Chapter 13 macroeconomic policies Flashcards
Define demand side-policy
demand side policies focus on shifting the aggregate-demand curve in the AD-AS model to achieve several macroeconomic goals.
Define supply-side policy
Supply-side policies are a variety of policies that focus on shifting the long-run aggregate-supply curve to the right in order to achieve long-term economic growth.
Roles of central bank (have 4)
- Banker to the government: holds government’s deposit, receive and make payment for the goverment
- Banker to commercial banks: make loans to commercial banks
- Regulate the banking system
- Conduct monetary policy: control the money supply -> determine interest rate -> achieve macroeconomic goals
Explain the independence of central bank
Degree of independence from government interference in the pursuit of monetary policy
Ensure monetary policy can be conducted in the best-longer term interests of the economy
Goals of monetary policy, fiscal policy
both:
Low and stable rate of inflation (stable -> less uncertainty)
Low unemployment
Reduce business cycle fluctuations
Promote a stable economic environment for long-term growth
External balance (import=export)
Fiscal only:
Equitable distribution of income
How to calculate real interest rate with norminal interest rate and inflation rate
Real interest rate = Nominal interest rate - inflation rate
Explain the mechanism of expansionary monetary policy
Interest rate decrease
Lower cost of borrowing, households and firms are likely to borrow more and spend more
Consumption and investment increase
AD increase
Evaluate monetary policy
Strengths:
1. Interest rate can be changed incrementally (if increase not enough, continue increase)
2. Interest rate changes are reversible (increase too much, then reduce)
3. Relatively short time lags
4. Central bank independence and limited political constraints
5. No budget deficit for government
Constraints:
1. Possible ineffectiveness in recession (interest low, people still want to save money and won’t consume too much)
2. Conflict between government objectives
3. Inflationary (price level increase due to exapnsionary policy)
4. Problematic when dealing with stagflation or cost-push inflation
stagflation means little economic growth but high inflation and unemployment
Define fiscal policy
Fiscal policy is a government measure to influence the level of aggregate demand by adjusting government expenditures and tax rates
List the source of government revenue and possible expenditures
Revenue:
sale of goods and services
sale of government-owned assets
taxation
Expenditure:
Currect expenditure (spending on day-to-day items)
Capital expenditures (public investments on capital goods)
Transfer payments (social welfare, unemployment benefit)
Important phrases:
Budget deficit
Budget surplus
Balanced budget
accumulation of deficit: government debt
Explain the mechanism of expansionary fiscal policy
Increase government expenditure and/or decrease government revenue
Increase government spending -> increase AD
Decrease income tax -> households spend more, consumption spending more -> AD increase
decrease business tax -> firms invest more -> AD increase
Evaluate fiscal policy
Strengths:
1. During recession, direct impact on AD
2. Ability to target sectors of the economy
3. Ability to affect potential output (government spending on education)
Constraints:
1. Time lags
2. Political constraints (increase tax will be disagreed by citizens all the time)
3. Sustainable debt (always spend too much)
4. Inability to fine tune the economy
5. May be inflationary
6. Inability to deal with cost push inflation
List the goals of supply-side policies
- Promote long-term growth by increasing the productive capacity of the economy
- Improve competition and efficiency
- Reduce costs of labour and reduce unemployment through greater labour market flexibility
- Increase incentives of firms to invest in innovation by lowering cost of production
- Reduce inflation to improve international competitiveness
Explain mechanism of market-based policy
Tips: Encourage competition, labour market reforms, incentive-related policies
Since real GDP automatically shift to full employment, should allow market forces to work with minimal government intervention
Can achieve rapid growth, price stability and full employment at the same time
Encourage competition:
1. Deregulation: Regulation increase cost of production, reduce competition and inefficient, which will reduce potential output
2. Anti-monopoly regulation: Monopoly can restrict output and increase price. Anti-monopoly increase competition, increase output
3. Privatization: Government enterprise inefficient since administrative cost, unproductive workers, no pressure to reduce cost
Nationalized firms have different goals from private firms, such as maintenance of employment -> inefficiency
4. Trade liberalization: Free trade -> more competition, greater efficiency in production
Disadvantage:
1. Deregulation -> higher prices and lower quality
2. Private firms with degree of market power can raise price over what government used to charge
Labour market reforms:
1. Reduce power of labour unions: reduce cost of production, increase potential output
2. Abolishment of minimum wage: reduce cost of producton
3. Lower unemployment benefit: More incentive for people to take available jobs
Disadvantage:
1. Reduce protection for workers -> lower income & job insecurity
2. Worsen income inequalities
3. Unemployment benefits compensate for the loss of income of the unemployed, thus helping maintain the level of consumption spending in a recession
Incentive-related policies:
1. Personal income tax cuts: more incentive to work harder and more productive
2. Cuts in business tax and capital gains tax: Firms gave more after-tax profit, more investment on research and development -> advance in technology
Disadvantage:
1. Tax cuts may increase inflation and worsen income distribution
2. Tax cuts might increase government budget deficit
Explain the mechanism of interventionist supply-side policies
Tips: human capital, new technology, infrastructure, industrial policies
Assume market cannot increase potential output, so givernment intervention is required
Investment in human capital:
1. More and better training and education, improve quality of labour resources
2. Improved health care services, healthier -> more productive
Investment in new technology:
1. Governments heavily involve R&D (research and development)
2. Provide incentives to private firms, in form of taxation, engage R&D activities
3. Advanced technology -> increase potential output
Investment in infrastructure:
1. Increase efficiencies as production costs reduced
Investment in industrial policies:
1. Governments support specific industries
2. Government support small and medium-sized enterprises. Promote efficiency, more captial formation and more employment opportunties
3. Government support infant industries, newly emerging industries. Potentially competitive to world market. Just too small to enjoy the benefits of economies of scale
Disadvantages:
1. Inefficiency and resource misallocation
2. Tax revenue for interventionist activities may have better alternative use
3. Require substantial amount of tax revenues to provide support services, high taxes and a large government sector
