Macro 12 - 15 Flashcards
Monetary policy:
Manipulation by gov of monetary variables to achieve its objectives
Fiscal policy:
Use of taxation, gov spending and gov borrowing to achieve its objectives
What are the two main monetary policy instruments?
- Quantitative easing
- Interest rates
What is the relationship between interest rate and aggregate demand and why?
- Higher the interest rates
- Higher the cost of borrowing
- Less consumption/investment
- Lower AD
What is the relationship between interest rates and durable goods and why?
- Higher the interest rates
- Higher the cost of borrowing
- Lower sales of durable goods as consumers would have to repay more
In what three ways does buying/moving house increase AD?
- Increase in demand for housing leads to increase in number of new houses being built
- Stimulates purchase of consumer durables
- Moving house releases money which can be spent
How do low interest rates cause the wealth effect?
- Increase in demand for housing
- Prices of housing increases
- Increase in consumer confidence
What is the relationship between saving and interest rates and why?
- Higher the interest rates
- Higher the cost of borrowing
- More attractive to save
What is the relationship between the exchange rate, balance of trade and interest rates and why?
- Lower the interest rates
- Fall in value of pound
- Greater exports than imports
Which two groups of people are responsible for monetary policy?
- Bank of England
- Monetary Policy Committee
What does MPC do?
- Sets Bank of England base rate
- Decides how QE is to be managed
Quantitative easing:
Introduction of new money into the national supply by the central bank
Process of QE:
1) Central bank digitally creates money
2) Central bank purchases financial assets from banks + other financial institutions
3) Value of financial institutions rises due ton increased demand for their financial assets
In what two ways does QE lead to greater AD?
- Greater lending by banks
- Wealth effect leads to greater consumption
What is the end goal by using QE?
Inflation target of 2% is reached
What is a balanced budget?
- Gov spending should be somewhat equal to gov revenue
- Neither budget deficit/surplus
Expansionary demand-side policy:
Any changes that shift AD outwards
Contractionary demand-side policy:
Any changes that shift AD inwards
What do Classical and Keynesian economists say about the use of monetary and fiscal policy?
- Keynesian: Favour use of both
- Classical: Only use monetary as fiscal is ineffective
What do Keynesian and Classical economists argue about how quickly an economy can revert to long-run equilibrium?
- Keynesian: Argue an economy could be in short-run disequilibrium for years due to lack of demand
- Classical: Economies adjust very quickly
What do Keynesian economists argue about the impact of demand-side policy on AD?
National debt is not a problem in short-term
What limitation is there of the implementation of demand-side policies
There are significant time lags so so it does not fix short-term issues in the short-term may not be fixed
Why do economists disagree about the effectiveness of QE?
Asset prices are pushed up, however, rather than building new houses, households and firms buy second-hand homes, which does not increase AD
What do Keynesian and Classical economists argue about the size of the multiplier?
- Keynesian: Multiplier is positive and can be large if fiscal policy is carefully targeted
- Classical: Multiplier is virtually zero as extra gov spending cuts spending of private sector (crowding out) and increase in budget deficit only leads to inflation, not extra output
Supply-side policies:
Policy that tries to increase quality/quantity of factors of production
What happens to LRAS if supply side policy is successful?
Shifts right
Two types of supply-side policies:
- Market-based
- Interventionist
What are interventionist policies?
Policies designed to correct market failure
In what way can interventionist supply-side policies can be implemented?
- Investment
- Industrial policies
What 3 forms can investment take?
- Human capital
- Technology
- Infrastructure
What are the two types of investment in human capital?
- Education and training
- Health services
2 advantages of investment in training and education:
Numerous positive externalities:
- Increases quality of labour, increases productivity, hence economic growth
- Reduces natural rate of unemployment
Give 2 examples of specific measures investing in education and training:
- Retraining programmes
- Low interest loans/grants assisting young people to pursue education
How does improved health care services increase supply?
Become healthier, better quality of labour, more productive
What is the fundamental activity behind developing new technologies and give examples of how this is promoted:
- Research and development
Examples: - Tax incentives/patents to private sector firms to engage in R&D activities
How is investment in infrastructure (physical capital) justified?
- Most infrastructure qualifies as merit/public good
- Increases efficiencies in production
What are the effects of investment in the short-term and long-term?
- Short-term: Increase in AD
- Long-term: Shift to right in LRAS
What are industrial policies?
An effort to encourage the development and growth of the economy
2 types of industrial policies:
- Support for SMEs
- Support for infant industries
How does support for SMEs and infant industries help supply?
- Promotes efficiency
- More employment possibilities
What are market-based policies?
Policies designed to remove barriers to the efficient working of free markets
In what ways can market-based policies be implemented?
1) Encouraging competition
2) Labour market reforms
3) Incentive-related policies
How does encouraging competition increase potential output?
- Greater efficiency in production
- Improvement in quality of goods and services
- Increased LRAS
What are the 6 ways competition can be encouraged?
- Privatisation
- Deregulation
- Private financing of public sector projects
- Outsourcing
- Restricting monopoly power
- Trade liberalisation
Why is privatisation believed to be more efficient?
Public sector has bureaucratic procedures, high administrative costs and unproductive workers, because they does not have the incentives to lower costs and maximise profits
What is deregulation and why is it believed to be more efficient?
- Involves elimination of gov regulation of private sector activities
- Gov regulation stifles competition and increases inefficiencies
What are the 2 types of regulation?
- Economic regulation –> involves gov control of prices, output and others for protection against competition
- Social regulation –> protecting consumers against undesirable effects of private sector activities
Evaluation of social regulation:
Some economists believe it is excessive as it results in costly bureaucratic procedures
How does the private financing of public sector projects promote competition?
Private sector firms compete with each other to be selected by gov to take on project
Give examples of public sector projects:
Building infrastructure eg. hospitals and airports
What is outsourcing and how does this promote competition?
- Public services provided by private firms based on a contractual agreement between gov and private service provider
- Private firms compete with each other to get contracts w/ gov
In what ways can monopoly power be restricted?
- Enforcing anti-monopoly legislation
- Breaking up large firms engaging in monopolistic practices
- Preventing mergers between firms that may result in monopoly power
What do labour market reforms intend to do?
- Make labour markets more competitive
- Lower labour costs
- Match wage responses to changes in supply and demand
- Lower rates of unemployment
In what 4 ways can labour market reforms be implemented?
- Abolishing minimum wage legislation
- Weakening power of TUs
- Reducing unemployment benefits
- Reducing job security
How does abolishing minimum wage legislation serve the aims of labour market reforms?
Increased wage flexibility allows firms to hire more labour at a lower wage, reducing unemployment
How does weakening the power of trade unions serve the aims of labour market reforms?
Wages will be more responsive to supply and demand rather than the actions of TUs
How does reducing unemployment benefits serve the aims of labour market reforms?
Reduces incentive to remain unemployed, encouraging them to look for work, reducing unemployment levels
How does reducing job security serve the aims of labour market reforms?
- Makes it easier to let go of workers meaning firms are more likely to hire new workers as they know they can also be let go of easily
- Labour costs are decreased
What do incentive related policies involve?
Cutting various types of taxes to change incentives
What are the 3 incentive-related policies and their aims?
- Lowering personal income taxes –> increases consumption + AD
- Lowering taxes on capital gains and interest income –> increases investment + AD
- Lowering business taxes –> increases investment + AD
Advantages of interventionist policies:
General:
- Effect on AD in short term
- Provides what market is unlikely to provide w/ gov support in areas like investment and R & D
- Positive equity effects, as unemployment is reduced
Industrial policies:
- Greatest possibilities for growth in future
Give 2 examples of situations where interventionist policies have succeeded in comparison to failures of market-based policies:
- ‘Asian Tigers’ (grp of Asian countries) achieved high rates of growth w/ highly interventionist industrial policies
- Questionable growth performance of many developing countries adopting market-based policies in 1980s
Disadvantages of interventionist policies:
General:
- Can lead to gov failure
- Rely heavily on gov spending
Advantage of market-based policies:
Reduces unemployment in long-run
Disadvantage of market-based policies:
General:
- Increases unemployment in short-run, as privatisation means firms fire workers to cut costs + jobs in domestic market are lost if projects are contacted to firms in other countries
- Negative effects on environment, as increased competition leads to increased scope for negative externalities
Encouraging competition:
- Outsourcing + Private financing of public sector projects may result in high prices, which becomes unaffordable for lower income groups
Labour market reforms:
- Removes protection for workers, increasing income inequality
Incentive-related:
- Impact of AD is greater than impact on AS, as tax cuts tend to increase consumption and reduce saving, which doesn’t necessarily increase output
- Tax cuts mean reduced gov revenues
- Tax cuts have negative equity effects, as it increases the after-tax incomes of the wealthy, reducing redistributive effects and negatively affecting the low-income earners
Conflicts of reducing AD to reduce inflation:
Likely to lead to a recession or cyclical unemploymemgb
What does the Phillips Curve show?
- Trade-off between unemployment and inflation in short-run
- As unemployment rate increases, inflation decreases
Explain the Phillips Curve:
As unemployment increases, there is less spending, which results in lower inflation
