government policy Flashcards
what are the three important branches of government policy
fiscal policy
monetary policy
supply-side policy
what is fiscal policy
Fiscal policy is the government using changes in public spending and/or taxation to alter the level of aggregate demand in order to influence the performance of the economy.
what are the government aims in terms of fiscal policy
- An inflation rate target of 2% (CPI).
- A high level of employment.
- A sustainable rate of economic growth.
- A balanced trade position.
how does the government use fiscal policy to reach an inflation target rate
If inflation is rising caused by aggregate demand being too high then the government could lower aggregate demand by:
- Cutting its capital and current spending which has the effect of decreasing aggregate demand
- Increasing taxation which will cut consumer spending and investment and also lower aggregate demand, easing inflationary pressures in the economy.
how does the government use fiscal policy to gain a high level of employment
If there is high unemployment caused by low aggregate demand then the government could increase demand by:
- Spending more, e.g. capital spending on new hospitals and roads, or current spending, e.g. employing more nurses and teachers. These measures would inject extra spending into the economy and would raise aggregate demand;
- Reducing taxation, e.g. reducing corporation tax. This allows firms to keep more of their profits which they could use for investment. This would stimulate aggregate demand. They could reduce income tax, allowing individuals more of their income to spend, which would also increase aggregate demand.
how does the government use fiscal policy to gain a sustainable rate of economic growth
Policies to stimulate economic growth are broadly those which lower unemployment. In both cases, rising output is required. This can be achieved by stimulating demand, or by lowering costs on the supply side.
The government can stimulate the output of goods and services in the economy by increasing aggregate demand by:
- Spending government money on capital investment in the economy, e.g. high speed rail;
- Tax cuts, to encourage consumers, which in turn leads to producers making more goods.
- Incentives to business to research and innovate and invest more.
how does the government use fiscal policy to gain a balanced trade position
Policies that reduce imports are similar to those that reduce inflation. On the demand side, the requirement is for the brakes to be put on an overheating (inflationary) economy. Supply measures can also help UK firms to compete.
The government can use fiscal policy to improve the UK’s International Trade position by:
- Increasing income tax to cut consumers buying power and so decrease the demand for imports;
- Spending money to lower business costs, such as by improving roads.
what are the problems with fiscal policies
- a fiscal policy used to meet one objective could actually result in another objective not being met;
- a fiscal policy which raises aggregate demand in order to increase employment might cause inflation if aggregate demand rose faster than output, or it might cause an increase in the demand for imports;
- a fiscal policy aimed at reducing aggregate demand to reduce inflation might cause unemployment to rise and growth to slow down.
why does demand change more than the initial government action
Demand will change by more than the initial government action would suggest. Remembering the multiplier effect, changes in demand caused by changes in tax or public spending will be difficult to forecast.
what is monetary policy
Monetary policy is the use of interest rates and the supply of money
how is the money supply controlled
- controlling banks’ ability to lend
- controlling borrowing from banks (the demand for money)
- controlling government borrowing from banks
what are the government aims in terms of monetary policy
- An inflation rate target of 2% (CPI).
- A high level of employment.
- A sustainable rate of economic growth.
- A balanced trade position.
how does the government use monetary policy to reach an inflation target rate
If prices are rising due to increasing aggregate demand the Bank of England could:
- raise interest rates and decrease bank lending which will discourage consumers and firms from borrowing and spending money, encourage saving which will lower aggregate demand and ease inflationary pressure
- raise interest rates to strengthen the exchange value of sterling making imports cheaper, easing inflation further.
how does the government use monetary policy to gain a high level of employment
If there is increasing unemployment due to falling aggregate demand then the Bank of England could:
- lower interest rates and increase bank lending which will encourage consumers and firms to spend money and discourage saving, which will raise aggregate demand and create jobs
- lower interest rates will also weaken the exchange value of sterling making UK exports more competitive and so create jobs
how does the government use monetary policy to gain a sustainable rate of economic growth
If the Bank of England wanted to boost demand in the economy and stimulate output it could:
- lower interest rates and increase bank lending which will encourage demand and investment so increases output in the economy.
- lower interest rates which makes exports cheaper and so will encourage output of export industries to go up.
