2.6 - Macroeconomic objectives and policies

Question 1

What are the 7 macroeconomic objectives?

Answer 1

Economic growth

Low unemployment

Low level of inflation

Greater equality

Balanced government budget

Balanced current account

Protection of the environment

Question 2

Which are the main 4 macroeconomic objectives?

Answer 2

Economic growth

Low unemployment

Low level of inflation

Greater equality

Question 3

What is a demand-side policy?

Answer 3

Any deliberate action taken by government or monetary authorities to shift the AD curve.

Question 4

What are the 2 types of demand-side policy?

Answer 4

Monetary policy - using monetary variables (e.g. interest rates) to influence AD.

Fiscal policy - manipulation of government spending and taxation in order to influence AD.

Question 5

What are the 2 main types of monetary policy?

Answer 5

Base interest rate manipulation - the interest rate that the central bank will charge commercial banks for loans.

Quantitative easing - the buying of government bonds or other financial assets by the central bank as a means of increasing money supply.

Question 6

Who sets the base interest rate?

Answer 6

Monetary Policy Committee (MPC)

Question 7

How can interest rates be used to reduce AD?

Answer 7

If inflation is above target level, the MPC may increase the base interest rate to decrease inflation. This occurs because C, I and (X-M) all fall.

Question 8

How can interest rates be used to increase AD?

Answer 8

If inflation is below target level, the MPC may decrease the base interest rate to increase inflation. This occurs because C, I and (X-M) all rise.

Question 9

How does quantitative easing work?

Answer 9

BoE creates money

BoE buys govt bonds from banks

Banks more inclined to lend to firms and individuals

Lowers interest rates

Greater lending boosts C + I and so AD

Extra spending/AD creates a stimulus to help an economy recover from recession

Question 10

When and how would quantitative easing be used?

Answer 10

When interest rates are already very low, quantitative easing must be used to stimulate demand.

Central banks then purchase long-term assets in the money or capital markets. As the demand of the assets rises, their price increases which means the interest rate on them falls.

Therefore, quantitative easing has the same impact as cutting interest rates, but has a direct effect on the money markets.

Question 11

How can fiscal policy be used to reduce AD?

Answer 11

Government can reduce spending and increase taxation. This would have a contractionary effect on AD.

Question 12

How can fiscal policy be used to increase AD?

Answer 12

Government can increase spending and decrease taxation. This would have an expansionary effect on AD.

Question 13

What is a government budget deficit?

Answer 13

Government spends more than it receives via taxation. (AD increases)

Question 14

What is a government budget surplus?

Answer 14

Government spends less than it receives via taxation. (AD decreases)

Question 15

What do the MPC do every month?

Answer 15

Meets and looks at factors that could influence inflation over the coming 18 months.

Question 16

What is the government target level of inflation the MPC tries to meet?

Answer 16

2%

Question 17

What were the demand-side policy responses to The Great Depression in the USA?

Answer 17

Initially they did very little.

When unemployment rose to 7 million, a limited public works programme was introduced.

Eventually, millions was spent on infrastructure and a larger public sector.

However, many say it was too little too late.

Question 18

What were the demand-side policy responses to The Great Depression in the UK?

Answer 18

The gold standard (where the pound is maintained at a fixed value against the value of gold) was left, meaning wage cuts and rising taxation could be avoided.

Interest rates were also reduced alongside an increase in money supply.

However, it did take a long time for the economy to fully recover.

Question 19

What were the demand-side policy responses to the 2008 financial crisis in the USA?

Answer 19

Tax cuts and increases in public expenditure amounted to around 700 billion.

Interest rates were significantly reduced and quantitative easing was also used.

Question 20

What were the demand-side policy responses to the 2008 financial crisis in the UK?

Answer 20

Government followed expansionary fiscal policy.

Base rate was reduced and quantitative easing was used.

However, many feel the authorities avoidance of using extreme measures early on led to a more severe recession.

Question 21

What are 3 advantages of demand-side policies?

Answer 21

If the multiplier is large then it can have massive impact on growth.

If there is spare capacity the economy can grow very quickly.

Can be used to quickly solve demand-pull inflation.

Question 22

What are 3 disadvantages of demand-side policies?

Answer 22

If the multiplier is low then there will be little impact.

If there is no spare capacity then supply-side policies must be used instead.

If expansionary, the government can end up with a deficit with can lead to large amounts of national debt.

Question 23

What is a supply-side policy?

Answer 23

A policy designed to increase LRAS through measures to increase the productivity and efficiency of the economy.

Question 24

What are the 2 types of supply-side policy?

Answer 24

Market-based - work through the market mechanism. Related to: increasing incentives, increasing competition and reduction regulation.

Interventionist - these involve government intervention to overcome market failure. Related to: government expenditure to increase productivity.

Question 25

State 3 examples of market-based supply-side policies.

Answer 25

Increasing incentive for worker, e.g. by cutting income tax or reducing benefits.

Reducing corporation tax - firms have strong incentive to then invest.

Removing regulation that are preventing firms growing, e.g. removing restriction on mergers.

Question 26

State 3 examples of interventionist supply-side policies.

Answer 26

Improving the skills and quality of the workforce, e.g. by providing a broader range of vocational subjects and apprenticeships.

Investment in infrastructure, e.g. green transport systems.

Finance business start-ups - this can helps small firms increase the size of there operations.

Question 27

In which direction do supply-side policies cause the LRAS curve to shift?

Answer 27

To the right.

Question 28

What are 3 advantages of supply-side policies?

Answer 28

Economic growth can be achieved without causing inflationary pressure.

They increase productivity.

Only way to achieve economic growth if there is no spare capacity.

Question 29

What are 3 disadvantages of supply-side policies?

Answer 29

If AD is very low, there will be no impact.

Interventionist policies can be very expensive.

Many of the policies can take a long time to actually work.

Question 30

Explain the conflict between the 2 macroeconomic objectives: low inflation and and low unemployment.

Answer 30

When government tries to reduce the level of inflation, it is likely to decrease AD.

Less spending will mean prices fall. The government may also increase taxation or the base rate might be increased

This reduces inflation but also AD.

Firms may start laying off workers due to the lack of demand. As workers are left unemployed, incomes fall and the cycle repeats.

Question 31

Which graph can be used to show the conflict between inflation and employment?

Answer 31

Phillips curve - show the trade-off between inflation and unemployment.

REVISE THIS GRAPH

Question 32

Explain the conflict between the 2 macroeconomic objectives: economic growth and the protection of the environment.

Answer 32

To achieve economic growth, for example by increasing capital stock, means more non-renewable resources are being used. These release fossil fuels that can damage the environment in the future.

The government must weigh up the benefits of growth in this way and aim for sustainable growth.

Question 33

How can fiscal policy conflict with monetary policy?

Answer 33

If the MPC believes government spending is too generous and could lead to a sharp rise in inflation, they may have increase the base rate.

If the MPC believes government spending is too low and could lead to a deflation, they may have decrease the base rate.

Question 34

How can monetary policy conflict with supply-side policy?

Answer 34

If interest rates rise, costs of production for firms increases and firms may decide to produce less

Question 35

How can fiscal policy conflict with supply side policy?

Answer 35

Improving education and health services in order to encourage people to be more productive requires high level of government spending.

Increasing time spent in education also reduces the money the government would receives through taxes. This because they lose money through students who might have earned had they been in work.