2.6 - Macroeconomic objectives and policies - DEMAND-SIDE Flashcards
What is fiscal policy?
Demand-side policy - tax and spend by the government to influence AD and levels of economic activity.
Expansionary fiscal policy (increase AD)
spend > tax -> increase G -> increase AD
- could add to National debt = all deficits - all surpluses
Contractionary fiscal policy (decrease AD)
tax > spend, budget surplus. Taking money out of the circular flow -> decrease G -> decrease AD
What is a balanced budget?
spend = tax
Keynesian AD
Keynes argued that in a recession, G is exogenous therefore increasing G -> increased AD - expansionary fiscal policy and multiplier effect. However, national debt -> intergenerational conflict.
Expansionary diagram
increase AD on LRAS curve
AD increases from AD1 -> AD2
Y1 -> Y2
PL1 -> PL2
Contractionary diagram
decrease AD on LRAS curve
AD decreases from AD1 -> AD2
Y1 -> Y2
PL1 -> PL2
The 4 main macroeconomic policy objectives
1) Low inflation (2%)
2) Economic Growth - stable
3) Low unemployment
4) Balance of payments (X+M)
What are direct taxes?
taxes on income and wealth
What are indirect taxes?
taxes on expenditure (E.g: VAT)
Issues with fiscal policy
- the impact depends on the multiplier - increase multiplier -> increase AD
- it sees a big time lag between introduction and effect (18 months)
- expansionary adds to National debt - higher taxes for future generations (intergenerational conflict)
- ‘Crowding out’ - the governor crowds out/buys money and resources so private firms are left with less to access
What is the golden rule?
“only borrow to invest” - Gordan Brown
Capital spending effects on fiscal policy
Capital (long-term projects) - time lags, short term loss and LR gain -> deficit increased taxes
Current spending effects on fiscal policy
Current (on going, day to day) - big multiplier effect -> increase AD, SR impact, LR cost
Classical economists and AD
Classical economists say that in LR, economy is ay YFE (full employment).
Increasing AD is purely inflationary (no impact on growth)
What is monetary policy?
Demand-side policy - use of interest rates/money supply to influence the economy
Who sets monetary policy?
Set by the Monetary Policy Committee (MPC) at the Bank of England, by altering interest rates to influence AD and inflation
Expansionary monetary policy
cutting interest rates -> increase AD
Contractionary monetary policy
raising interest rates -> decrease AD
(Hawks)
Data considered by MPC
- inflation
- unemployment rates -> ‘labour market trends’
- balance of payments (exchange rates)
- economic growth
- house/asset prices
- credit markets (level of lending/borrowing)
Monetary impacts on consumption
(expansionary) decrease r/i -> people have more money to spend, increase C, spend > save -> increase MPC (marginal propensity to consume)
decrease r/i -> increase C and increase AD
Monetary impacts on investment
(expansionary) decrease r/i -> increase investment -> increase AD
less money to back on investments, increase animal spirits, businesses increase investment -> increase profits
Monetary impacts on net trade
(expansionary) decrease r/i -> decrease exchange rates (lowers value of £) -> increase AD
weak pound makes imports dearer, exports cheaper
What is a liquidity trap?
decrease r/i, but consumers still prefer to save (not spend - animal spirits low) - nesting effects.
So interest rates become redundant -> QE (Quantative Easing)
Effects of monetary policy
1) when the fiscal (government) and monetary (Bank of England) policy’s contrast -> contractionary vs. expansionary
2) often only changed by 0.25% - minor impacts?
3) MPC might take time (time lags), or not pass them fully - profit
4) Takes about 18 months to work effectively. Needs to try and predict the economy 18 months from now - difficult. WHY -> knowledge and uncertainty, fixed interest rates for borrowing and saving, starting projects (firms)
5) a cut will reduce interest on savings for those with net-savings - impact on income distribution -> savers lose, borrowers benefit
6) interest rates become “redundant”. they become very low, but consumers still don’t spend -> QE
7) impact on investment etc
8) more = more effective
