4.2.5 Fiscal Policy + Supply-Side Policies Flashcards
State the determinants that Supply Side Policies Address.
- Labour
- Industry
- Free Market
- Efficency
Define Fiscal Policy.
Changes to gov spending + taxation in order to influence AD.
Define Contractionary Fiscal Policy.
Changes to G + T in order to reduce AD.
State + explain why the gov may use Contractionary Fiscal Policy to reduce AD.
• Reduce Inflation: in theory, if economy is being overworked, + there are high rates of demand-pull inflation, then reductions in AD via contractionary fiscal policy can help to reduce demand-pull inflation.
• Reduce Budget Deficit/National Debt: reduce amount of borrowing gov is doing annually, reduces overall debt gov has.
• Redistribute Income: via higher taxation on the rich, to gain money then redistribute it via income top ups to the poor.
• Reduce Current Account Deficit: if AD is reduced, then incomes in the economy are reduced, therefore there’ll be less sucking in of M, ceteris paribus, this will reduce the C.A deficit
Define Expansionary Fiscal Policy.
Changes to G + T in order to boost AD.
State + explain why the gov may use Expansionary Fiscal Policy to increase AD.
• Boost Economic Growth: if economy is sluggish/in recession, a boost in growth may be necessary, boost in AD achieves this.
• Reduce Unemployment (cyclical): if AD shifts right, there’s going to be more goods + services produced in economy, thus firms need more workers to producer that output (labour as derived demand).
• Increase Demand-Pull Inflation: in theory, if inflation rate is below target than a slight raise in inflation will be desirable through expansionary fiscal policy.
• Redistribute Income: reduce income inequality (e.g. by gov spending on welfare benefits/reduction in tax rates for those on lower incomes).
State + explain examples of Expansionary Fiscal Policy.
• Reduction in income tax: for those in lower income tax brackets, widening in tax bands, widening in tax free allowance, e.t.c. Increases disposable income of households, increases their MPC- increase of C in AD equation- shifts AD right.
• Reduction in Corporation Tax: increase retained profits for businesses, increases their MPI- increases I in AD equation- shifts right.
• Increase in Gov Spending: on education, on infrastructure,on public sector wages, e.t.c. Boosts G in AD equation.
State + explain the effects of Expansionary Fiscal Policy on LRAS.
Not the intention of the policy, just a side effect!
• Reduction in Income Tax: incentivises the inactive to become active (become part of the labour force), increase Q of labour + boost LRAS. For those in work, if income tax is cut, then there’s an incentive to work harder + earn more, as they can then keep more of the money that they earn as disposable income, thus productivity increases, so the quality of labour, boosting LRAS
* Reduction in Corporation Tax: I also boosts LRAS, due to the increase in the quantity + quality of capital, + that it increases productive efficiency in the economy.
* Increase in Gov Spending: if it’s on education + health, boosts productivity of labour + quality of labour, increases LRAS. Increase in gov spending on infrastructure, increases productive efficiency in economy + potentially produces more capital.
State + explain the cons of Fiscal Policy.
- Demand-Pull Inflation Pressure: if when AD increase, inflation overshoots the target this isn’t desirable- conflict of macroeconomic objectives.
- Current Account Deficit: if economic growth in economy increases, households have higher incomes- more spending on M (sucking in off imports effect) widens trade deficit. Undesirable macroeconomic objective tradeoff.
- Worsening of Gov Finances: likely to worsen with expansionary fiscal policy; budget deficits may rise, total debt/national debt could increase as well.
- Crowding Out Effect: gov spending is heavily debt fuelled (increase demand for loadable funds in the loadable funds market- pushes up equilibrium interest rates- more expensive for private businesses to borrow + fund their investment), could crowd out private sector + reduce private sector investment. More dependence on economy for gov spending to boost economic growth.
- X-Inefficiency: gov lacks a profit motive- gov spending could be wasteful for infrastructure projects, or gov organisations’ costs could spiral out of control (if there’s excessive gov spending).
- Time Lags: gov spending on infrastructure projects means rounds of gov spending. Corporation tax cut takes time before businesses invest those increased retained profits.
Evaluate the impact of Fiscal Policy.
- Size of the Output Gap: if economy is close to full employment, with a very small negative output gap, then expansionary fiscal policy is less likely to be effective in boosting growth + reducing unemployment.
- Size of the Multiplier: if multiplier value is large, then the impact of expansionary fiscal policy is likely to be greater.
- Consumer/Business Confidence: if low, then an income tax cut might be saved, businesses might not use increases in retained profit from corporation tax cuts to invest.
- State of Gov Finances: if there’s high budget deficits/lots of national debt, then maybe expansionary fiscal policy cannot be afforded, gov might be breaking its fiscal rules if they went ahead with it.
- LR Returns to the Gov: via higher tax revenues- gov spending on education, infrastructure, health-care, provides long-run growth to the economy- greater economic activity + great tax revenue returns over time.
- Crowding Out/Crowding in: Keynesian economists disagree very strongly with the crowding out effect- state that in a recession where expansionary fiscal policy is very much needed, then the risks of the crowding out effect is very low. Would also say that gov spending could crowd in (creates demand in the economy, generates economic activity, incentives private sector businesses to tap into that, invest + grow their business, because there’s greater profit potential when there’s more demand in the economy)
- Classical view of Self-Correcting an Economy in a Recession: eventually wages will fall + economy will return to full employment on its own. Thus, it’s not necessary for gov intervention.
State the reasons for a Budget Deficit occurring.
- Economic downturn/recession
- Expansionary Monetary Policy
- Increase in G investment (capital expenditure)
- Increase in G current spending (public services)
- Changes to tax/benefit system
- Change in demographics- ageing population
- Globalisation (companies relocating)
- Tax avoidance
Explain Cyclical Budget Deficits.
- Part of deficit that arises as a result of changes in rate of economic growth (fluctuations in economic cycle).
- When AD falls during a downturn G will rise (e.g. welfare benefits, JSA, e.t.c.), + gov income from tax revenues will fall. Therefore, during a downturn/recession there’ll be a rise in cyclical budget deficit.
- Cyclical deficit should be reduced/eliminated during upturns in conic cycle- tax revenues will recover + expenditure on welfare + JSA is reduced.
State + explain the justifications of Cyclical Budget Deficits.
- Economic Stability: In a recession, tax + benefit system will create a cyclical deficit + in a boom will create a surplus- prevents AD falling too far + dampens down excessive rise in AD that causes inflation- therefore smooths out economic cycle. Known as automatic stabilisers + help justify a progressive tax system + generous welfare system.
- Fiscal Stimulus: during a recession/downturn, economy can get stuck at very low levels of AD- consumers lack confidence + increase S, firms lack confidence + reduce I. Increase in G (discretionary fiscal policy) is a vital stimulus to aggregate demand. Multiplier effect means there’ll be an even bigger impact on AD + real GDP. Helping to increase incomes, reduce unemployment + kickstart economy to a higher growth path.
Explain Structural Budget Deficits.
- Portion of budget deficit that isn’t result of changes in economic cycle.
- Means that a deficit will exist even during periods of strong economic growth.
- Stem from a core imbalance between public spending + taxation revenues, therefore these imbalances need to be addressed to remove structural deficit.
- Therefore, more of a concern than cyclical deficits + more difficult to solve.
State + explain the justifications of Structural Budget Deficits.
- Investment + Improvements in Productive Potential: borrowing to spend on capital projects will improve LR productive potential + shift LRAS right. Could lead to improved skills + reductions in structural + natural rate of unemployment- improves productivity + competitiveness, + reduces inflationary pressures.
State + explain the negative consequences of Budget Deficits.
- Risk Of Inflation: expansionary fiscal policy increases AD + can lead to inflation (if economy is close to full employment)
- Reduction In Funds Available For Future G: borrowing money involves repayment of interest- reduces amount of expenditure that might be spent elsewhere in economy (e.g. 2015, UK gov spent approximately £52bn in interest payments.
State + explain the types of government spending.
- Current Spending: day to day spending on public services, maintenance of public services + paying public sector wages.
- Capital Spending: spending on infrastructure projects.
- Welfare Spending: gov spending on benefits + pensions in economy.
- Debt Interest Spending: cost for gov of servicing debt interest. Only form of G that doesn’t increase AD- non-productive form of G.
State + explain the reasons for government spending.
- Influence Macroeconomy: expansionary fiscal policy - higher G increases AD- in recession very useful, boosting growth, reducing cyclical unemployment + if inflation is below target, can raise inflation back to target. Help fight against deflationary pressures in economy.
- Reduce Income Inequality: (e.g. welfare spending - spending on benefits + pensions, raises disposable income for those on lower incomes).
- Correct Market Failure: policies like subsidies, state provision, advertising campaigns, e.t.c. Encourages more consumption / production of goods / services if there are positive externalities, or maybe G on negative adverting to reduce consumption that way.
Define indirect taxation + state the types of indirect taxation.
Indirect Taxation: expenditure taxes - levied on firms, increase CoP, but can be transferred to consumers. Paid when good / service is sold.
• Specific Indirect Taxes: tax per unit sold - each unit has same value of tax (e.g. cigarette duty, alcohol duty, sugar tax, e.t.c.).
• Ad Valorem Taxes: tax as % of final price of goods / service sold (e.g. VAT). Revenues earns by gov will vary depending on P of good / service - higher the P, more revenue gov will earn.
Define direct taxation + state the types of direct taxation.
Direct Taxation: taxes on income - can’t be transferred.
• Income Tax
• Corporation Tax
State + explain the reasons for taxation.
• Raise Gov Revenue: to fund key public services, welfare spending, e.t.c.
• Influence Macroeconomy: direct tax cuts can help to boost AD in recession - helpful to boost growth, reduce unemployment, bring inflation back up, fight against deflation. Can also help to cool economy down - if inflation positive output gap / inflation beyond target - higher rates of taxation by reducing AD help bring inflation back down. Helpful in bringing down budget deficits + national debt, in promoting more sound stable + sustainable gov finances.
• Reduce Income Inequality: help redistribute income (e.g. increasing taxes on high earners through progressive tax system - lowers disposable income - rev earned can be used to fund benefits to lower income Hh - increases their disposable income. Also reducing regressive taxation).
• Correct Market Failure: when there’s overconsumption / overproduction - indirect taxes can help increase CoP + P - brings down those overconsumption / overproduction issues - helps brings Q back down to socially optimum level.
• Protectionism: tariffs - taxes on M that raise P on M to protect domestic producers from foreign competition.
Define progressive taxation.
Progressive Tax: as income rises, average rate of tax rises- as people get richer, amount of tax they pay as proportion of their income goes up.
* Example: income tax
Define proportional taxation.
Proportional Tax: as income rises, average rate of tax stays exactly the same.
* Amount of tax you pay as proportion of income always remains the same (e.g. 20% no matter how much you’re earning.)
* Example: flat income tax
Define regressive taxation.
- Regressive Tax: as income rises, average rate of tax falls.
- As people get richer, amount of tax they pay as proportion of their income goes down.
- Burdens those on lower incomes, more than higher incomes.
- Example: indirect taxes (e.g. alcohol tax, cigarette tax).
State how taxable income is calculated.
Taxable Income = Income - Tax free allowance
Define the average rate of tax (ART).
Average tax paid as a proportion of total income earned.
State how the average rate of tax (ART) is calculated.
ART (%) = (Tax paid / Income) x 100
State how the marginal rate of tax (MRT) is calculated.
MRT (%) = (change in income tax paid / change in total income) x 100
Define automatic stabilisers.
Automatic Stabilisers: fiscal policy tools to influence GDP + counter fluctuations in the economic cycle.
* Progressive income tax system + welfare benefits (unemployment benefits)
State + explain the impact of automatic stabilisers in different stages of the economic cycle.
Boom (Cushion Demand):
* Progressive Income Tax: Growth is rampant- incomes rise - workers pushed into higher tax bands - increase ART - slowing down increases in C + AD - controls extent of boom - demand-pull inflation won’t overshoot target significantly.
* Welfare Benefits: unemployment low - gov spending on benefit reduces - helps cushion demand - extent of boom is lower - risk of high demand-pull inflation is lower.
Recession (Support Output):
* Progressive Income Tax: in recession, growth rates negative - incomes falling - workers move to lower income tax bands - reduces ART (%) - prevents large decreases in C - AD falls but not as much as it would otherwise - helps keep output up to certain level + prevents deep recession.
* Welfare Benefits: unemployment high - gov spending on unemployment benefits increases - helps increase AD + prevent deep recession.
Define a budget deficit.
When G > T in a year (gov borrowing in a year).
* Also known as a fiscal deficit.
Define a structural budget deficit.
Budget deficit at full employment.
Define a cyclical budget deficit.
Budget deficit in recession.
Define national debt.
Total stock of gov debt over time.
State + explain the benefits of budget deficits + increasing national debt.
- Higher Growth, Lower Unemployment: link to expansionary fiscal policy - higher AD, leads to higher growth + lower unemployment. Very desirable in recession to close negative output gap + return economy back to full employment. Keynesians argue that budget deficit in recession is worthwhile policy to get economy out of recession.
- Benefits Of Increasing Gov Spending: higher gov spending on education, healthcare, infrastructure + public services - long-run benefits - increase productive capacity in economy - boosts LRAS - good for LR growth rates, competitiveness + productivity. Can generate LR tax rev returns to gov. Solve market failure (e.g. education has positive externalities - merit goods, infrastructure - public goods) -improving resource allocation. Improving living standards.
- Redistribution Of Income: if G on benefits, healthcare, education rises. Lower regressive taxation, lower direct taxation (e.g. lower income tax on low earners) helps reduce income inequality.
- Incentives Of Tax Cuts: LR incentives - to work, work harder, be more productive in work, entrepreneurship, e.t.c - good for LRAS - boost LR growth rates - higher productivity - greater tax revenue returns.
- Crowding In: keynesian economists argue that more G can crowd in private sector - promotes more private sector I - G which increases AD in economy, increases output, increases economic activity - promotes private sector firms to tap into that - incentivises them to I, grow their business, sell more to tap into that D + increase profits.
State + explain the negatives of budget deficits + increasing national debt.
- Deterioration Of Gov Finances: if budget deficits rise, national debt rises - where gov is operating outside of fiscal rules - lower confidence in state of gov finances - people think this is unsustainable - reflected in lower credit ratings on gov bonds (reflects risk of lending money to gov - if credit ratings go down + you buy gov bond - at risk of not getting money back + not receiving annual interest - thus to entice people, gov has to offer higher coupon rates, higher i.r. - harder + more expensive for gov to borrow money overtime to fund their spending). Burdens on future generations - debt has to be paid back (e.g. through tax raises, cuts to G, greater debt interest payments, e.t.c.). Can also negatively impact FDI - harming SR + LR growth.
- Inflation Vs. Current Account Conflict: conflict of macroeconomic objectives - demand-pull inflation, as AD goes up, but worsening of current-account deficits as growth + employment rises - higher incomes -more spending on M. Higher demand-pull inflation can erode international competitiveness of X - worsening current account deficits.
- Crowding Out Effect: free market economists argue that debt fuelled G could crowd out private sector + harm private sector I - increases D for loanable funds - increasing equilibrium i.r. - more expensive for private sector firms to borrow + fund I projects - bad for SR + LR growth - I is component of AD equation + major factor determining LRAS.
- X-Inefficiency: wastefulness that comes with G - gov aren’t profit motivated - costs can’t spiral + public money is wasted.
Evaluate budget deficits + increasing national debt.
- Current State Of Gov Finances: if gov finances are already in a bad position (e.g. high budget deficits + national debt)- likely cons will outweigh pros.
- SR Vs. LR Impacts: LR returns on increasing G + direct tax cuts - could outweigh SR cons.
- Stage Of Economic Cycle: in recession, keynesians argue running budget deficit is desirable in increasing AD, closing output gap, returning economy to full employment. In boom, policies are likely to be inflationary - undesirable - taking on gov debt in boom may not be necessary - could argue it’s a time to mend gov finances, not worsen them.
- Specific Policy Used: i.e. increasing G + / or reducing T.
- Consumer / Business Confidence: cuts in direct taxation - reliant on consumer / business confidence being strong - if weak, could limit effectiveness of direct taxation cut.
- Automatic Stabilisers: can help naturally to support economic growth / output in recession may- role is strong, reduces need for discretionary (expansionary) fiscal policy on top of automatic stabilisers.
Define a budget surplus (fiscal surplus).
When T > G in a fiscal year.
Define a structural budget surplus.
Budget surplus at full employment
Define a cyclical budget surplus.
Budget surplus in boom- expected, given lower G on benefits + higher T.
State + explain the benefits of running a budget surplus + reducing national debt.
- Confidence In Gov Finances: by reducing budget deficits + national debt / running budget surplus - promotes confidence - translates to improved credit ratings on gov bonds - seen as less risky borrower - as a result, gov can issue lower coupon /i.r. on their bonds - easier + cheaper to borrow overtime + fund public services (major LR benefit). Can also attract inward FDI - foreign firms more likely to I in economy where gov finances are under control.
- Flexibility With Fiscal Policy: if budget surpluses are being run - gov can operate within fiscal rules - allowing space for fiscal policy whenever it’s needed. If national debt is coming down - less interest / servicing of debt taking place - freeing up fiscal policy / higher G + cuts to T whenever necessary.
- Less Crowding Out / X-Inefficiency: free market economists argue that with less debt fuelled G - therell be less crowding out in private sector - less detraction of priv sector I - wont be as much pressure for D in loanable funds market - keeping i.r. relatively low - allowing private sector firms to borrow + I - good for growth (SR + LR). Less x-inefficiency (wasteful spending)- especially in infrastructure projects.
- Lower Inflation + CA Deficit: lower demand pull inflation, lower AD - lower incomes - lower spending on M - increases position of CA.
State + explain the negatives of running a budget surplus + reducing national debt.
- Demand Side Shock: if polices are used strongly + simultaneously - can shock economy into deep recession on demand-side - by reducing AD - see lower growth, higher unemployment (cyclical), lower living standards.
- Micro + Macro Impacts Of Decreasing G + Increasing T: cuts in G in education (micro - larger class sizes, lower teacher recruitment, poor quality of teaching), healthcare (micro - longer wait times, lower quality healthcare), infrastructure (micro - people may rely on public transport), public sector W (micro - harm living standards for those relying on public sector W) - macro effect - harm LR productive potential of economy, harm LRAS + long-term prosperity. Harm productivity + competitiveness.
- LR Returns Of Increasing G + Decreasing T Ignored: policies trying to run a budget surplus ignore LR returns of these policies. Idea that these policies boost short-term growth, but also long-term growth - create activity / output in economy - generates T returns to gov.
- Incentives Distortion Of Higher Direct Taxation: lower incentive to work, lower incentive for economically inactive to join workforce, lower incentive to be entrepreneurial, greater incentive to leave country (emigration), greater incentive for tax evasion - harm T revenue. Laffer curve may argue it means lower T rev for gov. Raising corporation tax reduces incentive for private firms to I - bad for LR tax rev + productive capacity.
- Risk Of Income Inequality: if G on benefits is cut, if regressive taxation goes up.
Evaluate budget surpluses + reducing national debt.
- Whether It’s Necessary To Use Policies: is it necessary to run budget surplus / reduce national debt. If gov finances in bad way - operating outside fiscal rules - then there is the need - pros outweigh cons.
- Debt / GDP Rising: way we measure national debt is debt : GDP - looking at total national debt, relative to GDP - if policies are used so strongly they reduce GDP / shock economy - even if national debt is coming down, if GDP is coming down at quicker rate, debt : GDP ratios could be rising - gov finances could be worsening - cons outweigh benefits.
- Policy Used: if policies are balanced (e.g. cuts to G, without raising T)- mitigate some cons, while receiving pros.
- Stage Of Economic Cycle: when economy is booming - time to implement policies - cool down overheating economy - reduce inflation (demand-pull) - time to mend gov finances
Define supply side policies.
Supply Side Policies: policies designed to increase productive capacity of economy, shifting LRAS right.
* If successful all 4 main macro objectives will improve - increase in growth rates, reduction in unemployment (natural rate), reductions in LR rates of inflation + improvements in CA (X more competitive).
Define interventionist supply side policies.
Promote role for gov in economy to boost LRAS.
State + explain the interventionist supply side policies.
• Gov Spending On Education / Training: to build more schools, to recruit more teachers, train teachers better, e.t.c. Aim to boost skills of workforce / boost productivity of L (improvement in quality of L - shifts LRAS right).
• Gov Spending On Infrastructure: new transport infrastructure being built (e.g. newer roads, airports, railway lines, e.t.c.) - LR CoP for businesses falls - easier + cheaper to access raw materials + easier + cheaper to sell - productivity efficiency rises - shifts LRAS right. New infrastructure increases quantity of capital stock in economy - increases Q of capital - shifts LRAS right.
• Subsidies Given By Gov To Firms To Promote Investment: target firms spending on R&D, buying new capital, upgrading capital, new tech, e.t.c. Increases quantity + quality of capital, but also reduces LR COP for businesses - shifts LRAS right.
Define free-market supply side policies.
Aim to reduce role of gov in economy - take away gov from functioning of markets - therefore see LRAS shift right.
State + explain the free-market supply side policies.
• Tax Reform: lower income tax - for those inactive, incentive to join L force, increases Q of L + boosts LRAS- for those in work, incentive to work harder + be more productive - keep more income as disposable income - boosts quality + productivity of L - shifts LRAS right. Lower corporation tax - more retained profit - can use as I - improves quantity + quality of capital + reduces CoP.
• Labour Market Reform: reduction in benefits (welfare payments) - strong incentive for economically inactive to enter L force - increase Q of L, size of workforce + boosts LRAS. Reduction in min wages + reduction in TU power - reduces LR COP for businesses - boosts productive efficiency in economy - boosts LRAS.
• Competition Policy: privatisation, deregulation + trade liberalisation aim to boost competition across economy - firms have to reduce LR CoP to remain competitive - improves productive efficiency across economy - boosts LRAS.
Evaluate the use + effectiveness of supply side policies.
• No Guarantee Of Success: no guarantee that G on education + training will boost productivity of workforce, no guarantee that subsidies to firms will be used as I purposes, no guarantee lower corporation tax will lead to increased I, no guarantee competition policies will lead to higher competition - policies could fail.
• Cost: policies are very costly - risk / danger of wasteful spending on supply-side policies - especially interventionist supply side policies - how are they funded?
• Time Lags: G on infrastructure - years before infrastructure project is complete. G on education / training - years before seeing improvements in productivity. Tax cuts - time lags before we start seeing I.
• Negative Stakeholder Impacts: L market reform harsh - those on lower incomes - impact on living standards severe
• Output Gaps: supply-side policies to boost growth - depends on size of output gap + what stage of economic cycle economy is in - if in recession, supply-side policies useless in boosting growth.
• Need For Targeted SSPs: so many different types of policies - need to be used to target issues in economy - if infrastructure problems, spend on infrastructure, e.t.c.
State + explain the policies to increase short-run growth.
Where there’s low AD - recession - negative output gap - spare capacity in economy - then need to increase SR growth via increasing AD.
* Expansionary Fiscal Policy: increasing G, reducing T.
* Expansionary Monetary Policy: cut in i.r., boost in money supply.
* If policies successful, AD shifts right - increase in SR growth from Y1 to Y2 - using up more spare capacity - closer to YFE.
Evaluate the use of policies to increase short-run growth.
- Conflict Of Objectives: may get higher economic growth + reduced unemployment - but risk of demand-pull inflation - inflation overshooting target (2% + / - 1%) - not desirable. If size of output gap is small, risk of inflation is more significant. Risk of widening CA deficit - as incomes rise with economic growth - more sucking in off M - more spending on M by Hh.
- Gov Finances: expansionary fiscal policy has potential of worsening gov finances - increasing budget deficits, worsening national debts - causes LR issues when funding these policies.
- Consumer / Business Confidence: T cuts, i.r. cuts - in recession, when AD is very low - confidence is low - limits effectiveness of these policies in boosting AD + SR growth.
- Time Lags: limit effectiveness of policies straight away in boosting growth.
State + explain the policies used to increase long-run growth.
If economy is at full unemployment / very close to full unemployment - need policies to boost LR growth, potential growth - shift LRAS right.
* Supply Side Policies: interventionist (education, healthcare, infrastructure, subsidies to firms) or market based (tax reforms, labour market reforms, competition policies, deregulation).
* If successful, shifts LRAS right - boost of potential growth, LR growth (YFE1 to YFE2) - full employment level now higher.
Evaluate the use of policies to increase long-run growth.
- No Guarantee Of Success: theoretical effects may not happen in reality - diff effects may happen in reality - prevents LRAS shift.
- Cost: particularly interventionist SSPs very costly - LR issues with funding - could damage productive potential of economy.
- Time Lags: not going to see immediate impact of productive potential on economy.
- Negative Stakeholder Impacts: free market SSPs in particular - labour market reforms - impact on workers + worker welfare, worker living standards. Deregulation can hit environment ver hard, harm workers - worker safety, product safety.
Evaluate overall the use of policies to increase growth.
- Type Of Growth: policies to increase economic growth - depend on type of growth.
- Strong, Sustained, Sustainable Growth: macroeconomic objective - want to see high rates of growth in economy, but needs to be sustainable - growth without significant inflationary pressure, without significant damage to environment.
State + explain the policies used to reduce cyclical unemployment.
- Expansionary Fiscal Policy: increasing G, reducing T.
- Expansionary Monetary Policy: reduction in i.r.
- If policies successful - AD shifts right - higher economic growth.
- AS L is derived demand - reduces cyclical unemployment.
Evaluate the use of policies to reduce cyclical unemployment.
- Conflict Of Objectives: may be able to increase growth + bring cyclical unemployment down, but could be demand-pull inflation that overshoots target. If growth increases + incomes rise - could worsen CA if more sucking in off M.
- Gov Finances: expansionary fiscal policy could worsen gov finances - issues with funding in LR.
- Consumer / Business Confidence: Tax + i.r. cuts - in recession - confidence likely low - limiting effectiveness of these policies in increasing AD - bringing cyclical unemployment down.
- Time Lags: associated with policies.
State + explain the policies used to reduce real wage (classical) unemployment.
Need policies that bring down WR towards equilibrium in L market.
* Reduce Min Wages
* Reduce Strength Of Trade Unions
Evaluate the use of policies to reduce real wage (classical) unemployment.
- Impact On Workers: strong negative impact on workers + living standards.
- Income Inequality: potential to drive up income inequality in economy - conflict of macroeconomic objectives.
State + explain the policies used to reduce the NRU - in particular structural unemployment.
Supply side causes of unemployment - need SSPs to improve occupational + geographical mobility.
Interventionist SSPs:
* G On Education / Training: boosting skills of workforce - improving productivity - reducing occupational immobility of L.
* Subsidies For In Work-Training: encourage in-work training programmes - ensure that while workers are in work, still developing skills - so they have transferable skills - if they’re ever unemployed - transfer to different jobs in economy - reduces occupational immobility of L.
* G On Infrastructure: on transport infrastructure - reduces geographical immobility.
* Grants / Low Cost Housing: to encourage geographical mobility of L - take jobs further away.
Market Based SSPs:
* Reduce Benefits: provide incentive for workers to skill-up - make sure they’re suitable to take jobs in economy - reduces occupational immobility of L. Reduces geographical immobility of L - workers can’t be as fussy + reject job vacancies in areas they don’t like as much - no safety net of benefits.
* Deregulate Hiring / Firing Laws: reduces occupational immobility of L - workers now have incentive to hire low skilled workers - knowing they can pay them low W + train them up to productive workers - if they don’t end up benefiting firm - can fire them easily.
State + explain the policies used to reduce the NRU - in particular frictional unemployment.
Supply side causes of unemployment
Interventionist SSPs:
* More + Better Resources For Job Centres: more likely to find vacancies they’re after.
* Subsidies To Private Job Agencies: better resources , more equipped to deal with frictionally unemployed + provide appropriate jobs for them.
* G On Infrastructure: transport infrastructure - frictionally unemployed have greater search radius where they can look for vacancies - reduces search time.
Market Based SSPs:
* Reduce Benefits: force those looking for next job, to be quicker in finding job - knowing they don’t have safety net of benefits to fall back on -forcing them to be quicker.
Evaluate the use of policies to reduce the NRU (structural + frictional unemployment).
- No Guarantee Policies Will work
- Cost: interventionist SSPs especially costly.
- Time Lags
- Negative Stakeholder Impacts: on workers themselves
Evaluate overall the use of policies to reduce unemployment.
- Type Of Unemployment: targeted policies depending on type. Can be difficult to isolate which type of unemployment is higher than we like it to be. Some types worse than others - frictional unemployment quite healthy for economy - healthy for workers looking for next job - for more productive workplace for them. However, types like structural unemployment do need fixing.
- Full Employment (Rate Of U): target is full employment - if unemployment is at natural rate- maybe policies aren’t needed - giving side effects policies cause. Depends on how high NRU of is + if levels of unemployment are much higher than NRU.
State + explain the policies used to reduce demand-pull inflation.
- Contractionary Monetary Policy: increase in i.r. More suited to target inflation - MPC has variety of avenues for i.r. changes to feed through into economy.
-
Contractionary Fiscal Policy: cut in G, increases in T. However, unlikely to target inflation - central banks job to target inflation - using monetary policy, not job of gov.
• If successful, AD shifts left - reduction in demand-pull inflationary pressure (disinflationary pressure).
Evaluate the use of policies to reduce demand-pull inflation.
• Conflict Of Objectives: trade-offs - demand-pull inflationary pressure could come down, but there’s lower economic growth + higher unemployment - could lead to recession - not desirable.
• Impact On Investment: higher i.r. detract I - increases C of borrowing for firms - may put them off I - bad for SR growth, but also for LR growth - issues such as lower productivity, worsening of competitiveness of economy.
• Impact On Indebted: households with lots of debt, businesses carrying lots of debt - if i.r. go up what’s the impact on these? Could lead to bankruptcy - leads to homelessness - assets taken away from Hh. If businesses go bankrupt - leads to unemployment.
• Strong Exchange Rate: higher i.r. strengthen exchange rate - widen C.A deficit - could mean hot money inflows into economy (S chasing best i.r.). Not good for trading economy (e.g. China, Japan).
State + explain the policies used to reduce cost-push inflation.
- Implement / Reduce Inflation Target: reduces amount W rise in economy - workers W bargaining will be at that rate. Limits extent to which W rise - bring inflation rate down yearly as result.
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Reduce VAT / Subsidies To Firms: to reduce CoPs + bring inflation down. However, significant C to gov - worsening of gov finances - good idea in theory, however unrealistic.
• Intervene In FOREX Markets To Strengthen Exchange Rate: stronger exchange rate makes M cheaper - if M are cheaper, could reduce P of imported raw materials + reduce CoPs for firms who import raw materials. Good idea in theory, however in reality unrealistic - many countries have freely floating exchange rates - intervening in foreign markets wouldn’t happen in realty.
Evaluate the use of policies to reduce cost-push inflation.
• Short-term inflation - may be better to not act + allow it to solve itself - for instance, if raw material costs are high - nothing can be done.
• Policies may bring more negative side effects than they bring benefits.
State + explain the policies used to reduce high long-term inflation rates.
- Supply Side Policies: to increase productive capacity of economy + increase LR rate of economic growth.
- Interventionist or free market SSPs - leads to shift right in LRAS - see increase in potential growth + reductions in inflation rates overtime.
Evaluate the use of policies to reduce high long-term inflation rates.
- No Guarantee Of Success: in boosting LRAS.
- Cost: interventionist policies in particular very costly.
- Time Lags: length of time before policies would work in shifting LRAS - if there’s need for inflation rates to come down quickly - not necessarily going to see it.
- Negative Stake Holder Impacts: if market based SSPs are used.
Evaluate overall the use of policies to reduce inflation.
• Type Of Inflation: depending on type - need policies that can target that type + bring inflation down - in reality, hard to know what type of inflation is dominating + pushing inflation rate beyond target. Maybe a range of policies are needed to control inflation overall. Cost-push inflation can’t really be controlled.
• Low + Stable Inflation: target rate is 2% (+ / - 1%) - if rate is around there - that’s good - don’t need policies to reduce inflation - if inflation gets too low (deflation territory) - issues that come with that.
State + explain the macroeconomic objectives that expansionary fiscal + monetary policy can satisfy.
- Higher Growth
- Lower unemployment (cyclical)
- Reduced income inequality - if fiscal policies used focus on G for benefits + education + training. Cuts to regressive tax + cuts to income tax for lower income earners.
State + explain the trade-offs by implementing expansionary fiscal + monetary policy.
• Higher Demand Pull Inflation
• CA Deficit Could Rise: higher incomes (from higher growth) - more spending on M + higher demand-pull inflation might erode international competitiveness of X
• Worsen gov finances
• Higher Income Inequality: if tax rates are cut for high income earners. QUestion nature of growth - is growth actually promoting more inequality - if capital intensive it might, if one sector dominant it might, if higher growth comes with more poor quality jobs. If growth is uneven (e.g. in Uk growth mainly comes from South - leads to inequality). If we see higher growth without redistributive systems in place.
• Negative Environmental Impact Of Growth: more air pollution - due to increased transportation, more manufacturing taking place - resource degradation, water pollution, deforestation, desertification, sole erosion, lose of biodiversity, resource depletion. However, consider type of growth - if service / tech dominant - wont see same environmental concerns.
Evaluate the trade-offs that implementing expansionary fiscal + monetary policy can bring.
• Size Of Output Gap: expect there to be inflation trade off if negative output gap is really small. If large negative output gap + lots of spare capacity, inflation trade off less likely.
• Nature Of Growth: in determining whether there’s income inequality + environmental concerns.
• Policy Used: key as to whether gov finances are negatively impacted, whether income inequality will rise.
• Classical View Of Compatible Objectives: in LR, major macroeconomic objectives are compatible - especially in recession, if gov did nothing with fiscal policy - W would fall eventually - how economy can self-heal itself - without need for expansionary fiscal policy - go back to LR growth rates, back to NRU, with potentially low rates of inflation.
State + explain the macroeconomic objectives that contractionary fiscal + monetary policy can satisfy.
- Decrease in inflation
- Improvements in CA position
- Improvements in gov finances (contractionary fiscal policy)
- Reductions in income inequality (higher rates of T on higher income earners - progressive tax system)
- Environmental improvements (due to lower rates of growth).
State + explain the trade-offs by implementing contractionary fiscal + monetary policy.
- Lower Growth
- Higher Unemployment (cyclical) - potentially recessionary impacts
- Decrease In Labour Productivity: if T (direct taxes) go up - higher income taxes reduce incentive to work, to be entrepreneurial. Higher corporation taxes reduce I + reduce L productivity.
Evaluate the trade-offs that implementing contractionary fiscal + monetary policy can bring.
- Size Of Output Gap: if economy’s at full employment with very small negative output gap / positive output gap - if policies reduce AD - expect to see falls in inflation, but without much negative impact on growth + unemployment.
- Laffer Curve Concerns: if direct taxes go up (especially income tax) - less incentive to work - to work hard - to be entrepreneurial - more incentive for emigration with high income taxes, for tax evasion + avoidance - limits benefits of contractionary fiscal policy in improving gov finances. Laffer curve ideas links to worse gov finances - lower tax rev whilst also constraining supply-side of economy - constraining LRAS + growth rates.
- Policy Used: crucial in determining whether gov finances will be improved ,whether income inequality will come down, e.t.c.
State + explain the macroeconomic objectives that supply side policies can satisfy.
If policies are successful - all 4 main macroeconomic objectives should be satisfied:
* Low inflation
* High employment - especially in NRU - structural + frictional
* High growth - productive capacity increases
* CA position should improve - due to lower rates inflation, making X more internationally competitive, but also because SSPs can lower LR CoP + boost X competitiveness.
Evaluate the trade-offs that implementing supply side policies can bring.
- Size Of Output Gap: keynesian argument - in deep recession, where there’s huge negative output gap - don’t need SSPs - need to D side policies- because more D is needed.
- Gov Finances: interventionist SSPS, + T reform (market based) can damage gov finances - creates conflict.
- Income Inequality + Living Standards: free-market SSPs (e.g. L market reforms, competition policies) - for those on lower incomes - can lead to lower living standards, lower quality of life + higher income inequality.
- Environmental Concerns: if free-market policies (e.g. deregulation) are used.
