2.6 Macroeconomic Objectives & Policies Flashcards
1
Q
macroeconomic objectives
A
- different govts. prioritise different objectives, e.g. after the GFC the UK focused on fiscal balance whereas the USA focused on growth
2
Q
7 macroeconomic objectives
A
- economic growth; govt. aims to have sustainable economic growth for the long-run with a target of 2-3%
- low unemployment; govt. aims to have as near to full employment as possible, but there will always be a level of frictional unemployment so unemployment target is 4-5%
- low and stable rate of inflation; low inflation is a symptom of economic growth and the target is 2% (+/-1)
- balance of payments equilibrium on current account; means the country can sustainably finance the current account and there isn’t a surplus or deficit
- balanced govt. budget; this ensures that national debt doesn’t increase
- protection of the environment; long-run environmental stability is important so there’s not excessive pollution and so future generations have access to resources too
- greater income equality; a fairer society is important to ensure the gap between the rich and the poor isn’t extreme
3
Q
demand-side policies
A
- designed to increase consumer demand so total production in the economy increases
- fiscal policy
- monetary policy
4
Q
the difference between fiscal and monetary policy
A
- fiscal; involves the use of govt. spending and taxation to influence AD - set by the govt. each year when they deliver the govt. budget
- monetary; involves adjusting interest rates and the money supply to influence AD - set by the BoE who meet 8 times a year to set policy
5
Q
contractionary monetary policy
A
- contractionary policy = increasing interest rates;
- used to tackle hyperinflation when the economy is close to overheating
- decrease in demand for loans as cost of borrowing rises
- increases incentive to save as rate of return rices
- increases exchange rate as hot money flows in and currency is used up so price rises, and trade balance worsens
- reduces consumption and investment, and worsens trade balance so AD shifts left
6
Q
expansionary monetary policy
A
- expansionary policy = decreasing interest rates;
- used to tackle low inflation
- increased demand for loans as cost of borrowing falls
- reduces incentive to save as rate of return falls
- more income if variable mortgages decrease
- demand for houses rise, so house prices rise (wealth effect)
- exchange rate falls so hot money flows out, imports are dearer and the trade balance improves
- increases consumption and investment, and improves trade balance so AD shifts right
7
Q
quantitative easing
A
- refers to asset purchases to increase the money supply
- used by banks to help stimulate the economy when standard monetary policy is no longer effective, i.e. when inflation is low and they can’t lower IR further, e.g. after GFC
- process;
- the BoE buys assets in the form of govt. bonds from financial institutions using the money they’ve created electronically
- commercial banks recieve cash for this, which increases amount of cash flowing in and liquidity rises
- commercial banks then lower lending rates, so consumers and firms borrow more, so consumption and investment rises thus increasing AD (right shift)
- it has inflationary effects as it increases the money supply and can reduce the value of the currency
- it pumps money directly into the economy, e.g. £375bn after the GFC
8
Q
strengths of monetary policy
A
- BoE operates independently from the govt. so less political influences
- considers long-term outlook
- targets inflation and maintains stable prices
- depreciating currency can increase exports
- dual effects on AS as LRAS can increase and shift right due to investment increases, e.g. increased quantity/quality of capital shifts productive potential of an economy
9
Q
weaknesses of monetary policy
A
- demand pull inflationary pressure, especially with QE (conflicting goals)
- time lag of 18 months before a change in IR feeds through to the macroeconomy
- effects depend on;
- level of consumer / business confidence (e.g. after GFC IR lost effectiveness despite being low due to the liquidity trap)
- size of the multiplier; if it’s bigger, IR need to be cut less to see a big effect
- level of change in IR
- initial level of economic activity as close to full employment will be inflationary, so you need supply side policies too
10
Q
fiscal policy instruments
A
- govt. can change spending and taxation to stimulate the economy
- diagram 1
- contractionary/deflationary fiscal policy; reduces govt. spending / increases taxes to reduce AD - occurs when there’s a budget deficit (govt. expenditure > govt. revenue)
- expansionary fiscal policy; increases govt. spending / reduces taxes to increase AD - occurs when there’s a budget surplus (govt. revenue > govt. expenditure) - this is an austerity measure as it aims to reduce govt. budget deficits
11
Q
direct and indirect taxation
A
- direct taxes; imposed on income and paid directly to the govt. from the taxpayer, e.g. income tax, corporation tax, inheritance tax
- indirect taxes; imposed on expenditure on goods / services and they increase production costs for producers, who may pass it onto consumers through higher prices which contracts demand, e.g. VAT, excise duties
12
Q
strengths of fiscal policy
A
- spending can be targeted on specific industries
- short time lag compared to monetary policy
- redistributes income through taxation
- reduces negative externalities through taxation
- increased consumption of merit / public goods
- short-term govt. spending can increase and shift LRAS
- automatic stabilisers allow the economy to smoothly transition without active govt. intervention, e.g. in a recession, govt. spending rises and tax revenues fall as there’s more unemployment benefits the govt. has to pay and less income tax and consumption, and vice versa for a boom
13
Q
weaknesses of fiscal policy
A
- demand-pull inflationary pressure
- time lag before we see a real effect of the policy
- conflicts between objectives
- disincentive to work due to higher taxes (Laffer curve) so unemployment rises and the govt. spends more on unemployment benefits which defeats the purpose
- increased govt. spending may increase budget deficit which burdens future generations so it’s unsustainable
- crowding out; rising govt. spending financed through borrowing will put upward pressure on IR, causing the cost of borrowing to rise so consumption decreases thus crowding out private sector activity as their spending declines
14
Q
The Great Depression
A
- created a global slump
- 1929-1933; in USA real GDP fell by 30% and unemployment rate rose to 25%
causes; - set off by Wall Street Crash of 1970, which led to a huge loss in consumer / business confidence, decreasing consumption and investment
- 1920s was an unsustainable boom and the banking system was unstable
UK responses; - govt. cut public sector wages and unemployment benefits and raised income tax, to balance the govt. budget
- IR were high to maintain the pound, but eventually they were cut
USA responses; - Roosevelt’s New Deal used govt. spending on infrastructure and conservation projects to increase AD and bring about a recovery
- also tried to increase money supply
- the war eventually ended the Depression so it’s unclear if these policies were effective
15
Q
Global Financial Crisis of 2008
A
- decline in world GDP in 2007-8
causes; - before the crash, asset prices were high, there was a boom in economic demand, there were risky bank loans and mortgages (especially in the USA)
- after house prices crashed in 2006 in the USA, several homeowners defaulted on their mortgages in 2007, so banks lost huge funds and required govt. assistance through bailouts
UK and USA responses; - both govts. were forced to nationalise banks and building societies to guarantee savers their money to prevent the chaos of a collapsed system
- they used expansionary monetary policies, including record low IR and QE
- UK cut VAT to 15% and saw a huge rise in govt. borrowing
- USA used more expansionary fiscal policy, perhaps this is why it recovered faster - the UK prioritised reducing national debt in 2010 but the the USA didn’t make this decision till 2013
