econplusdal macro Flashcards
economic growth definition
economic growth is an increase in real GDP in an economy in a year caused by and increase in AD or increase in LRAS
factors that would shift AD to the right, and what part of the AD equation that factor influences
lower interest rates : consumption, investment, (x-m)
lower income/corporation tax : consumption , investment
higher consumer surplus: consumption , investment
higher government spending: government
weaker exchange rate: ( x-m)
why LRAS shifts
due to an increase in quality/quantity of factors of production
due to an increase in productive efficiency
factors that cause LRAS to shift
increase in labour productivity increase in workforce size ( immigration) investment infrastructure improvements increase in competition new resource discoveries
fiscal policy definition
changes to government spending and taxation in order to influence AD
why does government introduce expansionary fiscal policy
- boost growth, if growth is sluggish/ recession
- reduce unemployment , during a recession. –> if AD shifts to the right there will be more goods and services to be produced meaning firms will have to employ more people
- increase demand pull inflation ( only in theory as it is not the job of the government to control inflation)
- redistribution of income: welfare benefits, reduction in regressive taxation
why does government introduce contractionary fiscal policy
reduce inflation ( although this is not the job of the government) reduce budget deficit/ national debt --> reduce the amount of borrowing the government has to do ( debt interest repayments) redistribution of income --> higher rate of marginal tax reduce current account deficit , with less disposable income people import less goods
examples of expansionary fiscal policy and the effect these measures could have
reduction in income tax: to rich/poor , widen the tax bands, increase tax free allowance (C^)
reduction in corporation tax: increase retained profits, reduction in regressive taxes such as VAT (I^)
increase in government spending, public sector wages (G^)
how expansionary fiscal policy can effect LRAS
- reduction in income tax –> incentivises the economically inactive to enter the labour force
- -> those in work experience the positive income effect leading them to work more hours as they can keep more as disposable income
- reduction in corporation tax –> investment which shifts LRAS out
- government spending on: education/ healthcare increases the productivity of the workforce, infrastructure such as HS2 can increase productivity
cons of expansionary fiscal policy
- inflation could overshoot the target
- increased real income damages (x-m) as people import more
- worsening of government finances, budget deficit + national debt ( opportunity cost of paying debt interest)
- cuts in spending in other areas of the economy ( education/healthcare/public sector wages/ welfare)
Ricardian equivalence - if households in the economy know that government cannot afford expansionary fiscal policy in the form of a tax cut, then houses may save the effective tax cut not, expecting a tax rise in the future, this means a tax cut will not boost the economy - crowding out effect –> if government spending is borrowing fuelled as demand for loans increases, causing the equilibrium interest rates to rise making it more expensive for private firms to grow/fund their investment ( halting long term growth)
- x-inefficient, could be wasteful in infrastructure projects
- time lags
evaluation of expansionary fiscal policy, how effective is it
- size of the output gap, how close are we to full employment
- size of the multiplier ( may overshoot , may have to spend less)
- state of government finances ( can it be afforded Ricardian equivalence)
- consumer / business confidence
- LR return to government due to taxation
- Laffer curve ideas –> as income tax drops people will work more hours meaning they may end up paying more tax back to the government
- -> reduces incentive to tax evade
- -> incentive for entrepreneurs to be entrepreneurial due to higher rewards
- role of automatic stabilisers –> classical view that expansionary fiscal policy is unnecessary as the economy is self correcting
- crowding out vs crowding in –> Keynesian economists would argue that in a recession there are lots of savings taking place meaning the chance of equilibrium interest rats going up is very low
- -> they would argue the crowing in effect as government spending generates demand in the economy = incentive for private sector firms to invest and grow their business due to great chance of profits
definition of monetary policy
changes in interest rates , the money supply and the exchange rate by the central bank in order to influence AD
aims of expansionary monetary policy
increase inflation to the 2% target
boost economic growth
reduce unemployment
aims of contractionary monetary policy
reduce inflation to the 2% target
protect the financial sector –> prevent asset/credit bubbles
reduce excessive debt/promoting more saving
reduce current account deficit
expansionary monetary policy transmission mechanism
- central bank cuts interest rates
1 –> reduces credit card interest rates, reducing the cost of borrowing for consumers –> (C^)
2 savings interest rates fall __> drops in MPS –> (C^)
3 variable mortgage rates drop –> increases monthly disposable income for households –> (C^)
4 business loan repayments drop –> incentivises businesses to invest (I^)
5 weaker exchange rate –> people do not want to save their money in a country with a low IR, therefore they move their money elsewhere, reducing the demand for the pound causing depreciation, this is beneficial to the current account (x-m)
