2.6 Macroeconomic Objectives and Policies Flashcards
Taxation
Types / Reasons
Types:
- Indirect Tax (Specific / Ad Valorem)
- Direct Tax (Tax on income e.g. Income Tax / Corporation Tax)
Reasons:
- Raise Gov. Revenue
- Influence Macroeconomy
- Reduce income inequality
- Correct market failure
- Protectionism
Government Spending
Types / Reasons
Types:
- Current Spending (Public Service / Public Sector Wages / Maintenance)
- Capital Spending (Infrastructure Projects)
- Welfare Spending (Benefits & Pensions)
- Debt Interest Spending (Cost for government to service debt)
Reasons:
- Influencing Macroeconomy
- Reduce Income Inequality
- Correct Market Failure
Average Rate Of Tax Equation (ART)
ART (%) = Tax Paid / Income ×100
Progressive Tax
As income rises, average R.O.T rises
e.g. Progressive Income Tax
Proportional Tax (Flat Tax)
As income rises, average R.O.T Stays the same
e.g. Flat Income Tax
Regressive Tax
As income rises, average R.O.T falls
e.g. Indirect Tax
The Marginal Rate of Tax (MRT)
Equation
The Marginal Rate of Tax (MRT) refers to the percentage of additional income that is paid in tax when an individual earns an extra unit of currency
MRT = Δ Income Tax Paid / Δ Total Income ×100
Fiscal Policy
Changes to government spending and taxation in order to influence AD.
Expansionary Fiscal Policy
& Examples
(↑ AD)
i) Boost Growth
ii) Reduce Unemployment
iii) Increase Inflation
iv) Redistribute Income
Examples:
1. Reduction in income tax
2. Reduction in corporation tax
3. Increase in Government spending
Contractionary Fiscal Policy
(↓ AD)
i) Reduce Inflation
ii) Reduce Budget Deficit / National Debt
iii) Redistribute Income
iv) Reduce Current Account Deficit
Expansionary Fiscal Policy Problems
(CONS)
- Demand Pull Inflation (when aggregate demand (AD) rises faster than aggregate supply (AS), causing prices to increase)
- Current Account Deficit
- Worsening of government finance
- Crowding Out Effect (More government borrowing can raise interest rates, discouraging private investment)
- X - Inefficiency
- Time Lags (Fiscal policies take time to implement and show effects, making them less effective in urgent situations)
Automatic Stabilisers
Boom (Cushion Demand)
Recession (Support Output)
Fiscal Policy Tools to influence GDP and counter fluctuations in the economic cycle
Boom (Cushion Demand):
1. Income ↑ 🠮 Workers pushed into higher tax bands 🠮 ↑ A.R.T (Average Rate Of Tax) 🠮 Slowing down Consumption
2. Unemployment Low 🠮 Gov. Spending on benefits reduces
Recession (Support Output):
1. Income ↓ 🠮 workers move into a lower tax bands 🠮 ↓ A.R.T (Average Rate Of Tax) 🠮 Prevents large drop in Consumption
2. Unemployment High 🠮 Gov. Spending on Benefits Increases
(Fiscal) Budget Deficit / National Debt
(Fiscal) Budget Deficit: When Government Spending is greater than Tax Revenue in a year.
(Government borrowing in a year)
Structural Budget Deficit: Budget deficit at full employment.
Cyclical Budget Deficit: Budget Deficit In Recession.
National Debt: Total Stock of government debt over time.
Budget Deficit
PROS / CONS
PROS:
- Higher Growth, Lower Unemployment
- Benefits of ↑ Government Spending (Education, Healthcare, Infrastructure, Public Service)
- Redistribute Income
- Incentives of Tax Cuts
- Crowding In (Crowding occurs when higher government spending increases private sector investment, rather than reducing it.)
CONS:
- Deterioration of government finances
- Inflation Conflict
- Current account deficit conflict
- Crowding out effect
- X-inefficiency
EVAL: State of Gov. Finance / SR vs LR impacts / Stages of economic cycle / Specific policy used / Consumer & Business confidence / Automatic stabilities
Crowding In
Crowding In:
Definition: When higher government spending encourages private sector investment by boosting demand and business confidence.
Occurs when: Economy is in a recession, interest rates are low, or government investment improves infrastructure.
Crowding Out
Crowding Out:
Definition: When higher government spending reduces private sector investment because borrowing raises interest rates or uses up financial resources.
Occurs when: Economy is near full capacity, government debt is high, or interest rates rise.
(Fiscal) Budget Surplus / ↓ National Debt
(Fiscal) Budget Surplus: When Tax Revenue is greater than Government Spending in a year
Structural Budget Surplus: Budget Surplus is at full Employment
Cyclical Budget Surplus: Budget Surplus In a Boom
National Debt: Total stock of Gov. Debt over time
Budget Surplus
PROS / CONS
PROS:
- Confidence in Government Finances
- Flexibility with Fiscal Policy
- Less Crowding Out / X-Inefficiency
- Lower Inflation & Current Account Deficit
CONS:
- Demand Side Shock (↓ Growth / ↑ Unemployment)
- Micro & Macro Impacts of ↓ Government & Spending ↑ Tax Revenue
- Long Term Tax Revenue returns to ↑ Government Spending & ↓ Tax Revenue ignored
- Incentives Distortion of ↑ Tax Revenue
- Risk of Income Inequality
EVAL: Need? / Debt & GDP Rising? / Policy Used / Stage of economic cycle
Monetary Policy
Expansionary / Contractionary
Changes to interest rates, the money supply and the exchange rate by the central bank in order to influence AD.
Expansionary Monetary Policy: (Policy to increase AD)
- Increase inflation (Central Bank Mandate)
- Increase Growth
- Reduce Unemployment
Contractionary Monetary Policy: (Policy to reduce AD)
- Reduce Inflation
- Prevent Asset/Credit Bubbles
- Reduce Excess Debt & Promote Saving
- Reduce Current Account Deficit
Expansionary Monetary Policy Transmission Mechanism
i) ↓ Credit Card Interest Rates (Borrowing cost for consumers) = ↑C
ii) ↓ Saving Rates = ↑C
iii) ↓ Mortgage Rates = ↑C
iv) ↓ Rates on business Loans = ↑I
V) Weaker Exchange Rates = ↑ (X-M)
Expansionary Monetary Policy
CONS / Evaluation
CONS:
- Demand Pull Inflation
- Current Account Deficit
- Liquidity Trap (Interest Rates have a Lower Bound)
- Negative Impact On Savers
- Time Lags
Evaluation:
- Size Of Output Gaps
- Consumer Confidence
- Busienss Confidence
- Banks willingness to lend/Pass on the full cut
- Size of the Rate Cut
Contractionary Monetary Policy in Higher Interest Rates
PROS/CONS
PROS:
- ↓ Inflation (Demand Pull)
- Discourage Household / Corporate Debt
- More Sustainable Borrowing / Lending
- Encourage Saving
- Reduce Current Account Deficit
- Flexibility for Expansionary Monetary Policy
CONS:
- Lower Growth (Shock)
- Higher Unemployment (Shock)
- Impact on the Indebted
- Reduces Investment
- Worsening Current Account via Exchange Rate Strengthening
Supply Side Policies (Interventionist and Market Based)
With Evaluation
Policies designed to increase the productive capacity of the economy, shifting LRAS to the right (if successful, all 4 main macro objectives will increase)
Interventionist SSPs:
- Gov. Spending on Education/Training
- Giv. Spending on Infrastructure
- Subsidies to firms to Promote Investment
Market Based SSPs:
Tax Reform
- Lower Income Tax
- Lower Corporation Tax
Labour Market Reform
- Increase Benefits
- Reduce Min. Wage
- Reduce trade union power
Competition Policy
- Privatisation – Selling state-owned firms to the private sector to improve efficiency.
- Deregulation – Removing rules to increase competition & efficiency.
- Trade Liberalisation – reducing or removing trade barriers
Policies to Reduce Unemployment (Structural and Frictional)
With Evaluation
NRU - Structural Unemployment
Interventionalist SSPs
- G on Education/Training (Occ . Imm)
- Subsidies for in work training (Occ . Imm)
- G on infrastructure (Geo . Imm)
- Grant or Low Cost Housing (Geo . Imm)
Market Based SSPs
- Reduction Benefits (Occ & Geo . Imm)
- Deregulate Hiring/Firing Laws (Occ . Imm)
NRU - frictional Unemployment
Interventionalist SSPs
- More & Better resources for job centres
- Subsidies to private job agency
- G on Infrastructure
Market Based SSPs
- Reduce benefits
