AL Unit 10: Government Macroeconomic Intervention Flashcards
Interrelatedness of macroeconomic problems
The relationship between the internal and external values of money
The relationship between the balance of payments and inflation
The relationship between economic growth and inflation
The relationship between economic growth and the balance of payments
Government macroeconomic policy objectives
A relatively low and stable rate of inflation
Equilibrium in the balance of payments over a period of time
A low rate of unemployment or full employment
An appropriate rate of economic growth
An appropriate rate of development
Growth and development is regarded as sustainable
The redistribution of income and wealth
The relationship between the internal and external value of money
If the internal value falls due to high domestic inflation, exports become more expensive. If demand for exports falls so does demand for the currency so there will be a depreciation in the external value
The relationship between the balance of payments and inflation
High inflation makes exports more expensive so demand for them falls but the demand for imports may not change as many countries have a high MPC imported products so the balance of payments deteriorates
The relationship between economic growth and inflation
If fiscal and monetary policies are used to stimulate economic growth this could lead to an increase in inflation. If supply side policies are used causing a rightward shift of LRAS, economic growth could occur without inflation
The relationship between economic growth and the balance of payments
Higher economic growth could cause higher real incomes leading to an increase in imports having a negative effect on the balance of payments
The traditional Phillips curve
Shows the relationship between the level of inflation and rate of unemployment. As the rate of inflation increases there will be a fall in the rate of unemployment and as the rate of inflation decreases there will be a rise in the rate of unemployment. An increase in taxes or interest rates will put some people out of work. Is now largely disregarded
The expectations-augmented Phillips curve
If actual inflation rises, expected inflation will rise so the Phillips curve will move upward to give the same expected real wage increase at each employment level. The long run Phillips curve shows there is a rate of unemployment when inflation is stable. The is the non-accelerating inflation rate of unemployment. The LRPC is a straight vertical line
Discretionary fiscal policy
Refers to policies that are implemented by specific one-off policy changes
Automatic fiscal stabilisers
Where automatic changes in government spending or taxation reduce the volatility of the economic cycle
Effectiveness of fiscal policy to meet all macroeconomic objectives
Effectiveness depends on the balance between taxation and spending. Can be expansionary (budget deficit) or contractionary (budget surplus). Expansionary can help reduce the level of unemployment and contractionary can reduce the level of inflation. Taxation can find government projects which stimulate economic growth. Progressive taxation can help redistribute income and wealth
Advantages of fiscal policy
Public spending can impact the level of AD
Public spending can reduce the level of unemployment
Direct taxes can help redistribute income
Indirect taxes can alter certain behaviours
Spending on infrastructure can increase economic growth
Disadvantages of fiscal policy
Time lag between a revenue or spending decision takes effect
Benefit may not fully be seen due to information failure
May be supply side effects
Changing tax rates and bands is more complex than interest rates
Higher taxes may have a disincentive effect on work and enterprise
A government needs to accurately estimate taxation and spending change impacts
Some decisions may not be taken for political reasons
Laffer curve analysis
Shows the relationship between the rate of tax and revenue gained. As tax rate increases, the revenue gained increases up to a pint but at high rates the tax is not worthwhile since it brings less revenue
Monetary policy
Can be expansionary (increase in money supply or decrease in interest rate) or contractionary (decrease in money supply or increase in interest rate). Expansionary can help reduce unemployment and contractionary can help reduce the level of inflation
Advantages of monetary policy
Interest rates can affect spending so demand is interest inelastic
When a central bank is independent from the government they can change monetary policy tools without political interference
Interest rates can be adjusted monthly
Interest rates can immediately affect confidence
Disadvantages of monetary policy
Time lag between interest change and impact
Not everyone has the same interest elasticity of demand. High income earners have more inelastic interest elasticity of demand so hard to estimate effects
An increase in money supply will have an inflationary effect
Accuracy of inflation forecasts may be poor. If inflation is higher than predicted interest rates may be too low to control it effectively
An increase in interest rates to control inflation can negatively effect other areas
Money supply is hard to control in practice
Supply side policy
Market based policies include reducing the size of the government, lower taxes and opening more flexible markets. Interventionist policies include regional policies and education initiatives
Advantages of supply side policy
Some policies can increase LRAS and improve productive capacity and output
Reduce the natural rate of unemployment especially with structural and frictional
Can improve competition encouraging efficiency
Enable sustained economic growth to be achieved without inflation
Can improve a country’s balance of payments
Less likely to create conflicts between macroeconomic objectives
Disadvantages of supply side policy
No guarantee that a private sector firm will be more efficient increasing unemployment
A privatised firm may be in a monopoly position
A lowering of unemployment benefits or taxes may encourage people to look for jobs but have no effect if no jobs are available
Long time lags before effects are shown
Costly to imeplement
Some policies are resisted if they reduce the power of certain groups
Could be conflict with equity when there is a negative effect on income distribution
Exchange rate policy
Affects AD through impacts on export and import prices
Advantages of exchange rate policy
Depreciation can have an expansionary impact
A depreciation can increase national output
A depreciation can create jobs, reducing unemployment
A depreciation can improve the current account of the balance of payments
An appreciation can have a contractionary impact
An appreciation can reduce the rate of inflation
Disadvantages of exchange rate policy
A depreciation can increase inflation through increase import prices
Time lag to see an impact on the economy
Scale of change may be small so unlikely to have an effect
Assumed that PED for exports and imports is relatively elastic
An appreciation would increase the price of exports so could increase unemployment
Change may occur at an unfavourable phase in the business cycle
International trade policy
Impact will depend on the degree of liberalisation in relation t world trade especially the extent to which protective trade barriers are reduce or removed
