️ lower prices encouraging higher demand, more output and increased employment
  2. improved competitiveness and trade performance (BOP)
  3. higher profits: efficiency gains are a source of larger profits ➡️ reinvested
  4. higher wages: businesses can afford higher wages when workers are more efficient
  5. economic growth: if an economy can rise productivity then the trend growth of national output can pick up
58
Q

Evaluating supply side policies ?

A
  • can have long time lags (especially when trying to achieve structural changes): polices may be ineffective
    when there is low AD when reflationary monetary and fiscal policies would be more appropriate
  • some supply-side policies (e.g. cutting higher-rate income taxes) might lead to greater inequalities of income and wealth
  • state intervention to “pick winners” in different industries/sectors may be ineffective ➡️ ie. risks of government failure
  • sustainability issues arise if policies raise a country’s long term growth rate ➡️ leading to increased externalities eg. pollution
  • supply side improvements can also occur from non-govt policies eg. firms innovating/investing/productivity improvements
  • level of AD is important in making business investment and innovation viable

Macro Economics (13 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions