macro 2.6 - macroeconomic objectives and policies Flashcards
fiscal policy
- fiscal policy - changes to government spending and taxation in order to influence AD
expansionary fiscal policy:
- expansionary fiscal policy - tax decreases and government spending increases - AD increases
aims of expansionary fiscal policy:
- boost economic growth
- reduce unemployment
- increase inflation to hit inflation target
expansionary fiscal policy examples:
- reduction in income tax - increased disposable income - consumption increases - AD shifts right
- reduction in corporation tax - increased retained profit - investment increases - AD shifts right
- increase in government spending e.g. education and healthcare - boost G in AD equation - AD shifts right
expansionary fiscal policy side effects (LRAS)
- reduction in income tax - incentivise inactive to become active - increase quantity of labour - LRAS shifts right// for those in work - incentive to work harder as they can keep more income - productivity increases - quality of labour increases - LRAS shifts right
- reduction in corporation tax - investment increases - increase in quantity/quality of capital and increase in productive efficiency - LRAS shifts right
- increase in government spending —> e.g. spending on education and health - productivity of labour increases as people are healthier and have stronger human capital - quality of labour increases - LRAS shifts right
conflicts:
- demand pull inflation
- current account deficit - economic growth - AD shifts right - price level increases - UK competitiveness decreases - demand for exports decreases// AD increases - higher incomes - more spending on imports
- negative impact on environment
- worsening of government finances - more government spending and less taxation - fiscal deficit increases
evaluation:
- low consumer/business confidence - income tax cuts might be saved// businesses increased retained profit may not be used to invest
- time lags - tax cuts takes time to feed through into the economy e.g. households will take time before income tax cut is spent, corporation tax cut will take time before businesses invest
- ricardian equivalence - consumers anticipate the future - if they receive a tax cut, they anticipate future taxes will rise - consumer spending remains unchanged
- in the SR, there’s a budget deficit but in the LR, it can lead to growth
contractionary fiscal policy:
- contractionary fiscal policy - taxes increase and government spending decreases - AD falls
aims of contractionary fiscal policy:
- reduce inflation to reach inflation target
- reduce budget deficit
- reduce current account deficit
monetary policy
expansionary monetary policy:
- monetary policy - changes to interest rates and the money supply by the central bank in order to influence AD
aims of expansionary monetary policy:
- increase inflation to hit inflation target
- increase economic growth
- reduce unemployment
examples of expansionary monetary policy:
interest rates:
- low interest rates - cost of borrowing falls - greater incentive to borrow - consumption increases - AD increases// ROR on savings decreases - increases incentive to spend - consumption increases - AD increases
money supply:
quantitative easing diagram:
- y axis - IR (interest rates), x axis - QM (quantity of money supply)
- demand curve - Dm
- supply curve - inelastic MS1 - shifts right to MS2
- as a result of quantitative easing, money supply increases from MS1 to MS2 - money supply increases through increasing the demand for bonds or electronic printing - as the demand for bonds increases, price of bonds increases - bonds and yields (interest rates) are inversely related - this leads to a fall in interest rates - banks are more willing to lend as they have more money - as interest rates fall from IR1 to IR2, cost of borrowing decreases and ROR on savings decreases - incentivises firms to invest and consumers to spend - C and I are components of AD - economic growth occurs
conflicts:
- demand pull inflation
- current account deficit
- negative impact on the environment
expansionary monetary policy side effects (LRAS):
- interest rates fall - incentivises firms to borrow and invest - investment increases - quality/quantity of capital/productive efficiency increases - LRAS shifts right
evaluation:
- depends on consumer and business confidence
- size of IR cut and money supply increase
- liquidity trap - people prefer to keep their savings instead of spending them despite zero/very low-interest rates
- time lags —> takes long time for interest rate cut to impact AD
aims of contractionary monetary policy:
- reduce inflation to hit inflation target
- reduces current account deficit
contractionary monetary policy examples:
- higher interest rates
- decrease money supply from __ through selling bonds - as supply of bonds increases, price of bonds decreases - bonds and yields inversely related - leads to an increase in the IR from ___ - banks are less willing to lend as they have less money - cost of borrowing increases and ROR on savings increases
cons:
- lower growth
- higher unemployment
automatic stabilisers
automatic stabilisers - when the economy automatically responds to different stages of the economic cycle
boom:
- incomes are high - workers pushed into higher tax bands - paying higher rates of income tax - slows down increases in consumption and therefore slows down increases in AD - controls extent of the boom
- unemployment is low - government spending on benefits decreases - AD doesn’t increase as much - controls extent of the boom
recession:
- incomes are low - workers move into lower tax bands - paying lower rates of income tax - prevents large decreases in consumption and therefore slows down decreases in AD - controls extent of the recession
- unemployment is high - government spending on benefits increases - increases AD and prevents deep recession
supply side policies
supply side policies:
- supply side policies - policies designed to increase the productive capacity of the economy, shifting LRAS to the right - if successful then all 4 main macro economic objectives will improve
4 main macro economic objectives:
- lower unemployment
- growth
- reduction in inflation
- current account deficit improves - reduction in inflation - COP decreases - exports are more internationally competitive - demand for exports increases - net exports increase
2 types of supply side policies:
interventionist (government intervention)
- government spending on education/training - human capital increases - productivity increases - quality of labour increases - LRAS shifts right
- government spending on healthcare - less absenteeism - quality of labour improves - LRAS shifts right
- government spending on housing supply/transportation - reduces labour immobility - quantity of labour increases - LRAS shifts right
market based (removing obstructions in the free market)
- deregulation - reduced barriers to entry - incentivises new firms to enter the market - competition increases - firms will be more efficient to lower COP - productive efficiency increases - LRAS shifts right
- removing red tape - reduction in regulatory costs e.g. less health and safety regulations - COP falls - profit for firms increase - retained profit increases which incentivises firms to invest - quantity/quality of capital increases - shifts LRAS right// incentivises new firms to enter the market - competition increases - firms will be more efficient to lower COP - productive efficiency increases - LRAS shifts right
- reducing welfare benefits - incentivises inactive to enter the labour force - quantity of labour increases - LRAS shifts right
- income tax cuts/corporation tax cuts - lower income tax - incentive for inactive to enter the labour force - quantity of labour increases// for those in work, greater incentive to work harder as they can keep more of their money as disposable income - productivity increases - quality of labour increases - LRAS shifts right// lower corporation tax - higher retained profit - investment increases - increases quality/quantity of capital and productive efficiency increases
- privatisation - competition increases - firms will be more efficient to lower COP - productive efficiency increases - LRAS shifts right
cons/evaluation:
- no guarantee of success - e.g. no guarantee that gov spending on education/training will boost productivity of workforce
- costly
- time lags e.g. government spending - takes a long time before infrastructure project is completed (spending on infrastructure), takes a long time before we see an increase in productivity (spending on education and training), takes a long time before we see investment take place (corporation tax cuts)
- negative stakeholder impacts —> e.g. removing health and safety regulations can impact consumer/producer safety
- depends on the quality of services produced by government spending (e.g. depends on quality of healthcare, education and training etc)
laffer curve
diagram:
- y axis - tax revenue, x axis - tax rate
- n shaped curve
- increasing taxes will increase tax revenue up to a point
- however increasing taxes beyond the efficient tax rate leads to a reduction in tax revenue
3 reasons why tax revenue decreases beyond efficient tax rate:
1. less incentive to work as workers keep less of their income - workers work less - less income - tax revenue decreases
2. brain drain - highly skilled workers will move elsewhere - tax revenue decreases
3. tax evasion/tax avoidance increases - tax revenue decreases
macroeconomic objectives
macroeconomic objectives:
- economic growth
- low unemployment
- low and stable inflation
- current account (trade balance)
- balanced government budget
- environment
- income equality
role of bank of england
great depression and financial crisis
short run phillips curve
diagram:
- x axis: unemployment rate, y axis: inflation rate
- shows inverse relationship between unemployment rate and inflation rate
- this trade-off makes it difficult for the government to achieve both low unemployment and low inflation
