2.6 - Macroeconomic objectives and policies - DEMAND-SIDE

Question 1

What is fiscal policy?

Answer 1

Demand-side policy - tax and spend by the government to influence AD and levels of economic activity.

Question 2

Expansionary fiscal policy (increase AD)

Answer 2

spend > tax -> increase G -> increase AD
- could add to National debt = all deficits - all surpluses

Question 3

Contractionary fiscal policy (decrease AD)

Answer 3

tax > spend, budget surplus. Taking money out of the circular flow -> decrease G -> decrease AD

Question 4

What is a balanced budget?

Answer 4

spend = tax

Question 5

Keynesian AD

Answer 5

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.

Question 6

Expansionary diagram

Answer 6

increase AD on LRAS curve
AD increases from AD1 -> AD2
Y1 -> Y2
PL1 -> PL2

Question 7

Contractionary diagram

Answer 7

decrease AD on LRAS curve
AD decreases from AD1 -> AD2
Y1 -> Y2
PL1 -> PL2

Question 8

The 4 main macroeconomic policy objectives

Answer 8

1) Low inflation (2%)
2) Economic Growth - stable
3) Low unemployment
4) Balance of payments (X+M)

Question 9

What are direct taxes?

Answer 9

taxes on income and wealth

Question 10

What are indirect taxes?

Answer 10

taxes on expenditure (E.g: VAT)

Question 11

Issues with fiscal policy

Answer 11

• 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

Question 12

What is the golden rule?

Answer 12

“only borrow to invest” - Gordan Brown

Question 13

Capital spending effects on fiscal policy

Answer 13

Capital (long-term projects) - time lags, short term loss and LR gain -> deficit increased taxes

Question 14

Current spending effects on fiscal policy

Answer 14

Current (on going, day to day) - big multiplier effect -> increase AD, SR impact, LR cost

Question 15

Classical economists and AD

Answer 15

Classical economists say that in LR, economy is ay YFE (full employment).
Increasing AD is purely inflationary (no impact on growth)

Question 16

What is monetary policy?

Answer 16

Demand-side policy - use of interest rates/money supply to influence the economy

Question 17

Who sets monetary policy?

Answer 17

Set by the Monetary Policy Committee (MPC) at the Bank of England, by altering interest rates to influence AD and inflation

Question 18

Expansionary monetary policy

Answer 18

cutting interest rates -> increase AD

Question 19

Contractionary monetary policy

Answer 19

raising interest rates -> decrease AD
(Hawks)

Question 20

Data considered by MPC

Answer 20

• inflation
• unemployment rates -> ‘labour market trends’
• balance of payments (exchange rates)
• economic growth
• house/asset prices
• credit markets (level of lending/borrowing)

Question 21

Monetary impacts on consumption

Answer 21

(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

Question 22

Monetary impacts on investment

Answer 22

(expansionary) decrease r/i -> increase investment -> increase AD
less money to back on investments, increase animal spirits, businesses increase investment -> increase profits

Question 23

Monetary impacts on net trade

Answer 23

(expansionary) decrease r/i -> decrease exchange rates (lowers value of £) -> increase AD
weak pound makes imports dearer, exports cheaper

Question 24

What is a liquidity trap?

Answer 24

decrease r/i, but consumers still prefer to save (not spend - animal spirits low) - nesting effects.
So interest rates become redundant -> QE (Quantative Easing)

Question 25

Effects of monetary policy

Answer 25

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