4.0. Government macro policy aims

Question 1

The main government macroeconomic policy aims:

Answer 1

1) Full employment.
2) Low and stable inflation.
3) Balance of payments equilibrium.
4) Steady and sustainable economic growth.
5) Exchange rate stability.
6) Sustainable economic development (rising living standards).

Question 2

GUILT EX (main government macroeconomic policy aims)

Answer 2

Growth
Unemployment
Inflation
Living standards
Trade
EXchange rate

Question 3

Other government macroeconomic aims

Answer 3

1) Redistribution of income and wealth.
2) Access to public services.
3) Environmental sustainability.
4) International competitiveness.
5) Good public finances (balanced budget / debt reduction).

Question 4

Government macroeconomic aims depends on

Answer 4

• How different areas of the economy are performing.
• Underperforming areas are likely to be more of a priority.
• Priorities change over time.
• Government is likely to pursue a range of aims at the same time.

Most important: involves a value judgement.

Question 5

Complementary government macroeconomic aims

Answer 5

• Economic growth & full employment.
• Full employment & living standards.
• Balance of payments & economic growth.

Question 6

Conflicting government macroeconomic aims

Answer 6

• Full employment vs Inflation.
• Economic growth vs Inflation.
• Economic growth vs Inequality.
• Economic growth vs Environment.
• Economic growth vs BoP
• Balanced budget vs Economic growth.

Question 7

Macroeconomic Policies to achieve aims

Answer 7

1) Fiscal Policy
2) Monetary Policy
3) Supply-side Policy

Question 8

Fiscal Policy

Answer 8

The use of taxation and government spending.

Question 9

Monetary Policy

Answer 9

The use of interest rates, the money supply and the exchange rate.

Question 10

Supply-side Policy

Answer 10

Long-term policies aimed at increasing productive capacity e.g. education, training, deregulation.

Question 11

Internal value of money

Answer 11

• The value of money when buying goods and services.
• This is the real value of money and it is measured by the purchasing power of money.
• Determined by inflation and subsequent purchasing power

Question 12

External value of money

Answer 12

• What the currency is worth, as measured in foreign currency.
• This is the exchange rate
• Determined by foreign exchange rate of the domestic currency

Question 13

Effect of Internal value of money external value of money

Answer 13

• Internal value of money falls (inflation rises)
• Export prices rise (less demand) and import prices fall (more demand) - only falling relative to domestic export prices
• Less demand for currency and more supply of currency (more demand for imports)
• External value of money falls (exchange rate falls)

Question 14

Effect of External value of money on Internal value of money

Answer 14

• External value of money falls (exchange rate falls)
• Import prices rise (finished products and raw materials)
• Domestic prices rise (higher imported raw material costs)
• Internal value of money falls (inflation rate rises)

Question 15

Effect of Inflation on Balance of payments (BOP)

Answer 15

• If domestic inflation rate rises
• This makes the Price of X rise & the Price of M fall.
• This causes a fall in Demand for X & a rise in Demand for M which results in a fall in X revenue & rise in M revenue
• This leads to a fall in net exports
• Hence, the BOP worsens

Question 16

Effect of Balance of payments (BOP) on Inflation

Answer 16

• If there is a BOP surplus, this means the value of X exceeds to value of M
• This causes a rise in AD
• If the economy is close to full capacity, this causes the price levels to rise and results in high rates of inflation

Question 17

Conflict between unemployment and inflation (Keynesian View)

Answer 17

Expansionary FP / MP
- leads to a decrease in unemployment and an increase in wage rates, leading to a rise in inflation

Contractionary FP / MP
- leads to a increase in unemployment and a decrease in wage rates, leading to a fall in inflation

Question 18

Conflict between unemployment and inflation (Monetarist View)

Answer 18

(Phillips Curve)
Expansionary FP / MP
- leads to a decrease in unemployment and an increase in wage rates, leading to a rise in inflation
- in the long term, rational workers realise their nominal wage rise lags behind inflation.
- Workers adapt their inflation expectations and demand a real wage increase.
- Rising costs of production force firms to cut output and employment
- Unemployment returns to the NRU but with higher expected inflation.

Question 19

Meaning of Government failure in macro policies

Answer 19

when government intervention worsens economic performance

Question 20

Reaons for Government failure in macro policies

Answer 20

• Time lags:
• Recognition lag: time taken to recognise there is a problem.
• Implementation lag: time taken to come up with an implement a policy.
• Behavioural lag: time taken to influence behaviour of households / firms.
• Information failure: government does have all information about policy impacts.
• Excessive bureaucracy: paperwork.
• Political interference: policies designed to win votes.
• Political self-interest
• Change of governments
• Regulatory capture: decisions that favour producers over consumers.
• Unintended consequences: impacts that were not anticipated in advance.

Question 21

Laffer Curve definition

Answer 21

graph showing the relationship between tax rates and tax revenue.

Question 22

How the Laffer Curve works

Answer 22

• To increase tax revenue, the government may have to raise taxes or lower taxes, depending on where the current tax rate is in relation to the optimum.
• However, it is difficult to identify the optimum tax rate and it is hard to establish how labour will respond to changes in tax rates. Tax evasion and tax avoidance need to be considered when raising taxes.
• there is a peak of tax revenue at the optimum tax rate, which depends on each country