3.2.4 Macroeconomic Policy Flashcards
What are the 3 macroeconomic policies?
- Monetary policy (SRAS, demand side shifts AD)
- interest rates
- quantitative easing - Fiscal policy (SRAS, demand side shifts AD)
- Supply side (shifts LRAS)
Define fiscal policy
Use of taxation, public spending, governments budgetary position to achieve the government policy objectives
What differentiates a budget surplus, deficit and balanced budget?
Budget surplus: Gov spending < tax
Balanced budget: “ = “
Budget deficit: “ > “
What are the 5 types of taxes?
- Direct taxation:
taxied levied on incomes and wealth
I.e income tax. Not possible to shift onto someone else - Progressive taxation:
As income rises, a larger proportion of income is paid in tax
I.e corporation tax - Indirect tax:
Tax levied on spending. It’s possible to be shifted onto someone else
I.e VAT - Regressive tax:
When proportion of income paid in tax falls as income increases
I.e alcohol duties - Proportional tax:
When proportion of income paid in tax stays the same as income increases
I.e VAT
What characteristics does a good tax have?
- equitable
- economical
- flexible
- convenient
- efficient
- certain
What is inheritance tax?
Paid if a persons estate (property, possessions) is worth more than £325,000 when they die
Define public sector borrowing
Borrowing by the government revenue in a particular time period, usually a year
— if there is a budget deficit, there is a positive borrowing requirement
Define deficit financing
Deliberately running a budget deficit and borrowing to finance the deficit
Name the 3 types of cyclical and structural budget deficits
- Cyclical budget deficit
Rises in downswings, falls in upswings - Cyclical budget surplus
Could arise during an upswing of an economic cycle if the structural deficit is 0 - Structural budget deficit
Isn’t affected by economic cycle but results from structural change in economy
What does the effectiveness of fiscal policies depend on?
- size of cut in tax or rise in Gov spending
- size of multiplier
- initial equilibrium
- short-run / long-run
Advantages and disadvantages of fiscal policies?
Advantages:
- stabilises an economy by offsetting cyclical functions
- G stimulates economic growth and employment
- tax generates revenue and can provide public goods
- effective if Gov spending multiplier is large
Disadvantages:
- decision may be based off of poor information
- g can result in budget deficit
- time lags
- crowding out
What is crowding out?
Situation where an increase in Gov or public sector spending displaces private sector spending with little or no increase in AD
If the economy is on the PPF, it’s impossible to simultaneously employ resources in private and public sector
Define short-run
Time period when at least one FOP is in fixed supply I.e capital
Define long-run
Time period when all FOP are variable and reach their productive potential
What is monetary policy?
Involves central bank taking action to influence the manipulation of interest rates, supply of money, credit and exchange rates
Central bank controls banking system on behalf of UK Gov
What is the MPC?
Monetary Policy Committee:
Consists of 9 economists who meet monthly to set the bank rate and decide what other elements of monetary policy need changing
Define bank rate
Rate of interest the BofE pays to commercial banks on their deposits held at the BofE
Objective of the MPC?
Control inflation and keep it +/- 1% of the 2% target
What components are in each of the 3 stages of the transmission mechanism?
Stage 1
Official rate
Market rates
Asset prices
Expectations / confidence
Exchange rates
Stage 2:
Domestic demand
External demand
Total demand
Stage 3:
Domestic inflationary pressure
Import prices
Inflation
Acronym for £’s exchange rate value?
S trong P ound I mports C heap E xports D ear
Advantages and disadvantages of the monetary policy?
Advantages:
- effective at increasing / decreasing inflation
- quick to take a effect
- flexible
- not politically motivated
- cheap
Disadvantages:
- time lag can take up to 2 years
- liquidity trap: ineffective during recession
- difficult to control many objectives with one tool
Define bonds
Financial securities sold by companies (corporate bonds) or the government (Gov bonds) which are a form of long-term borrowing
Have a maturity date, with borrower typically making fixed interest payments each year until the bond matures
Price ^ , Yield v
What is an expansionary monetary policy?
Involves central bank decreasing interest rates in order to increase AD and shift it rightwards
A depreciation in exchange rate is still expansionary monetary policy
What is a contractionary monetary policy?
Involves the central bank raising interest rates in order to decrease AD and shift it leftwards
An appreciation in exchange rates is also contractionary monetary policy
What is quantitative easing?
Employed during recession
The central bank buys existing corporate and government bonds held by private businesses i.e pension fund holders, insurance companies
Which is done through an injection of electronic money
Improves their liquidity
Price of existing assets rise, yield decreases
BofE BUYS BONDS, MONEY SUPPLY INCREASES
How does quantitative easing affect the real economy?
- bank lending flows again — increased household and corporate spending
- confidence rises
- AD increased and economy grows
- inflation target is achieved
What are some key supply-side challenges for the UK economy?
- persistent productivity gap
- high youth unemployment
- rise of emerging nations
- deep regional economic divide
- riding inequality/ relative poverty
Name 4 industrial policy measures
-
Privatisation
Selling of assets -
Marketisation
Shifting provision of goods and services from non-market to market sector -
Deregulation
Removal of regulation to promote competition -
internal markets
Taxpayer finances public sector
Name 5 labour market measures (supply side policies)
-
Tax cuts
Lowering income taxes / raising -
Welfare reduction
Lower welfare payments or making welfare harder to claim -
Trade union reform
Removing TU legal protection -
Flexible pension arrangements
Encouraging workers to ‘opt out’ of staff pensions and organise private ones - Improving education and training
Name 4 financial and capital market measures
- Deregulating financial markets
Increasing competition among banks - Encouraging saving
Tax privileges for saving - Promoting entrepreneurship
Grants, tax breaks etc - Reducing public spending and public sector borrowing
Avoid crowding ojr
What are supply side fiscal policies?
Aim to increase economies ability to produce and supply goods, via creating incentives to work, save, invest and be entrepreneurial.
Shifts LRAS rightwards — aims to improve the long run productive potential of the economy
Define supply side economics
Branch of free market economics arguing Gov policy should be used to improve competitiveness and efficiency of markets
Offers originate in private sector
Every macro objective can be achieved through supply side policy
What 4 economic indicators do the MPC consider when making decisions?
- Domestic monetary developments
- Exchange rate statistics
- Demand and output policies
- Labour market signals
How do changes in the exchange rate affect AD and various macro policy objectives
SPICED:
strong pound imports cheap exports dear
Life becomes easier for British retailers as resources become cheaper, however exported goods / services become dearer for foreign consumers which hits britains BOP
WPIDEC:
weak pound imports dear exports cheap
Exports become cheap meaning they will rise in AD and cause subsequent economic growth (if demand is elastic)
— inelastic will fall as import price will rise which would cause a larger withdrawal from the circular flow of income
What are 3 objectives of monetary policy?
- Inflation — 2% target
- Unemployment — below 3%
- Currency exchange rates — increasing money supply by issuing more currency etc. which makes domestic currency cheaper than foreign counterparts
How can expansionary fiscal policy influence AD?
Expansionary fiscal policy gets put in place in response to recessions or employment shocks.
Government spending is increased in areas such as infrastructure, education and unemployment benefits
How can contractionary fiscal policy influence AD?
Contractionary fiscal policy can be used to reduce government spending and sovereign debt or to correct out-of-control growth fuelled by rapid inflation and asset bubbles during booms which decreases AD
How can fiscal policy influence aggregate supply (short run)?
Short run:
- changes in VAT
affects supply costs of businesses - changes in environmental taxes
Rise is carbon tax will increase the costs especially of energy-intensive firms - Changes in import tariffs
Lower tariffs as a result of trade liberalisation will lead — ceteris paribus — to lower costs - changes in Gov subsidies
Input subsidies paid to producers lower their costs
How can fiscal policy influence aggregate supply (long run)?
Long run:
- state funding in research and development can affect the dynamic efficiency in markets
- higher gov spending on education and training can increase human capital / productivity for long term growth
- changes in corporation tax and import tariffs can influence FDI
How can Gov spending and taxation affect the pattern of economic activity?
Gov spending:
Subsidising businesses to fund capital projects, improve public services etc, works as a large component of AD - stimulates growth
- reduces inequality
- improves infrastructure
Taxation:
Promotes ‘wanted’ and beneficial behaviour, whilst constraining ‘unwanted’ harmful behaviour
- raises revenue
- adjusts level of AD
- alters pattern of spending towards merit goods
- redistributes income
- controls imports
Define a balanced budget
Total expected = Total planned
Revenue Spending
Define a national debt
Total outstanding borrowings of a central government
What is supply side improvement, and why does it differ from supply side policy?
Supply side improvement occurs when the actions taken by firms are made in self interest i.e increasing staff training or tech which will improve productivity.
Other firms may adopt the same principles to gain a competitive advantage, therefore improving that industry
Whereas policy is applied for all firms by the Gov
What are the 2 types of supply side policies?
- Interventionist:
Involve Gov intervention to overcome market failure i.e higher Gov spending on transport
- Free market:
Involve policies to increase competitiveness and free-market efficiency i.e privatisation
How can tax changes be designed to appeal to personal incentives?
The tax system can stimulate factor output, rather than alter demand:
Reducing tax rates, including income and corporation tax will act as an incentive for
- unemployed workers to join the labour market.
- Existing workers will work harder
- Encourages startups
This would increase potential output in the economy
How can supply side policies affect unemployment?
Decreasing unemployment:
- funding apprenticeships / paid internships
- reductions in rate of national insurance contributions
How can supply side policies affect the exchange rate in the uk?
- Depreciation in the exchange rate (helps exporters)
- low interest rates + improving credit supply to businesses
