Macro 11 - Financial Markets and Monetary Policy

Question 1

Demand-side definition

Answer 1

>Influence AD.
>Includes fiscal and monetary policy.

Question 2

Supply-side definition

Answer 2

>Attempt to increase SRAS or LRAS.
>Can be interventionist or market-based.

Question 3

Fiscal policy - definition

Answer 3

>Direct changes to AD through government spending and withdrawals from the circular flow through taxation.

Question 4

Monetary policy - definition

Answer 4

>Changes to the supply of money.
>Increasing or decreasing interest rates, printing money (QE), open market operations (buying and selling assets) and exchange rate manipulations.

Question 5

Interventionist - definition

Answer 5

>Increasing government intervention in the economy (e.g. spending on infrastructure and education).

Question 6

Market-based - definition

Answer 6

>Reducing the amount of state intervention.
>E.g. tax cuts, decrease welfare provision, deregulation.

Question 7

Demand and supply side policies

Answer 7

>A supply side policy will have demand side impacts and demand side policy will have supply side impacts.
>The key is intention.
>Both demand and supply side policies will have short and long run impacts. Analysis should consider both.

Question 8

Positive output gap policy

Answer 8

>Increase tax rates, reduce spending when there’s a positive output gap to dampen inflation.
>Tax revenue can be used to pay off debt or saved for future spending.

Question 9

Negative output gap policy

Answer 9

>Increase spending and cut tax during a negative output gap.
>Funded through borrowing (issuing bonds).

Question 10

Automatic stabilisers

Answer 10

>Even without deliberate fiscal interventions, any economy with a tax and welfare system will see naturally occurring ‘corrections’ to the cycle - ‘automatic stabilisers’.
>Fiscal policy can reduce the severity of the trade cycle.

Question 11

Budget and trade deficit

Answer 11

>The budget and trade deficit are different.

Question 12

Expansionary fiscal policy - definition

Answer 12

>Fiscal policy which aims to increase AD by cutting tax and increasing spending.
>This means there’s a budget deficit.

Question 13

Contractionary fiscal policy - definition

Answer 13

>Fiscal policy which aims to decrease or slow down the growth of AD and avoid overheating.
>This means the government is running a budget surplus.

Question 14

Fiscal policy’s applications

Answer 14

>Fiscal policy has macroeconomic and microeconomic application.
>It can be used to influence the ‘quantity’ (AD, AS - macroeconomic) and the ‘pattern’ (individuals, firms - microeconomic) of consumption.
>There are microeconomic implications of macroeconomic policy.

Question 15

Budget deficit - definition

Answer 15

>Total government spending minus total government revenue when spending is higher than revenue.
>The value of the deficit is also known as the public sector net cash requirement.

Question 16

Budget surplus - definition

Answer 16

>Total government revenue minus total government spending when revenue is higher than spending.
>The value of the surplus is known as the public sector debt repayment.

Question 17

National debt - definition

Answer 17

>The amount of money the government owes at any given time.
>This continues to increase whenever the government runs a deficit and reduces when the government runs a surplus.

Question 18

PSNCR - definition

Answer 18

>Public Sector Net Cash Requirement.
>The sum of money the government must borrow when it spends more than it receives.

Question 19

PSDR

Answer 19

>Public Sector Debt Repayment.
>The value of total revenue additional to government spending.

Question 20

Rules of fiscal policy

Answer 20

1. Any budget deficit that is run over an economic cycle must be used to fund long run growth and increase the economy’s capacity. Golden rule.
2. The Treasury must set a clear deadline by which the budget will no longer be running a deficit.
3. The Treasury must set out a clear and transparent plan for their spending and borrowing.

Question 21

Where did the principles of taxation come from?

Answer 21

>Adam Smith’s ‘canons of taxation’.

Question 22

The principles of taxation - list

Answer 22

1. Canon of Equity
2. Canon of Certainty
3. Canon of Convenience and Simplicity
4. Canon of Economy

Question 23

The principles of taxation - canon of equity

Answer 23

>Taxation should be equitable or fair.
>Involves value judgement.

Question 24

The principles of taxation - canon of certainty

Answer 24

>Those who pay tax should be able to predict how much they will pay to enable them to confidently plan their expenditure.
>Likewise, the government should be confident in their forecasts of how much tax revenue they will receive.

Question 25

The principles of taxation - canon of convenience and simplicity

Answer 25

>The tax should be convenient and easy to pay.
>Should be easy to calculate.

Question 26

The principles of taxation - canon of economy

Answer 26

>The cost of tax collection should be lower than the amount of tax collected or the very purpose of applying tax has been undermined.

Question 27

Aims of fiscal policy

Answer 27

>Although the primary aim of fiscal policy is to influence AD, fiscal policy will also influence supply, either inadvertently or deliberately.

Question 28

Example of how a demand side policy affects supply - reduced income tax rates

Answer 28

>Firstly whenever there’s an increase in LRAS one would expect SRAS to follow.
>This is because a greater abundance of resources or improved productivity would mean that there’s less scarcity and so less rationing so firms can source resources at a lower cost.
>The reduced tax rate means that workers who earn in the lower tax bracket keep more of their pay so are more incentivised to work as the OC of working, e.g. lost JSA, will be better compensated with the income received.
>Also as more workers enter the workforce, there will be less scarcity so employers may be able to pay workers a little less.
>Finally, it’s possible that employers could afford to reduce or freeze wages as, with the increased income tax, a lower wage would provide the same disposable income and so still incentivise the same number of workers to take up employment.
>Note that the national insurance and pensions contributions are made by workers and employers so if these were reduced then the impact on costs would be more direct.

Question 29

Progressive tax - definition

Answer 29

>A tax imposed in such a way that means the greater the amount that is subject to the tax, the greater the tax rate, or the greater the proportion that is paid.

Question 30

Regressive tax - definition

Answer 30

>A tax imposed in such a way that means the rate of tax decreases as the amount subject to tax increases.
>It is also taken to mean that the greater your wealth or income, the lower the proportion of it that is spent on tax.

Question 31

Proportional tax - definition

Answer 31

>A tax that has a tax rate that is fixed no matter how much is being taxed.

Question 32

Direct tax - definition

Answer 32

>Tax paid directly from income and wealth.

Question 33

Indirect tax - definition

Answer 33

>Taxes levied on transaction, such as VAT or import tariffs.
>Indirect taxes have microeconomic applications.

Question 34

Income tax - definition

Answer 34

>A common form of tax which takes a percentage of income. Progressive.

Question 35

Corporation tax - definition

Answer 35

>A tax that is payable from all taxable profits of any company that is based in the UK, no matter where in the world profit was generated.

Question 36

VAT - definition

Answer 36

>Value Added Tax is a tax on goods and services.
>20% for most but there’s a reduced rate of 5% on some goods and a zero rate on essential items.

Question 37

Capital gains tax - definition

Answer 37

>A tax on the profit when you sell something that’s increased in value.

Question 38

National Insurance

Answer 38

>The amount of National Insurance you pay depends on your employment status and how much you earn. >You pay National Insurance with your tax.
>Your employer will take it from your wages before you get paid.
>Your payslip will show your contributions.

Question 39

Excise duties

Answer 39

> Excise taxes are taxes required on specific goods or services like fuel, tobacco, and alcohol.
>Excise taxes are primarily taxes that must be paid by businesses, usually increasing prices for consumers indirectly.
>Excise taxes can be ad valorem (paid by percentage) or specific (cost charged by unit).

Question 40

Council tax

Answer 40

>Council Tax is a local taxation system used in England, Scotland and Wales.
>Each property is assigned one of eight bands in England and Scotland (A to H), or nine bands in Wales (A to I), based on property value, and the tax is set as a fixed amount for each band.

Question 41

Stamp duty

Answer 41

>This is the tax you pay on the purchase of land, i.e. a house.
>It varies depending on the price of the property you are purchasing.

Question 42

Hypothecation - definition

Answer 42

>Hypothecation occurs when an asset is pledged as collateral to secure a loan, without giving up title, possession, or ownership rights, such as income generated by the asset. However, the lender can seize the asset if the terms of the agreement are not met.

Question 43

Pigovian and sin taxes

Answer 43

>Pigovian tax is a kind of tax, which is levied to correct a negative cost that is created by the actions of any business firm, but that is not considered in a firm’s private costs or profits.
>Also known as ‘sin tax’, it is a tax placed on an action with a negative externality, to correct market failure.

Question 44

Government public spending can be categorised into what key forms of spending?

Answer 44

1. Current government spending.
2. Transfer payments.
3. Capital payments.

Question 45

Government public spending categories - current government spending

Answer 45

>Spending on public goods and services such as education and healthcare.
>Money is spent on salaries and consumable goods/services used in the public sector.

Question 46

Government public spending categories - transfer payments

Answer 46

>Welfare payments made though the social security system.
>The primary purpose of this is to provide a basic income for all members of society to keep the population out of poverty and ensure a basic standard of living.

Question 47

Government public spending categories - capital payments

Answer 47

>Capital investment on infrastructure that will increase the capacity of the economy and increase long-run growth.