2.6 Macroeconomic objectives and policies

Question 1

What are Monetary polices VS Fiscal Policies

Answer 1

Monetary: The manipulation of the rate of interest, the money supply and exchange rates to influence the level of economic activity.

Fiscal: The manipulation of governemnt spending, taxation and government borrowing

Question 2

What is hot money flow (involving IR and ExR)

Answer 2

IR and ExR are directly related;

If the UK raises IR, then investors will move their money to the UK in order to get the best return.

This means they will have to sell their $s and buy £s to deposit in the UK.

This increased demand for the UK pound increases the exchange rate which feeds through to exports making them relatively less price competitive and making imports more attractive.

This will cause a deficit in the current account and therefore worsening the balance of payments.

Question 3

Briefly explain how IR and QE can be used for Monetary

Answer 3

IR: In general, when interest rates are higher or increasing the housing market slows down. When interest rates are growing up the cost of owning a home becomes more expensive due to higher interest rates which reduces demand.

This reduction in demand then results in a drop in home prices.

QE: When the recession began in the UK 2008. The BOE sought to boost the funds available for lending to businesses and firm

Question 4

What affects does Monetary policy have on AD

Answer 4

Consumption: Low interest rates = less incentive to save, more incentive to borrow and therefore higher consumption. This affects general spending and consumer durables especially. Higher interest rates = vice versa

Investment: Low interest = investment projects become less costly/more profitable this more attractive, so investment should rise. Higher interest rates = vice versa

Net Exports: Low interest rates= weaker pound as less attractive to currency investor. Weak pound = more exports, fewer imports. Higher interest rates = vice versa

Question 5

What evaluations (the extent of the increase depends on…) are there for Expansionary Monetary Policy

Answer 5

• Time lag: How long / lead time (longer lead time = less impact / change on AD)
• Size of the multiplier: Influences the size of leakages in the economy.
• Conflict of objectives with primary target being control of inflation: If the primary target is controlling inflation this can limit how much the central bank lowers interest rates.
• The size of the change / decrease
• The stage of the economic cycle

Question 6

What are the 3 targets of fiscal policies

Answer 6

1. Keep inflation on target
2. Stimulate economic growth and employment during times of recession
3. Maintain a stable economic cycle that minimises ‘boom and bust’

Question 7

What are possible methods of expansionary fiscal policy (3)

Answer 7

1. Cutting taxes: A cut in income tax may give consumers more disposable income, raising consumption and a cut in corporation tax may increase the available profits for firms which may stimulate investment.
2. Raising government spending: The government may increase its spending on core infrastructure projects or increase the pay of public sector workers
3. Increasing the budget deficit: Another way of increasing spending if the government do not wish to raise taxation is to increase borrowing.
   This can be spent on a variety of projects nationally. However, this adds to the national debt and must be repaid with interest

Question 8

What are possible methods of contractionary fiscal policy (3)

Answer 8

1. Increasing taxes: If income tax is raised this may discourage spending and reduce consumption. This will reduce AD and may help to bring inflation under control.
2. Cutting government spending: The government may decide to reduce expenditure on public projects or cut key government budgets if it considers excessive government spending to be unaffordable or perhaps inflationary
3. Cutting the budget deficit: The UK budget deficit is large and must be repaid with interest. Cutting the governments long-term borrowing commitments may help to stabilise economic growth as reduced debt repayments in future can be reinvested back into the economy

Question 9

How does a budget surplus VS budget deficit occur and what happens as a result

Answer 9

A budget deficit occurs when a government receives less income through tax receipts and other government revenue than it spends.

This will lead to increased government debt that will have to be paid off in future year.

A budget surplus occurs when a government receives more income through tax receipts and other government revenue than it has to pay out in its spending plans.

This will allow the government to reduce its debt burden and therefore reduce interest payments.

Question 10

What is direct VS indirect tax (give 3 examples of each)

Answer 10

Direct tax is imposed on the income of individuals or profits of businesses. This type of tax is paid directly to the government. Examples:
- Income tax
- Corporation tax
- Inheritance tax

Indirect tax is imposed on goods or services. This increases the price of that good or service. Examples:
- Value added tax
- Excise duty: These are indirect taxes on the sale or use of specific products such as alcohol, tobacco and energy
- Customs duty: Is a tax imposed on imports and exports of goods. The rates of custom duties are either specific or on ad valorem