2.6 - Macroeconomic Objectives and Policies

Question 1

Possible macroeconomic objectives

Answer 1

1. Economic growth
2. Low unemployment
3. Low and stable inflation
4. Balance of payment equilibrium on the current account
5. Balance government budget
6. Protection of the environment
7. Greater income equality

Question 2

Demand-side policies

Answer 2

Government policies aimed at influencing aggregate demand to achieve macroeconomic objectives like growth, low unemployment, and stable inflation

Question 3

Expansionary policy

Answer 3

A demand-side policy used to boost aggregate demand and stimulate economic growth, typically during a recession or negative output gap

Question 4

Contractionary policy

Answer 4

A demand-side policy used to reduce aggregate demand and control inflation, typically during a boom or positive output gap

Question 5

Monetary policy

Answer 5

The use of interest rates, money supply, and exchange rates by a central bank (e.g., the Bank of England) to influence aggregate demand and achieve macroeconomic objectives

Question 6

Fiscal policy

Answer 6

The use of government spending and taxation to influence aggregate demand and achieve macroeconomic objectives like economic growth, low unemployment, and price stability

Question 7

Expansionary monetary policy

Answer 7

1. Lower interest rates, encourages borrowing and spending
2. Increase money supply, more liquidity in the economy
3. Weaker exchange rate, boosts exports and reduces imports

Question 8

Contractionary monetary policy

Answer 8

1. Raise interest rates, discourages borrowing and spending
2. Reduce money supply, limits excess liquidity
3. Stronger exchange rate, reduces inflation but makes exports less competitive

Question 9

Expansionary fiscal policy

Answer 9

1. Increase government spending on infrastructure, healthcare, and education
2. Cut taxes to raise disposable income and encourage consumption and investment

Question 10

Contractionary fiscal policy

Answer 10

1. Decrease government spending, to cool down an overheating economy
2. Increase taxes, to reduce disposable income and limit inflation

Question 11

Limitations of monetary policy

Answer 11

1. Liquidity trap, if interest rates are already very low, further cuts may not encourage borrowing or spending
2. Time Lags, changes in interest rates take 12-24 months to fully impact the economy
3. Interest rate insensitivity, consumers and businesses may not respond to lower rates if confidence is low (e.g., during a recession)
4. Conflict with other policies, fiscal policy (government spending & taxation) may counteract monetary policy effects (e.g., government austerity could limit Aggregate Demand growth despite low interest rates)

Question 12

Limitations of fiscal policy

Answer 12

1. Budget deficits and national debt, expansionary fiscal policy (higher spending or tax cuts) can lead to higher government debt, which may require future tax increases or spending cuts
2. Inflationary pressure, excessive government spending can cause demand-pull inflation, reducing purchasing power
3. Political constraints, governments may make decisions based on political popularity rather than economic necessity (e.g., avoiding tax increases before elections)
4. Effectiveness depends on multiplier, if the fiscal multiplier is low (e.g., due to high imports or low confidence), the impact of fiscal policy may be weaker than expected

Question 13

Quantitative Easing

Answer 13

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

Question 14

Positive effects of Quantitative Easing

Answer 14

1. Lower Interest Rates, Quantitative Easing increases the money supply, reducing interest rates and making borrowing cheaper for consumers and businesses
2. Weaker exchange rate, more money in the economy can depreciate the currency, making exports more competitive
3. Higher asset prices, Quantitative Easing raises demand for financial assets (e.g., bonds, stocks), increasing their prices and creating a wealth effect that encourages spending

Question 15

Negative effects of Quantitative Easing

Answer 15

1. Inflation risk, excessive Quantitative Easing can overstimulate demand, leading to demand-pull inflation
2. Inequality, wealthier individuals benefit more from rising asset prices, increasing income inequality
3. Asset bubbles, Quantitative Easing boosts financial markets, potentially leading to overvaluation of assets (e.g., stocks, real estate)

Question 16

Budget surplus

Answer 16

When government revenue (taxes) exceeds government spending over a specific period, leading to a positive fiscal balance

Question 17

Budget deficit

Answer 17

When government spending exceeds government revenue (taxes) over a specific period, leading to increased borrowing

Question 18

Direct taxes

Answer 18

Taxes levied directly on individuals or businesses based on income, profits, or wealth, such as income tax, corporation tax, and inheritance tax

Question 19

Indirect taxes

Answer 19

Taxes levied on goods and services, such as VAT, excise duties, and sales tax, which are paid by consumers through higher prices

Question 20

Great Depression

Answer 20

In the 1930s, the world experienced a severe depression known as the Great Depression, in the UK unemployment was over 15% and in the US it was almost 25%. The areas most affected in the UK were the primary industry and the manufacturing industry which relied on exports and so were impacted by the collapse of world trade

Question 21

Causes of the Great Depression

Answer 21

1. Stock market crash (1929), a major collapse in share prices led to panic selling and a loss of wealth and confidence
2. Bank failures, many banks collapsed due to loan defaults, reducing money supply and causing a credit crunch
3. Protectionism and trade barriers, policies like the Smoot-Hawley Tariff (1930) reduced international trade, worsening the downturn

Question 22

Policy responses to the Great Depression in the UK

Answer 22

1. Abandoning the Gold Standard (1931), the UK left the gold standard, allowing the pound to depreciate, making exports more competitive and boosting economic growth
2. Fiscal austerity, the government cut public sector wages and unemployment benefits to reduce the budget deficit, but this worsened unemployment in the short run
3. Interest rate cuts, the Bank of England lowered interest rates to 2%, reducing borrowing costs and encouraging investment

Question 23

Policy responses to the Great Depression in the USA

Answer 23

1. The New Deal, introduced by President Franklin D. Roosevelt, the New Deal aimed to provide relief, recovery, and reform through government intervention
2. Monetary policy, the US left the gold standard, allowing the dollar to depreciate, making exports more competitive and increasing the money supply

Question 24

Global Financial Crisis

Answer 24

A severe worldwide economic crisis triggered by the collapse of the US housing market and banking system, leading to a credit crunch, recession, and government bailouts

Question 25

Causes of the Global Financial Crisis

Answer 25

1. Subprime mortgage collapse, banks issued high-risk subprime loans in the US, leading to massive defaults 2. Housing market bubble, easy credit and speculation caused housing prices to soar, followed by a sharp crash 3. Bank failures and credit crunch, major banks collapsed (e.g., Lehman Brothers, 2008), leading to a loss of confidence and reduced lending

Question 26

Policy responses to the Global Financial Crisis in the UK and the USA

Answer 26

1. Both governments were forced to nationalise banks and building societies and guarantee savers their money in order to prevent the chaos of a collapsed banking system. For example, the British government bought Northern Rock and most of Royal Bank of Scotland and Lloyds Bank 2. They used expansionary monetary policies with record low interest rates and quantitative easing. The Bank of England said the QE led to lower unemployment and higher growth than would otherwise have been the case

Question 27

Supply-side policies

Answer 27

Policies aimed at increasing the productive capacity of the economy by improving efficiency, competition, and incentives in markets. These policies shift the long-run aggregate supply (LRAS) curve to the right, leading to sustainable economic growth

Question 28

Market based policies

Answer 28

Policies that aim to increase efficiency and economic growth by reducing government intervention and allowing free market forces to operate more effectively

Question 29

Interventionist policies

Answer 29

Policies where the government actively intervenes in the economy to improve productivity, infrastructure, and human capital, leading to long-term economic growth

Question 30

Examples of market based policies

Answer 30

1. Increase incentives, reducing income and corporation tax to encourage spending and investment and/or reducing benefits to increase the opportunity cost of being out of work 2. Promote competition, privatisation (selling nationalised companies to private sectors) or deregulation (reducing restriction on businesses which restrict entry to the market) makes firms more competitive 3. Reform the labour market, reducing trade union power makes employing workers less restrictive and it increases the mobility of labour, making the labour market more efficient

Question 31

Examples of interventionist policies

Answer 31

1. Promote competition, a stricter government competition policy could help reduce the monopoly power of some firms and ensure smaller firms can compete 2. Reform the labour market, governments could try and improve the geographical mobility of labour by subsidising the relocation of workers and improving the availability of job vacancy information 3. Improve skills and quality of the labour force, the government could subsidise training, lowering costs for firms, since they will have to train fewer workers or spend more on healthcare to help improve the quality of the labour force and contributes towards higher productivity 4. Improve infrastructure, governments could spend more on infrastructure, such as improving roads and schools

Question 32

Strengths of of supply-side policies

Answer 32

1. Unlike demand-side policies, supply side policies are able to both increase output and decrease prices 2. More long-term policies and lead to long term economic growth, rather than small changes in economic growth following changes in Aggregate Demand 3. Can be directed at increasing exports which will also improve the balance of payments

Question 33

Weaknesses of supply-side policies

Answer 33

1. The Keynesian Long Run Aggregate Supply curve shows that they have no impact when Long Run Aggregate Supply is elastic, and so demand-side policies are needed to fix the problem in the short run 2. Not all supply side policies work at actually increasing supply, whilst others cause conflicts and both these issues vary depending on which policies are used 3. Often the government has to spend more money (for example on education) or decrease taxes, which will decrease their revenue and lead to a budget deficit

Question 34

Conflicts and trade-offs between objectives

Answer 34

1. Economic growth vs. Protection of the environment 2. Economic growth vs. Balance of Payments 3. Unemployment vs Inflation

Question 35

Conflicts and trade-offs between economic growth and protection of the environment

Answer 35

As the economy grows, we expect more resources to be used. As we use resources and produce goods, we produce pollution and noise and destroy habitats. Economic growth in China has been rapid but it has led to serious levels of pollution

Question 36

Conflicts and trade-offs between economic growth and Balance of Payments

Answer 36

Some countries such as India have seen rapid economic growth leading to balance of payments problems. The country is so large that its industry is largely producing goods for its own people and the wealth of the people has led to increased demand for imported goods

Question 37

Conflicts and trade-offs between unemployment and inflation

Answer 37

In the short run, there is a trade-off between the level of unemployment and the inflation rate, illustrated with a Phillips curve. As economic growth increases, unemployment falls due to more jobs being created. However, this causes wages to increase, which can lead to more consumer spending and an increase in the average price level

Question 38

Conflict and trade-offs between policies

Answer 38

1. Expansionary and deflationary fiscal and monetary policies 2. Changes in interest rates 3. Supply-side policies 4. Fiscal deficits

Question 39

Conflict and trade-offs between expansionary and deflationary fiscal and monetary policies

Answer 39

Expansionary policies will increase AD, to increase output, employment and economic growth but will lead to increased inflation and may worsen the balance of payments as some of the increased demand for goods and services will be met by imports. On the other hand, deflationary policies will decrease AD to improve inflation but will decrease employment and economic growth

Question 40

Conflict and trade-offs with changes in interest rates

Answer 40

An increase in interest rates will be used to decrease inflation. However, continuously high rates will damage long-term investment as less businesses will want to invest, and this will decrease long-term growth. Moreover, they will raise the value of the pound which will decrease exports and increase imports, worsening the balance of payments. Whereas, low interest rates tend to increase income inequality, as the richest people hold a larger proportion of their wealth in non-money assets, such as stocks, shares and belongings and so aren’t affected much by interest rates

Question 41

Conflict and trade-offs with supply-side policies

Answer 41

Supply side policies intend to increase aggregate supply, and therefore improve long term economic growth. They are also able to decrease long term inflation but may increase it in the short term if they encourage investment as this will increase Aggregate Demand. Moreover, policies which decrease trade union power, reduce wages, lower benefits, change taxation etc. may increase income inequality as these will negatively affect the poorest in the country

Question 42

Conflict and trade-offs with fiscal deficits

Answer 42

In order to reduce fiscal deficits, the government may decide to reduce government spending and increase taxes. Firstly, this will reduce Aggregate Demand and decrease short term economic growth and higher unemployment. Also, the higher the fall in output as a result of these measures, the higher the fall in tax revenues will be and so therefore the more ineffective the policy