6. Macroeconomic Objectives & Policies

Question 1

What is monetary policy?

Answer 1

The use of interest rates and money supply to achieve the macroeconomic objectives such as growth and inflation

Question 2

What are interest rates?

Answer 2

The cost of borrowing money, expressed as a percentage of the amount borrowed

Question 3

What is contractionary monetary policy?

Answer 3

Involves raising interest rates (and reducing the money supply) in order to reduce the inflation rate

Question 4

What is expansionary monetary policy?

Answer 4

Involves cutting interest rates or increasing the money supply to boost economic activity

Question 5

How do high interest rates affect AD?

Answer 5

Higher interest rates increase the cost of borrowing and reduce the value of assets leading to a decrease in AD

Question 6

What is quantitative easing?

Answer 6

When the central bank buys financial assets e.g government bonds in exchange for money in order to increase borrowing and lending in the economy

Question 7

How does quantitative easing increase AD?

Answer 7

The commercial bank now holds fewer bonds/loans and more money which it can lend to customers e.g households, firms wanting to invest. This leads to higher investment and consumption

Question 8

What is the purpose of negative interest rates?

Answer 8

• Get banks lending: central bank pays commercial banks money for borrowing
• Lower the risks to output, profit, employment and wages from deflation

Question 9

What are 2 risks of negative interest rates?

Answer 9

• Lowers bank profitability: erodes interest rate income of banks
• Can cause banks to take excessive risks in search of higher returns

Question 10

What is negative interest rates?

Answer 10

When central bank lowers the nominal interest rate below zero so interest is paid to borrowers rather than to lenders

Question 11

Name 2 advantages of monetary policy

Answer 11

• Targeting interest rate controls inflation
• Easy to implement

Question 12

Name 3 disadvantages of monetary policy

Answer 12

• Effects have a time lag
• Ability to reduce inflation depends on type (effective on demand-pull)
• Risk of hyperinflation

Question 13

How does quantitative easing affect interest rates?

Answer 13

Lowers interest rates in order to encourage borrowing

Question 14

How does quantitative easing affect exchange rates?

Answer 14

When interest rates fall, investors switch money from Uk assets to others. There is a fall in demand for the pound but a rise in supply. Therefore price falls against other currencies

Question 15

What is fiscal policy?

Answer 15

The use of government spending, taxation and borrowing to meet its macroeconomic objectives

Question 16

What is expansionary fiscal policy?

Answer 16

Involves an increase in government spending and lowering taxes to boost AD

Question 17

What is contractionary fiscal policy?

Answer 17

Involves a decrease in government spending and raising taxes to lower AD

Question 18

What is a drawback of expansionary fiscal policy?

Answer 18

Leads to a worsening of government budget deficit, and may mean government have to borrow more to finance this

Question 19

What is the difference between a budget deficit and budget surplus?

Answer 19

Budget deficit - when expenditure exceeds tax receipts in a financial year
Budget surplus - when tax receipts/income exceed expenditure

Question 20

What are 3 limitations of fiscal policy?

Answer 20

• Governments may have imperfect information about the economy, leading to inefficient spending
• Time lag: could take months or years to have an effect
• If government spends too much, could be difficulties paying back and borrowing in the future

Question 21

What are 2 sources of government revenue?

Answer 21

• Direct taxation: taxation on income, wealth and profit e.g income tax
• Indirect taxation: taxation on spending by consumers on goods and services e.g VAT

Question 22

What is government debt?

Answer 22

The total amount of money the British government owes to the private sector and other purchasers of UK gilts e.g Bank of England

Question 23

What are automatic stabilisers?

Answer 23

Automatic fiscal changes in the economy as it moves through different stages of the business cycle without direct intervention from government e.g increase in welfare benefits when unemployment rises

Question 24

What is discretionary fiscal policy?

Answer 24

Intentional government policies to increase or decrease government spending or taxation

Question 25

What is crowding out and give an explanation

Answer 25

The negative impact that government spending can have on private investment

Government borrowing to finance spending reduces the availability of credit in the private sector due to competition within the economy, raising interest rates and reducing private investment

Question 26

What are 2 benefits of fiscal policy?

Answer 26

• Can promote strong and sustainable growth
• Effective in deep recession (direct, not reliant on confidence)

Question 27

What impacts the effect of fiscal policy?

Answer 27

• Crowding out
• The size of the multiplier
• Political willingness/ability to borrow

Question 28

What are 2 examples of automatic stabilisers?

Answer 28

• A fall in tax revenues during a recession
• Increase in state welfare benefits when unemployment is rising

Question 29

What are the 3 types of tax?

Answer 29

• Progressive: when the average rate of tax rises as incomes increase
• Regressive: a tax which takes a higher rate of tax from low incomes
• Proportional: a tax with a fixed rate for all taxpayers, regardless of income

Question 30

What are supply side policies?

Answer 30

A set of economic measures/strategies that aim to increase the ability of an economy to produce goods and services, improving long-run productive capacity and efficiency (LRAS)

Question 31

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

Answer 31

Market-based - limit the intervention of government and allow the free market to eliminate imbalances

Interventionist - rely on government intervening in markets

Question 32

What are 3 aims of market-based supply side policies?

Answer 32

• To increase incentives: reducing income and corporation tax to encourage spending/investment
• To promote competition: by deregulation or privatisation there is more competitiveness, increasing economic efficiency
• To reform the labour market: reducing minimum wage and trade unions, increases mobility of labour, more efficient market

Question 33

What are 4 aims of interventionist supply side policies?

Answer 33

• To promote competition: stricter competition policy could reduce monopolies
• To reform the labour market: can improve geographical immobility by subsidising relocation of workers
• To improve skills and quality of labour market: government can subsidise training/education, more spending on health improves quality of labour force
• To improve infrastructure

Question 34

What are 3 aims of supply side policies?

Answer 34

• To improve incentives to work and invest in skills (human capital)
• To increase labour/capital productivity
• To increase capital investment

Question 35

What are 3 weaknesses of supply side policies?

Answer 35

• Market based policies e.g cutting tax could widen inequality
• Can impact government budget (tax cuts means government earns less)
• Can create negative externalities e.g environmental degregation (pollution, deforestation)

Question 36

What are 2 strengths of supply side policies?

Answer 36

• Only policies that tackle structural unemployment: directly improve education and training
• Improved productivity, efficiency and economic growth

Question 37

How does cutting tax (e.g income, corporation) affect LRAS?

Answer 37

• When taxes are cut, consumers earn more disposable income and firms retain more profit
• This results in consumers being more motivated to work harder, increasing productivity
• This results in firms increasing capital investment and producing more goods/services
• Overall, shifting LRAS outwards

Question 38

How does deregulation affect LRAS? (supply side policies)

Answer 38

• When there is a removal of government controls, it becomes cheaper for firms to produce a good
• This results in a reduction of production costs, allowing firms to retain more profit
• This encourages firms to invest in capital, increasing productivity and therefore LRAS

Question 39

How does privatisation affect LRAS? (supply side polcies)

Answer 39

-This means that firms move out of the public sector and into the private sector
- Firms are profit maximisers, so there is incentive to innovate and become efficient
- This increases the supply ogf goods/services and LRAS shifts outwards

Question 40

What are the 2 categories of supply-side policies?

Answer 40

• Market-based supply side policies
• Interventionist supply side policies

Question 41

What are market-based supply side policies and 3 examples?

Answer 41

Involves removing the barriers which prevent the efficient work of free markets, increasing competitiveness e.g privatisation, deregulation, lowering tax

Question 42

What are interventionist supply side policies and 2 examples?

Answer 42

Involves government intervention to boost the economy and overcome market failure e.g government spending on human capital (training and education), direct subsidies