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Macroeconomics > Demand Side Policy > Flashcards

Demand Side Policy Flashcards

1
Q

3 Broad Categories of Macroeconomic Policy

A

Fiscal Policy - Government Spending, Taxation and/or borrowing to affect AD

Monetary Policy - Interest Rates, Money Supply and/or exchange rate

Supply Side Policy - Increase productive potential, relation to increases in the quantity and/or quality of an economy’s factor of production

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2
Q

What is Fiscal Policy

A

The use of government spending, direct and indirect taxation and government borrowing to affect the level and growth of aggregate demand, output and jobs

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3
Q

Why is fiscal policy used

A

Change the pattern of spending on goods and services

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4
Q

What is fiscal policy a means of

A

Redistribution of income and wealth

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5
Q

What does fiscal policy affect

A

AD and AS

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6
Q

What is it used to correct

A

Market failures - used in microeconomic government intervention

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7
Q

Situations where Fiscal Policy is used

A

Finance of government spending

Changing the distribution of final income and wealth

Provide a safety net of welfare

Help manage the economic cycle

Improve long run competitiveness

Tackle market failures

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8
Q

What tax rates and allowances have an effect on AD and how

A

Income tax and national insurance - direct effect on peoples disposable incomes

Corporation Tax - Post tax profit available for business to invest

National Insurance for Employers - Cost of employing extra workers

VAT - Affects real income of consumers

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9
Q

Justifications for Government Spending

A

Provide a socially efficient level of public goods and overcome one or more market failures

Provide welfare benefits

Provide necessary infrastructure through capital spending

Manage the level and growth of AD

Promoting equity in the allocation of scarce resources

Catalyst for improving economic efficiency

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10
Q

Describe Direct Taxes

A

Levied on income, wealth and profits

Burden of a direct tax cannot be passed on

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11
Q

Example of direct tax

A

Income tax, inheritance tax, national insurance, capital gains, corporation tax

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12
Q

Describe Indirect Tax

A

Taxes on spending

Burden can be passed on by producers - depends on elasticity of demand and supply

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13
Q

Examples of indirect tax

A

Excise duties on fuel, cigarettes and alcohol

VAT

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14
Q

How can changes in tax rates and allowances have an effect on SRAS and LRAS

A

Changes in VAT affects business costs

Changes in Direct tax can influence work incentives

Changes in business taxes might affect the level of foreign direct investment

Can affect the incentive to start a business or to spend money on R+D

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15
Q

When is there a budget surplus / fiscal surplus

A

Government spending is less than tax revenues

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16
Q

When is there a budget deficit / fiscal deficit

A

Government revenues are less than government spending

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17
Q

Causes of a budget / fiscal deficit

A

A recession leads to rising unemployment- less taxes paid

Decrease in consumer spending and profits

Increase in economic activity

Use of fiscal stimulus by a government to lift AD and stabilise the economy

Increase in interest rates on debt

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18
Q

What do Keynesian economists believe about fiscal policy

A

Most effect form of managing demand, output and confidence at times of economic instant

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19
Q

What is fiscal policy

A

Policies that manage the level of and rate of growth of AD

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20
Q

What is fiscal austerity

A

When government uses contradictory fiscal policy to decrease their budget deficit

Aim to not decrease AD but to slow the rate of growth of the national debt

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21
Q

Policies used to reduce the size of a budget deficit

A

Cuts in government spending

Higher taxes

Supply side policies to encourage growth

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22
Q

What is Monetary Policy

A

Changes in interest rates, supply of money and credit, and exchange rates by the central bank to influence AD

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23
Q

How is the exchange rate of the £ determined

A

Demand and Supply in international foreign exchange markets

Not directly influenced by the Bank of England

24
Q

What is Monetary Stability

A

Stable prices and confidence in the currency

25
Q

Expansionary monetary policy mechanisms

A

Fall in nominal and real level of interest rates

Expand the supply of credit - fall in credit interest

Depreciation of the external value of the exchange rate

26
Q

Deflationary monetary policy mechanisms

A

Higher interest rates

Tightening of credit supply (loans become harder to get)

Appreciation of the exchange rate

27
Q

To who is the real rate of interest important and why

A

To businesses and consumers when making decisions

28
Q

What is the real rate of return on savings

A

Money rate of interest - Rate of inflation

29
Q

When can real interest rates be negative

A

Nominal rate of interest is less than inflation

30
Q

What can price deflation lead to

A

Increase in real interest rates

31
Q

What is the aim of fiscal austerity

A

To reduce the rate of growth of national debt

32
Q

Aims of Expansionary Fiscal Policy

A 
Boost Growth
Reduce Unemployment 
Increase Inflation
Redistribution of Income 
Increase in AD
33
Q

Aims of Contractionary Fiscal Policy

A

Reduction in AD
Reduce Budget Deficit and National Debt
Redistribution of Income
Reduce Current Account Deficit

34
Q

How does Expansionary Fiscal Policy affect the Keynesian curve

A

AD shifts to the right

Price increases and output increases

Not in the intention of EFP - just a side effect

35
Q

How does Expansionary Fiscal Policy affect the Classical curve

A

LRAS shifts to the right

Decreases in price and increase in real output

36
Q

What does Expansionary Fiscal Policy help with

A

The multiplier effect - reduction in income tax increases MPC

37
Q

Cons of Expansionary Fiscal Policy

A 
Demand Pull Inflation and Current Account Deficit - trade off  
Worsening of Gov Finances
Crowding Out Effect 
X Inefficiency 
Time Lags
38
Q

What is the crowding out effect

A

When debt fuelled public spending reduces private sector investment due to an increase in interest rates

39
Q

What is X inefficiency

A

When government spending has excess costs

40
Q

Expansionary Fiscal Policy evaluation

A

Size of output gap - effectiveness of EFP depends on this
Size of multiplier - increases of AD depends on this
Animal spirits - tax cuts won’t increase spending to a noticeable effect
Gov finances - bad state of finances means EFP can’t be afforded
LR returns to the government - greater tax revenue down the line from increased economic activity
Role of Automatic Stabilisers - strong stabilisers reduces the need for them and vice versa

41
Q

Expansionary Monetary Policy Goals

A

Increase inflation
Increase growth
Reduce unemployment

42
Q

Reasons why Contractionary Monetary Policy may be used

A

Hit Inflation target

43
Q

Contradictory Monetary Policies Goals

A

Reduce inflation
Present asset ad credit bubbles
Reduce excess debt and promote saving
Reduce current account deficit

44
Q

Expansionary Monetary Policy effect on LRAS curve

A

AD shifts to the right

Y increases and price increases

Increase investment

45
Q

Expansionary Monetary Policy effect on classical curve

A

LRAS shifts to the right

Price decreases and real gdp increases

46
Q

Cons of Expansionary Monetary Policy

A

Demand Pull Inflation and Current Account Deficit - trade off
Liquidity Trap
Negative Impact on Savers
Time Lags

47
Q

Evaluation of Expansionary Monetary Policy

A

Size of output gap
Animal spirits
Size of rate cut
Banks willingness to lend/pass on the full cut

48
Q

What are Automatic Stabilisers

A

Changes in tax revenues and government spending that come about automatically as an economy moves through the business cycle

49
Q

Pros of Budget Surplus

A

Confidence in Gov Finances
Flexibility with Fiscal Policy
Less Crowding Out
Less X-Inefficiency
Lower Inflation and Current Account Deficit

50
Q

Cons of Budget Surplus

A

Demand Side Shocks
Risk of income inequality
LR Returns of rising government spending and fall in taxation
Incentives Distortion of an increase in taxation
Micro and Macro impacts of a fall in govern,ent spending and increase in taxation

51
Q

Eval of Budget Surplus

A

Need for it
Debt/GDP could rise
Policies used
Stage of economic cycle

52
Q

What is QE

A

Introduction of new money into the money supply by a central bank through government bonds

53
Q

What is QE an alternative to

A

Cutting interest rates

54
Q

How does QE work

A

Lowers interest rates and borrowing costs
Increases the amount banks can lend and weakens exchange rates

55
Q

Steps to QE

A

Creation of Money by BoE
Buy bonds
Price of bonds rise, yields fall
LR interest rates in the economy fall
Cost reduces and ease of raising finance for banks increase Cheaper loans for firms & individuals
More C & I thus more AD

56
Q

What is the Ricardian Equivalent

A

Government cuts income tax rates hoping households will spend extra disposable income
RE is when households know a tax cut can’t be afforded by the government
So the government would have to raise other tax rates in order to fund tax cut
Households save disposable income for future tax raises
Todays tax cut = tomorrows tax raise

57
Q

Expansionary Fiscal Policy Eval

A

Crowding Out vs Crowding In (Promotes Economic Activity can be an incentive)
Multiplier (Greater the multiplier, greater the effect) (Greater multiplier, reduces the need for heavy policies)
Automatic Stabilisers (Stronger automatic stabilisers reduces need for discretionary fiscal policy, reduce fluctuations in business cycle)
Tax Cuts (Laffer Curve and LR Returns, Ricardian Equivalent)

Macroeconomics (45 decks)

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