2.6 - Macroeconomic objectives and policies

Question 1

What are the possible macroeconomic objectives?

Answer 1

• Sustainable economic growth
• Low unemployment
• Low and stable rate of inflation (2%)
• Balance of payments equilibrium on current account
• Balanced government budget
• Protection of the environment
• Greater income equality

Question 2

What is sustained economic growth?

Answer 2

The level of output is increasing so citizens have increased living standards, but a rate where growth can be maintained

Question 3

What is full employment?

Answer 3

Where those who are willing and able to work either have a job or can readily get one

Question 4

What is price stability?

Answer 4

Where inflation is low and prices remain largely stable

Question 5

What is monetary policy?

Answer 5

The manipulation of the rate of interest, the money supply, and exchange rates by the central bank in order to influence AD

Question 6

What is the distinction between deflationary monetary policy and inflationary policy?

Answer 6

• Deflationary (tight) monetary policy: increases in interest rates/cuts to money supply in order to decrease AD and reduce inflation
• Inflationary (loose) monetary policy: decreases in interest rates/increases to money supply in order to increase AD and increase inflation

Question 7

What is Quantitative easing (QE) and when is it used?

Answer 7

This is when the Bank of England buys assets in exchange for money to increase money supply and get money moving around the economy during times of very low demand

Question 8

What is the quantitative easing process?

Answer 8

1. Central bank prints electronic money
2. That money is used to buy financial assets from financial institutions (government bonds)
3. Price of gov bonds rises and yield (interest rates) fall
4. Financial institutions either loan the money out or invest in risky corporate bonds or shares
5. Price of corporate bonds rises and yield (interest rates) falls → reduces cost of borrowing
6. Access to credit improves, global interest rates fall, willingness to lend rises at lower interest rates
7. Stimulates borrowing, spending, & investment → AD & growth rise

Question 9

What 4 ways does a rise interest rates cause a fall in AD?

Answer 9

• Increased cost of borrowing for firms and consumers
• Less people borrowing, more saving → fall in demand for assets such as stocks, shares & gov bonds → fall in prices for these assets (negative wealth effect)
• Lower confidence about borrowing & spending if interest rates rise
• Higher rates will increase the incentive for foreigners to hold their money in British banks as they can see a higher rate of return → increased demand for pound → value of the pound will rise

Question 10

What are bonds?

Answer 10

Debt instruments issued by government/corporations to raise money from the government

Question 11

What is the Monetary policy committee (MPC)?

Answer 11

• A committee of 9 people led by the governor of the Bank of England, who meet monthly to assess the state of the economy and decide whether to alter interest rates
• Independent of government to ensure no policy myopia

Question 12

What is fiscal policy?

Answer 12

Policies that change the level of government spending, taxation or borrowing in order to manage the level of AD

Question 13

What is the distinction between a budget deficit and budget surplus?

Answer 13

• Budget deficit: where government spending exceeds tax revenue
• Budget surplus: where tax revenue exceed government spending?

Question 14

What is the distinction between direct and indirect taxes?

Answer 14

• Indirect taxes: charged on producers of goods and services and paid by the consumer indirectly
• Direct taxes: tax imposed on income or profit paid directly to the government by an individual or organisation

Question 15

What are supply-side polices?
What are the two types?

Answer 15

Policies that seek to improve the long-run productive potential of the economy

• Market-based
• Interventionist

Question 16

What are market-based supply-side policies?

Answer 16

Increased productive potential from allowing markets to operate more freely (less government interference) boosting competitiveness & efficiency

Question 17

What are interventionist supply-side policies?

Answer 17

Government intervention in markets designed to promote factors of production where the free market would fail to do so

Question 18

Why are supply-side policies important for the economy?

Answer 18

• Long-term growth: increases in AD and AS will eventually see no growth in actual output
• Higher living standards: policies that increase productivity will lead to greater output derived from FOP -> more g&s to go around
• Non-inflationary growth: allows output to rise into the LR without increased price level
• Welfare gains: more competition -> lower prices -> boost consumer surplus
• International competitiveness: boost net exports
• Budget balance: increased profits + tax revenue for gov

Question 19

What are some general evaluations for supply-side policies?

Answer 19

• Knock-on effects: SSPs which involve increased gov spending could also increase AD
• Recessions: SSPs can’t tackle an output gap caused by suppressed AD
• Unemployment: short-term unemployment may occur as capital replaces workers
• Time lag: policies may take time to affect AS
• Likelihood of government failure: there are several cases of poorly administered government SSPs which have not had the desired outcome

Question 20

What are some examples of market-based supply-side policies?

Answer 20

• Privatisation
• Deregulation
• Reducing corporation tax
• Labour market reforms

Question 21

What is privatisation as a market-based SSP and what are some evaluation points?

Answer 21

• The transfer of inefficient state-owned firms into the private sector -> firms are exposed to competition and face a profit motive, promoting productivity gains
• Eval: Limited gains still to be made as most UK gov-owned firms have already been sold off

Question 22

What is deregulation as a market-based SSP and what are some evaluation points?

Answer 22

• Removing legal restrictions on businesses to encourage competition -> increased competition for consumers -> increased productivity in order to lower prices
• Eval: possible disadvantages of excessive choice + deteriorating quality

Question 23

What are some examples of interventionist supply-side policies?

Answer 23

• Education & training
• Work visas/immigration
• Public sector investment
• Increased house supply
• Healthcare provision

Question 24

What is education and training as an interventionist SSP and what are some evaluation points?

Answer 24

• Increased quantity and quality of education & training -> labour becomes more productive -> increased productive potential
• Eval: Time lag while people train

Question 24

What is public sector investment as an interventionist SSP and what are some evaluation points?

Answer 24

• Government spending on improved infrastructure such as transport links can boost productivity -> lower COP and reduced time spent commuting
• Eval: in a crowded country like the UK, it can be difficult to increase transport capacity

Question 25

What are the strengths and weaknesses of fiscal policy?

Answer 25

• Fastest acting of the three key types of economic policies - increased gov spending & tax cuts can be felt by the economy almost immediately with real take-home incomes rising & profits
• Demand-pull inflation
• CA deficit
• Time lags
• Can be targeted at particular parts of the economy that need the most help (e.g. targeting weaker regions)
• Expansionary fiscal policy leads to increased gov and national debt -> can be a tricky policy to take on if gov debt is already high -> national bankruptcy

Question 26

What are the strengths and weaknesses of monetary policy?

Answer 26

• Requires no spending on behalf of the government
• Allows households & firms the freedom to choose what to do with the extra available money
• Can take up to 18 months for monetary improvement to lead to general economic improvement
• Negative impact on savers
• Expansionary monetary policy requires consumer and business confidence in order to work. When the bank rate was cut to 0.5% in the UK after the financial crisis there was little change in AD as due to economic uncertainty

Question 27

What does the short-run phillips curve show?

Answer 27

• It states that when unemployment is low, inflation tends to be high, and vice-versa
• When unemployment is low, employers compete for a limited number of workers -> have to offer higher wages to attract & retain employees
• As wages rise, the cost of goods and services also rises (money illusion), leading to higher inflation

Question 28

What does the long-run Phillips curve show?

Answer 28

• A vertical line at the natural rate of unemployment, indicating no tradeoff between inflation and unemployment in the long run
• In the long term, changes in inflation will only lead to more inflation, not changes in unemployment

Question 29

What is the NAIRU?

Answer 29

• Non-Accelerating Inflation Rate of Unemployment
• The level of unemployment at which inflation is stable or constant in the economy
• Represents the rate of unemployment below which inflationary pressures tend to increase, and above which inflationary pressures tend to decrease

Question 30

What is fiscal drag?

Answer 30

Where inflation and earnings growth may push more taxpayers into higher tax brackets
Raises government tax revenue -> improved budget deficit
However income inequality