2.6 Macroeconomic objectives and policies

Question 1

What are the seven possible macroeconomic objectives?

Answer 1

• Stable economic growth
• Low unemployment
• Low and stable rate of inflation
• Balance of payments on current account
• Balanced government spending
• Protection of the environment
• Greater income equality

Question 2

What is fiscal policy?

Answer 2

Goverment’s spending and taxation with the aim of changing the total level of spending in the economy (AD)

Question 3

What is monetary policy?

Answer 3

Decision making using monetary instruments (done by the MPC in the UK) to influence the money supply

Question 4

What are the two monetary policy instruments?

Answer 4

1. Quantative easing
2. Adjusting interest rates

Question 5

How do interest rates impact AD? [4]

Answer 5

If interest rates rise, overall negative wealth effect - a reduction in wealth leading to less consumption, and therefore a reduction in AD.

1. Cost of borrowing rises - people spend less and firms borrow less to invest less. Consumer durables and credit is less attractive.
2. Repayments rise - on mortgages and consumer durables. This reduces the amount of disposable income, reducing consumption.
3. Incentive to save rises - people make more on returns so save more and spend less overall.
4. Demand for UK currency increases as it has high interest rates, meaning that the exchange rate increases. This decreases exports and increases imports, therefore reducing AD.

Question 6

What is quantative easing?

Answer 6

The purchae of gilts (long-term loans) and other illiquid assets as a means of increasing the level of credit in the economy.

Question 7

How does QE work in three steps?

Answer 7

1. The central bank makes large purchases of government bonds, pushing up their price and lowering interest rates
2. These lower interest rates feed through the economy and reduce cost of borrowing.
3. This rise in asset prices causes an increase in the wealth effect and so boosts consumption

Question 8

What is quantative tightening?

Answer 8

This is a contractionary policy to decrease the amount of liquid assets in the economy.

Question 9

What are the fiscal policy instruments?

Answer 9

Taxation and government spending

Question 10

What is the difference between expansionary and contractionary fiscal policy?

Answer 10

Expansionary policy involves a budget defecit in order to boost AD (e.g. in a recession), and contractionary* policy involves running a *surplus* in order to curb *inflationary pressures.

Question 11

What is the difference between direct and indirect taxation? Give an example of each.

Answer 11

Direct taxes are taxes paid by the consumer directly to the government (e.g. income tax), whereas indirect taxes are taxes that firms can pass onto someone else (e.g. VAT)

Question 12

What is the role of the Bank of England?

Answer 12

They have the Monetary Policy Committee (MPC) - they are responsibile for controlling the level of inflation (2% target) in the economy. They meet at least once a month to discuss setting interest rates.

Question 13

What was the difference between the responses of the Great Depression and the 2008 global financial crisis? Why did the policies used in the Great Depression become so unpopular?

Answer 13

• In both the US and the UK (although much later for the UK), expansionary policy was heavily favoured in 1929 and was used to bounce the economy back.
• However, due to heavy demand-side spending in the 1970s that led to stagflation (inflation with no growth), expansionary policy was frowned upon.
• From 2008-2010, the UK and USA had largely similair responses to the crash with expansionary policy favoured. However, David Cameron then was elected and prioritised fiscal balance instead, harming long term growth.

Question 14

What are two stengths and two weaknesses of monetary policy?

Answer 14

Stengths:

• Monetary policy is quick acting
• It does not require excessive amounts of government spending (good for curbing demand-pull inflation)

Weaknesses:

• It is a blunt tool that affects the whole economy, not targeted
• Higher interest rates raise the costs of production, meaing it affects those in debt.

Question 15

What are two stengths and weaknesses of fiscal policy?

Answer 15

Strengths:

• Can be targeted to extreme areas
• Can even equality

Weaknesses:

• Time lag effect, changes only introduced in autumn statement
• Crowding out - increase in government spending reduces resources for the private sector

Question 16

What is supply-side policy?

Answer 16

These are policies designed to increase long-run aggregate supply

Question 17

What is the difference between market-based and interventionist policies?

Answer 17

Market-based policies involve increasing the flexibility of the market and leaving it, whereas interventionist policies are governments getting directly involved to solve failures.

Question 18

Describe four market based approaches

Answer 18

1. Improving incentives - e.g. cutting income tax rates to increase the oppurtunity cost of leisure and motivate working longer hours
2. Increasing competition - the use of deregulation or encouraging small firms to enter the market. This allows for innovation and increased productivity.
3. Labour market reforms - reducing welfare and benefits to incentivise people to get off the benefits trap
4. Increasing price flexibility and signalling - to prevent overconsumption of goods.

Question 19

Describe three interventionist methods

Answer 19

1. Improving education and training - huge time lags but improve the skill and quality level of the workforce
2. Improving infrastructure (operational framework of economy) - reduce costs of firms and increase oppurtunities
3. Improving healthcare - increases productivity and longevity of the workforce.

Question 20

What are strengths of supply-side policies?

Answer 20

• Has helped reduce prices in the deregulation of the telephone industry
• Improved after-care service
• Low inflation with high economic growth

Question 21

What are weaknesses of supply-side policies?

Answer 21

• Increased competition in the NHS had only led to higher costs
• Time lag of years - education reduces labour force in the short term
• If there is demand deficient unemployment, than the productive capacity increasing will have no impact on real output.

Question 22

Name five conflicts between macroeconomic objectives.

Answer 22

1. Inflation and unemployment
2. Economic growth and the balance of payments on the current account
3. Low unemployment and sustainability
4. Economic growth and income equality
5. Low inflation and balance of payments on the current account

Question 23

Explain the trade off between inflation and unemployment. How is this relationship displayed? Why can’t this be exploited by the Government?

Answer 23

Lower unemployment causes wage pressures to increase - as wages increase, people spend more and the costs of production increase and this causes high inflation.

This is shown on the short-run Phillips curve.

It cannot be exploited as any increase in employment with high inflation will not last long term, as workers realise their wages are valued less.

Question 24

Explain the conflict between economic growth and the balance of payments on the current account.

What is the one exception to this?

Answer 24

As an economy grows, demand for goods will increases, and therefore imports will increase. Additionally, firms incentive to exports will diminish as they can profit of the high domestic demand.

The only exception to this is export-led growth, as seen in China.

Question 25

Explain the conflict between low unemployment and environmental protection.

How can this be combatted?

Answer 25

If employment (and therefore output) is higher, there is more congestion on the roads, more manafacuring and energy use. Additionally foreign travel increases carbon emissions.

This can be stopped if the government uses the higher tax revenues from employment to improve the enviornment (e.g. taxes on diesel cars)

Question 26

Explain the conflict between economic growth and income inequality.

Is this always true?

Answer 26

As the economy grows, income at the top end of the spectrum is most likely to rise, in the forms of higher profits and bonuses. This can increase income inequality in absolute terms.

If higher wages trickle down, those on lower-incomes will benefit (although not as much). Additionally, extra tax revenue may be used as welfare to combat poverty.

Question 27

Explain the conflict between low inflation and equilibrium of balance of payments on the current account.

Is this always true?

Answer 27

If inflation is low, interest rates will be higher in order to stimulate demand.

• However, this strengthens the currency, as demand for savings in the pound increases, and therefore makes imports more attractive as they are relatively cheaper.
• It also means lower exports, as they’re more expensive.

However, if inflation is low, price levels may be cheaper compared to other countries and exports more attractive. It depends on the exchange rate.

Question 28

Name three conflicts between macroeconomic policies.

Question 29

Explain the conflict between fiscal and supply side policy

Answer 29

Whilst an expansionary fiscal policy may also have the effect of working in tandem with supply side policies:

• Contractionary policy to control the price level may impact productive capacity and therefore causes the AS level to shift inwards (or shift outwards by less than trend).

Question 30

Explain the conflict between fiscal policy and monetary policy

Answer 30

Budgets defecits are financed using government bonds and Treasury bills.

These can be easily traded by investors, and therefore might cause an increase in interest rates offered.

This can offset the impacts of any monetary policy.

Question 31

Explain the conflict between monetary and suppy-side policies.

To what extent does this occur?

Answer 31

High interest rates caused by contractionary monetary policy means:

• Higher borrowing costs and so less investment in firms
• This can inhibit the AS curve
• However, higher interest rates leading to s_tronger currency_ means that imports of raw materials are cheaper, which may improve the productive capacity.

Therefore, the extent to which this occurs depends on the global export economy, and how strong the currency is at the time.