Gov't Macro Intervention Flashcards
Fiscal Policy
- The use of government spending and taxation to influence the economy
Government Budget
Definition -> Annual financial statement showing the estimates of expected revenue and spending during a fiscal year
National Debt
-> Amount of money Government owes both domestically and abroad, which has accumulated over the years
Government ends up Needing to Raise Extra Finance -> Printing more money, or by borrowing even more money
Printing Money -> Reduces its actual value in the greater scheme/term, leading to inflation
Further Borrowing -> Either short or long term, and domestic or foreign sources
Main Takeaway -> Either method increases the National Debt
Main Issue -> When large proportion is owed abroad, or it looks as if it can’t be paid
Domestic Debt -> Paid back to those with government bills through tax revenue
National Debt is NOT the Same -> National debt is internal, while BOP is external
Automatic Stabilisers
Automatic stabilisers in economics are built-in government policies that help to soften the impact of economic fluctuations without the need for new legislation or direct intervention.
During a recession: If people lose their jobs, they automatically receive unemployment benefits. This extra money helps them continue to spend, which supports the economy.
During a boom: When people earn more, they pay more in taxes. This reduces the amount of money they have to spend, which helps prevent the economy from overheating.
In short, automatic stabilisers work like a cushion that helps keep the economy stable by adjusting spending and taxes automatically in response to changes in the economy.
Reasons for Taxation
1)Raise Revenue for Government Spending Taxation is used along other methods simultaneously
2)Manage Aggregate Demand Taxation is one of various methods to meet the Government’s economic objectives
3)Alter Distribution of Income & Wealth Income tax’s aim is to take money from the better off and give it to the poorer
4)Manage Market Failure or Environmental Issues Taxation is one way in which market failures can be reduced/minimised
Direct Tax VS Indirect Tax
Direct Tax -> Tax levied directly on incomes & wealth, individuals or firms
Indirect Tax -> Levied when goods & services are bought, taxes on expenditure
Capital Expenditure VS Current Expenditure
Definition -> Spending by the Government on goods & services intended to create future benefits
Alias -> Government Investment; Gross Capital Formation
Infrastructure -> Roads, buildings, etc.
Health & Education -> New hospitals, Schools or Sewage Systems
Research/Innovation -> Defence, Space or Vaccinations
Definition -> Government Consumption spending on goods & services for current use to directly satisfy the needs of members of the community
Examples -> Wages of Public Sector’s Workforce, Road Maintenance, etc.
Rates of Tax
A)Average Rate of Tax
Alias -> “Effective Rate of Tax” ; “Average Propensity to Pay Tax”
Calculation -> ART = (Total Tax Due) / (Total Taxable Income)
B)Marginal Rate of Tax
Alias -> “Proportion of Increase in Income which is Taken in Tax”
Calculation -> MRT = (Change in Tax Due) / (Total Taxable Income)
Reasons for Government Spending
1)Supply Goods & Services that Private Sector Would Fail to Do Public goods (eg. Defence), Merit goods (eg. hospitals), and Transfer Payments (eg. Benefits)
2)Achieve Supply-Side Improvements in Macroeconomy Spending on Education = Labour Productivity
3)Reduce Negative Externalities Effects Eg. Pollution
4)Subsidise Industries in Need of Financial Support Eg. Agriculture
5)Redistribute Income Thus achieve more equity
6)Inject Extra Spending into Macroeconomy Help increase Aggregate Demand and Economic Activity
Expansionary // Reflationary Fiscal Policy
- Use of fiscal policy to enable the economy to grow, increase the level of AD
- Methods: Cut in Taxes, Increase in Government Spending; Main Outcome -> C rises, I rises, G rises
- Unemployment Falls
- Inflation Rises, since Price Level increases
- Balance of Payments Possible Deficit
- National Budget Results in Deficit Generally
Contractionary // Deflationary Fiscal Policy
- Use of fiscal policy to reduce the size of the economy, decrease in the level of AD
- Methods: Rise in Taxes, Decrease in Government Spending; Main Outcome -> C falls, I falls, G falls
- Unemployment Falls
- Inflation -> Falls since Price Level decreases
- Balance of Payments -> NA
- National Budget Results in Surplus, as Government Revenue is increased
Con of fiscal policy
- Demand pull inflation
- Current account deficit
- Worsening of Gov. finances
- Gov spending is heavenly borrowing fuel that’s going to increase the demand the loanable funds, which pushes up equilibrium interest rates -> More expensive for private business to borrow money -> No money to fund their investment
- Time Lag
Evaluation of fiscal policy
- Consumer business confidence
- State of the gov’s finance
- Long run returns to the gov (Positive)
- Role of automatic stabilizer is good no need for big op
Monetary policy
Central Bank’s use of interest rates, money supply and exchange rates to control the economy
Monetary (Interest Rates)
Definition -> Cost of borrowing money, and reward on lending/saving money
Interest Rate Policy -> Use of interest rates to influence AD, through consumers and businesses
Other Banks -> Set their rates according the Central Bank’s base rate
Purpose -> Ensure targeted inflation rate and liquidity in the economy
Expansionary
- Interest rates Lower Rates; Main Outcome: C rises, I rises, AD rises
- Cost of borrowing is Lower, hence people can borrow more money
- Saving is Discouraged, since reward for saving is lower
- Spending greater than Saving
Contractionary
- Interest rates Higher Rates; Main Outcome: C falls, I falls, AD falls
- Cost of borrowing is Higher, hence people borrow less money
- Saving is Encouraged, since reward for saving is higher
- Spending is smaller than Saving
2)Money Supply
Definition -> Total amount of money circulating in an economy at a given time
Considers: Coins, Notes, Deposits, Current Accounts, etc.
Controlling Supply -> Very complex, hence this method has been mostly replaced by managing interest rates; yet it’s still relevant and applicable
Quantitative Easing -> Central Bank prints money to buy paper assets in order to increase money supply
Increased Money Supply, More money to lend, Interest rate Falls, since the value of lending is lesser, Consumption & Investment Both rise, AD Rises
Decreased Money Supply, Less money to lend, Interest rate Rises, since the value of lending is greater, Consumption & Investment Both fall, AD Falls
Credit Regulations
Definition -> Use of qualitative control measures by the Central Bank to regulate the consumer credit on certain products
Certain Products -> Mainly the ones affected by inflation or deflation
Inflation -> Central Bank aims to make borrowing and spending harder
Main Outcome -> Price Level Falls = Stability
Deflation -> Central Bank aims to make borrowing and spending easier
Main Outcome -> Price Level Rises = Stability
3)Exchange Rates
Definition -> Cost of domestic currency in relation to other currencies
Higher Interest Rates -> Domestic currency appreciates in value
AD Falls -> Net Exports fall, since exports become more expensive abroad and imports become cheaper
Attracts Foreign Depositors -> Increases the demand for the domestic currency (hot money flows)
Expansionary Monetary Policy Con
= IR low & MS high
- Demand pull inflation -> There is a risk of inflation as growth and unemployment is more important
- Current account deficit -> People will have more income hence more inclined to spend on foreign goods
- Negative impact on savers -> Rate of return on savings will fall and if inflation is higher than the interest rate, then the real return on IR can be negative -> The incentive is to borrow and spend and that is a big risk
- Liquidity trap (Keynesian theory) -> They have converted all their bonds to cash due to lack of security hence if the central bank wants to cut interest rate, it will be ineffective as most have already made it into cash
- Time lags
Expansionary Monetary Evaluation
- Size of the output gap -> IR is cut and if the economy is already at full with a small negative output gap then any cut in aggregate demand -> We will not see much growth but instead will see inflation
- Consumer confidence -> If IR is cut, if they are confident, they will have the incentive to borrow and invest
- Business confidence -> If IR is cut, if they are confident, they will have the incentive to borrow and invest
- Bank willingness to lend/pass on the full cut -> If the bank is unwilling to lend any money, then the IR is useless -> They would rather hold cash ///// If if they did lend it, are they going to be passing on the full cut
- Size of the rate cut
Supply-Side Policy
Definition -> Policy that helps to improve a country’s productive potential of the economy
Purpose -> Shift the Long-Run Aggregate Supply Curve (LRAS) to the right
Method -> Increasing the quantity or quality of the FOPS
Tools of Supply-Side Policy
1)Labour Market Measures
Definition -> Policies that involve increasing Government intervention in the development of the FOPS
Alias -> Interventionist Supply-Side Policy
A)Pressuring Trade Unions -> Enhance working of the labour market
B)Education & Training -> Improves worker’s human capital, productivity improves
C)Tax and Benefits -> Lower tax rates encourage people to work, so does lowering unemployment benefits
Lower Corporate Tax -> Encourages firms to try and be more efficient, since they can keep more of their profits
2)Product-Market Measures
Definition -> Policies that involve decreasing Government intervention or involvement in markets
Alias -> Market-led Supply-Side Policy
A)Privatisation & Deregulation -> Introduce competition into market, thus improving efficiency and productivity
B)Investment in Technology -> Productivity and Efficiency would improve
Financing -> Done through grants or through the tax system
Main Outcome -> Encourages a more entrepreneurial culture
C)Reduction in Red Tape -> Allows businesses to establish themselves, or to make changes
Objectives of Supply-Side Policy
Purpose -> Improving productivity and productive capacity of the economy
Microeconomic Measures -> That influence the Macroeconomy
Productivity -> Quantity of goods & services produced per unit of input
Increasing Productivity -> Real output can rise without an increase in the price level
Productive Capacity Increase -> Potential output of the economy has increased
Shifting LRAS Outwards = PPC Outwards -> Supply-side policies’ effect can be shown in either PPCs or LRAS graphs
Shifting the PPC Outwards
Main Factors
Immigration
Deregulation
Labour Market Participation
Innovation
Investment
Productivity Gains
Education
Evaluating Supply-Side Policy
- Interventionist Policies -> May increase aggregate demand, due to an increase in Government Expenditure
- Other Policies -> May have harmful effects on consumers, workers and the environment
- Environmental Deregulation -> Leads to negative externalities to society
- Supply-Side Policies -> Usually effective at shifting LRAS
Main Downside -> They may take years in order to show their results - Very expensive -> High opportunity cost
- Time lag
- No guarantee that it will be effective
