2.6 Macroeconomic Objectives and Policies Flashcards
What is the UK target economic growth rate and why?
2±1%
- considered to be sustainable growth
- less likely to cause excessive demand pull inflation
What is the target unemployment rate for the UK and why?
4±1%
- its close to the full employment level of labour
- there will always be a level of frictional unemployment making it impossible to achieve 100% employment
What is the relationship between unemployment and realGDP growth?
unemployment is inversely proportional to real GDP growth
- when realGDP increases, unemployment falls
when realGDP decreases, unemployment rises
Why is a low rate of inflation desirable?
It is a symptom of economic growth
What are the government responses and what do they do?
demand side policies - ease demand pull inflation
supply side policies - ease cost push inflatioin
What is the balance of payments?
a record of all the financial transactions that occur between a country and the rest of the world
What is the current account?
- part of the balance of paymentts
- focusses on financial transactions related to exports and imports of goods/services
What can occur for balance of payments on the current accounts?
- balance of payments equilibrium on the current account
- if export>imports it will create a current account surplus
- if imports>exports, a current account deficit is created
What is the trade status in the UK?
A deficit
- as a % of GDP the UK current account deficit is insignificant so has not been problematic
What is a government budget?
annual forecast made by the government of forecasted revenue and expenditure
What is government revenue?
comes from sale of assets, taxes, sales revenue from goods/services
What is governments expenditure?
all government spending such as public sector salaries; unemployment benefits; spending on public & merit goods
What does the UK government aim to have their budget as?
a balanced budget where expenditure = revenue
What is a budget deficit?
- expenditure > revenue
- any deficit has to be financed through the public sectors borrowing
- any borrowing is added to the public sector debt (government debt)
what happens If the UK government debt becomes too high? (As a % of GDP) 3
if debt becomes too high
- lenders begin to lose confidence in the governments ability to repay debt
- government then raides the interest rate it offers to lenders
- making borrowing more expensive
How can governments reduce the deficit?4
- cutting public sector pay
- raising taxes
- reducing unemployment benefits
- reducing spending on merit goods
What is the governments aim regarding environmental protection?
to reduce emissions by 78% by 2035
What are the UK’s environmental aims including? 3
- focus on sustainability
- reduction of negative externalities of production
- 200% energy from renewable sources by 2035
Why is income inequality a problem?2
- high levels of it create social unrest
- ultimately leading to revolutions
What is income inequality measured using?
the Gini coefficient
What do most developed economies have a Gini target of?
0.3-0.4
What is wrong with perfect income equality?
- its not desirable as it removes the incentive to work and study
What is the relationship between unchecked capitalism and high income inequality?3
unchecked capitalism has a natural outcome of high income inequality
- the wealthy are able to keep buying factors of production
- the concentration of ownership becomes more and more narrow with fewer individuals owning the bulk of the worlds wealth
What is absolute poverty?
when household income is below a certain level that means people are unable to afford necessities
What is the aim of demand - side policies?
to shift AD
What are the 2 different types of demand-side policies?
- fiscal policy
- monetary policy
What is fiscal policy?
- involves the use of government spending and taxation to influence AD
- government is responsible for setting fiscal policy
- government presents these in the government budget
What is monetary policy?
involves adjusting interest rates and the money supply to influence AD
- Bank of England is responsible for setting monetary policy
- Banks Monetary Policy Committee meets 8 times a year to set policy
What are the 2 main instruments of monetary policy?
- incremental adjustments to the interest rate (usually not more than 0.25%)
- Quantitative easing
What is quantitative easing?
when the central bank creates new money and uses it to buy open-market assets
increasing the supply of money in the economy
What is the official rate?
The base rate set by the bank of Englands monetary policy committee
What are market rates?
interest rates set by commercial banks
What are asset prices?
the price of products that provide an economic benefit in the future
What is exchange rate?
the price of one currency in terms of another
What is net external demand?
the demand for a countries exports
What is inflation?
sustained increase in the general price level
What happens to inflation if the official rate decreases by 0.25%?
- market rates decrease
- loans are cheaper
- consumers borrow more
- consumption increases
- AD increases
- inflation increases
What happens to the demand for houses and in turn assets prices if the official rate decrease by 0.25%
- market rates decrease
- mortgagees are cheaper
- property buyers borrow more
- demand for houses increases
- asset prices increase
What happens when buyers borrow more when the official rate decreases by 0.25%?
- market rates decrease
- buyers borrow more
- assets price increases
- households with assets feel wealthier
- consumption increases
- AD increases
- inflation increases
What is hot money flows?
the flow of money from one country to another in order to earn short term profits on interest rates differences
When the official rate increases by 0.25% due to hot money flows what is the impact on inflation?
- hot money flows increases
- the exchange rate appreciates
- exports more expensive and imports cheaper
- net exports reduce
- AD decreases
- inflation decreases
When officials rate increases by 0.25%, with market rates what is the effect on inflation?
- market rates increase
- existing loan repayments now more expensive to repay
- discretionary income falls
- consumption decreases
- AD decreases
- inflation decreases
What is a Gilt or Bond?
long-term form of lending by the government to the private sector who consider it to be a very safe investment
If the Bank of England commits to buy £60bn of gilts a month, what is its effect on inflation?
- commercial banks receive cash for their gilts
- liquidity in the market increases
- commercial banks lower lending rates
- consumers and firms borrow more
- consumption and investment increase
- AD increases
- inflation increases
What is fiscal policy?
the use of government spending and taxation to influence AD in the economy
What are transfer payments?
payments made by the governments for which no goods/services are exchanged e.g. subsidies, unemployment benifits
What is the effect in inflation if the government increases VAT from 20% to 22%?
- consumers pay more tax
- discretionary income reduces
- consumption reduces
- AD reduces
- inflation eases
What is the effect on inflation if the government decreases corporation tax?
- firms net profits increase
- investment by firms increase
- AD increases
- inflation increases
What is the effect on inflation if the government decreases corporation tax?
- firms net profits increase
- investment by firms increase
- AD increases
- inflation increases
What is the effect on inflation if the government freezes/reduces public sector pay?
- consumer confidence falls
- consumption decreases
- AD decreases
- inflation decreases
What is the effect on inflation if the government increases the allowances in the universal credit (unemployment benefits)?
- household income increases
- consumption increases
- AD increases
- inflation increases
How is the government budget presented each year?
- balanced budget
- budget deficit
- budget surplus
What is the main source of government revenue?
taxation
What are the different types of taxes?
- direct taxes
- indirect taxes
What are Direct taxes?
- imposed on income and profits
- paid directly to the government by the individual or firm
e.g. income tax, corporation tax, capital gains tax, NIC’s, inheritance tax
What is capital gains tax?
tax imposed on the profit gained by a consumer through an asset
What are indirect taxes?4
- taxes imposed on spending
- supplier is responsible for sending the payment to the government
- dependent on the PES and PES producers are able to pass on a proportion of the indirect tax to consumer
- the lower a consumer spends ht less indirect tax they pay
e.g. VAT (20%), excise duties
What does MPC stand for?
monetary policy committee
How many members are in the MPC
9
What is the role of the MPC?
to meet 8 times a year to set the monetary policy
What occurs at the MPC meetings? 3
- setting the bank rate and discuss if quantitive easing is required
- policy is decided by majority vote
- can take up to two years for the full effects of decisions to be seen in the economy
What are the factors that influence decisions made by the MPC?9
- the state of the economy without further intervention
- rate of realGDP
- current level of CPI inflation
- interest rate elasticity (low confidence = inelastic response)
- business and consumer confidence
- state of the property market
- global outlook
- unemployment figures
- exchange rates
What is the Great Depression?3
- started in the USA in October 1929 till late 30’s
- by 1932 the USA unemployment rate was around 25%
- more than 9,000 banks closed during this decade. The flow of money in the economy was weak
What was the effect of the Great Depression?2
- created a global slump
- in the UK, unemployment doubled and exports halved leading to a major recession
What is the 2008 global financial crisis?5
- started in september 08 the collapse of the investment bank of the Lehman brothers
- the crisis was inextricably linked to interest rates and risky lending in the property market
- in total, about 10 million households lost their homes
- unemployment doubled from 5% to 10%
- 489 banks failed in the 5 year period following crisis - most were bailed out by central governments
What was the 2008’s GFC effect on the UK?
unemployment rising from 5.2% to 7.8%
What were the fiscal policies used in the Great Depression in the USA? 4
- Roosevelts new deal
- government encouraging construction
- protectionism to increase consumption
- increased government spending
What was Roosevelts New Deal?
- (1933-1939)
- provided large government spending on infrastructure
- and spending on conservation projects
- he took the Keynesian approach, that increases AD
How did the government increase construction projects?
- government employed many people, increasing employment
- construction projects included
- the Edgar hoover dam
- The Golden Gate Bridge
Why did the government increase protectionism?
to increase domestic production and consumption
What fiscal policy was introduced due to ww2?
boosted government spending and recovery
What were the monetary policy’s used in the Great Depression?
- disagreement over the effectiveness of monetary policy occurred
- in feb 1930 the Federal reserve bank cut the bank rate from 6% to 4%
- later that year they raised it to help strengthen the exchange rate as investors were selling dollars to buy gold
- raising the rate was a contractionary policy that further weakened the flow of money
What was the fiscal policy included in the great depression policy responses UK?
- the government prioritised a balanced budget with contractionary policies as they wanted to avoid crowding out
- in 1931, they cut public sector wages and unemployment benefits by 10% -ehich further reduced consumption and confidence in the economy
- in 1931 they raised income tax from 22.5% to 25% which decreased disposable income and consumption
- in 32 they introduced a 10% tariff on all imports to increase production and consumption within the UK
What were the monetary policies used in the Great Depression in the UK?
- in 1931, the UK stoped using the gold standard which. had appreciated the currency significantly since 1919
- the pound depreciated by nearly 25%; exports immediately increased and so did AD
- the bank rate was lowered from 6% to 2% in late 31, helping to increase AD
What was the fiscal policies used in the 2008 Financial Crisis in the USA?
- keynsian approach involving significant govt spending and expansionary fiscal policy from 2008 to 2012
- banks were not allowed to fail and supported by the government
- the economic stimulus act of 2008 injected $152bn. in fiscal stimulus
- the American recovery and reinvestment act of 2009 injected another $787bn. over the next few years
- both of these increased AD and helped. the economy to quickly recover
What were the monetary policies used in 2008 Financial Crisis in the USA?
- federal reserve cut bank rates 8x between October 2007 and the end of 2008 from 5.25% to 0.25%
- 3 rounds of quantitative easing injected over $3trilion into the money supply
What was the fiscal policies used in the 2008 Financial Crisis in the UK?
- keynsian approach involving significant government spending and expansionary fiscal policy from 08 to 2010
- the banks were not allowed to fail and were supported by the government
- policies included income tax cuts, VAT reduction of 2.5%, £20bill small business loan guarantee scheme, a car scrapple scheme to support the car industry
- a major injection by the government was £3bn investment spending on infrastructure and defence
- the new conservative government switched from expansionary fiscal policy to austerity
- cutting government spending and raising taxes delayed the recovery
What was the monetary policies used in the 2008 Financial Crisis UK
- bank rate was cut 9 times between Demeter 07 and march 09 dropping from 5.75% to 0.5%
- several rounds of quantitative easing worth £375bn took place between march 09 & july 2012
What are the strengths of monetary policy?4
the Bank operates independently from the government
- able to consider the long-term outlook
- targets inflation and maintains stable prices
- depreciating the currency can increase exports
What are the weaknesses of monetary policy? 5
- conflicting goals
- economic growth puts upward pressure on inflation
- time lags between policy and the desired impact (up to 2 years)
- expansionary policy is less effective in negative output gaps than when used with positive output gaps
- consumers may not respond to lower interest rates when confidence is low
- cheaper credit can inflate asset prices in the long term
- the interest rate has limitations on downward adgjustment
What are the strengths of fiscal policy? 6
- spending can be targeted on specific industries
- short time lag as compared with monetary policy
- redistributes income through taxation
- reduces negative externalities through taxation
- increased consumption of merit/public goods
- short term government spending can lead to an increase in the long-run aggregate supply
What are the weaknesses of fiscal policy? 3
- policies can fluctuate significantly as governing parties change
- long term infrastructure projects may lack follow through
- increased government spending can create budget deficits
- repaying this debt may lead to austerity on future generations
- conflicts between objectives
- cutting taxes to increase economic growth may cause inflation
What is the aim of supply side policies?
to shift the LRAS
What are the 2 types of supply side policies?
- interventionist
- market-based
What are interventionist supply-side policies?
policies that require government intervention in order to increase the full employment level of output
- these are mainly used to correct market failure
What are Market-based supply-side policies?
- removing obstructions in the free market that are holding back improvements to the long-run potential
- e.g. setting up a regulator to prevent monopolies forming
What is the overall aim of the supply side policy?
to increase LRAS means to increase the quantity/quality of the factors of production
What are the 5 aims of supply side policies?
- to increase incentives
- to promote competition
- to reform the labour market
- to improve the skills and quality of the labour force
- to improve infrastructure
What is the market based approach to meet the supply side aim of increasing incentives?
- reducing income/corporation tax rates
- restructuring the unemployment benefits system to incentivise the employed to seek work
What is the market based approach to meet the supply side aim of promoting competition?2
- privatisation and deregulation
- trade liberalisation
what is trade liberalisation?
removing the barriers to trade such as tariffs
What is the market based approach to meet the supply side aim of reforming the labour market?
- decreasing trade union power so wages can be decreased
- decreasing minimum wages to lower costs of production
What is the interventionist based approach to meet the supply side aim of promoting competition?
- increased government spending on innovation
- direct support to firms promotes international competitiveness
What is the interventionist based approach to meet the supply side aim of reforming the labour markets
- increased government spending on improving occupational mobility
What is the interventionist based approach to meet the supply side aim of improving the skills and quality of the labour force?
- increasing government spending on education and retraining
- increasing government spending on healthcare so that productivity improves
What is the interventionist based approach to meet the supply side aim of improving infrastructure?
- increased government spending on infrastructure
What are the strengths of supply side policies? 5
- to increase the rate of growth of an economy
- reduce average price levels
- reduce unemployment
- increase the value of net exports
- improvements in infrastructure can raise the quality of life for all citizens
What are the weaknesses of supply-side policy? 5
- distribution of income worsenes as labour market reforms and wage policies lower workers wages
- expensive to implement
- significant time lags between expenditure and seeing the benefits
- due to the long term nature, changes in government often result in changes to budgets and scope of projects
- the end result may be less effective than it could have been
- vested interests can result in less effective outcomes e.g. many ecamplesof privatisation occurring in such a way that the governments preferred bidders obtained an asset at a knock down price
- often the preferred bidders were not necessarily the most efficient firms
What are the common trade-offs that exist between macroeconomic objectives?6
- economic growth & inflation
- economic growth and environmental sustainability
- economic growth and inequality
- economic growth and balanced budget
- economic growth and balancing the current account
- low unemployment and low inflation
What are Trade-offs?
achieving one macroeconomic objective at the cost of worsening progress in another objective
What is the economic growth and inflation trade off trade-off?
- increasing economic growth causes the economy to move closer to full employment
- prices for remaining resources are bid up leading to inflation which may outpace the target inflation rate of 2%
What is the economic growth and environmental sustainability trade off?
- economic growth often increases pollution, negative externalities and the depletion of non renewable resources
- the higher the growth, the faster the depletion
what is the economic growth and inequality trade-off?
- during periods of high economic growth, the profits the owners of the factors of production receive are disproportionate to any increase in workers wages leading to greater inequality
what is economic growth and balanced budget trade-off?
economic growth driven by expansionary fiscal policy often requires a budget deficit
what is the economic growth and the balancing current account trade off?
- economic growth usually leads to high income
- leads to an increase in imports by households
- thereby worsening the current account balance
what is the low unemployment and low inflation trade-off?
- the closer an economy moves to full employment the less workers will be available for hire
- wage inflation will help increase overall inflation
What does SRPC stand for?
short-run Philips curve
What is the short run Philips curve?
- it observes that there must be a trade of between unemployment and inflation
- rising inflation is accompanied by falling unemployment
- rising unemployment is accompanied by falling inflation
- this trade-off makes it difficult for the government to achieve both low unemployment and low inflation
