Macro - Which policies can the UK government use

Question 1

What is fiscal policy

Answer 1

The deliberate manipulation of government spending and taxes by the government in order to achieve its macro-economic objectives

Question 2

How can a government achieve a balanced budget

Answer 2

Government Spending = Government Revenue

Question 3

How can a government achieve a budget surplus

Answer 3

Government Revenue is greater than Government Spending

Question 4

How can a government achieve a budget deficit

Answer 4

Government Spending is greater than Government Revenue

Question 5

Describe the problems with the fiscal policy(4)

Answer 5

There may be a time lag

There are trade-offs - For example using fiscal policy to stimulate demand will increase GDP and reduce unemployment BUT it may also cause demand-pull inflation and suck in imports, thus making the current account worse

Expansionary fiscal policy (aimed at stimulating demand) will require increasing government spending and reducing taxes
-This will contribute to a budget deficit and will require borrowing

High levels of tax at times of boom may affect the supply side of the economy and will cause disincentive effects

Question 6

What is interest rate

Answer 6

The reward to saving and the cost of borrowing

Question 7

Why are there different rates of interest(2+3+2)

Answer 7

There are different rates between savings accounts and loan accounts
-Banks make their money by charging higher interest rates on loans than they give on savings

Different amounts of risk

• Most banks will deter risky borrowers with high rates of interest
• Safe borrowers who are perhaps longstanding customers will be rewarded by lower interest rates

Interest rates given on savings account will be higher if you have a bigger deposit and are less likely to take out your money
-This is because the bank can make a lot of money from loaning out your money

Question 8

What is interest rate policy

Answer 8

Deliberately manipulating the rate of interest in order to achieve macro-economic objectives

Question 9

What is monetary policy

Answer 9

Deliberately manipulating the money supply and the rate of interest in order to achieve macro-economic objectives

Question 10

How does interest rate policy works to achieve a target rate of inflation(6)

Answer 10

Affects aggregate demand therefore affecting demand pull inflation,since it affects:

• borrowing
• saving
• mortgage repayments
• the cost of borrowing for firms (for investment)
• exchange rates - a rise in interest rates will lead to a rise in exchange rates which causes a lack of demand for UK goods as they are less competitive

Question 11

Describe the problems with the interest rate policy(4)

Answer 11

Time lags

Commercial banks don’t always pass on base rate cuts

Trade offs - using interest rate policy to decrease AG decreases inflation BUT could increase unemployment as labour is a derived demand

Link between interest rate and exchange rate means that the the effect on international competitiveness and trade always has to be considered

Question 12

What is supply side policy(2)

Answer 12

Policies that are aimed at increasing the amount of aggregate supply in the economy

Done through increasing the quality or quantity of the factors of productions(enterprise, labour, land, capital)

Question 13

How can supply side policy affect land(1+1)

Answer 13

Increase quantity
-Discovery of new resources

Increase quality
-Investment in new technologies, eg farming methods

Question 14

How can supply side policy affect labour(1+1)

Answer 14

Increase quantity
-Reduce direct taxes and benefits so that there is more incentive to go to work

Increase quality
-Improved education, health and training

Question 15

How can supply side policy affect capital(3+1)

Answer 15

Increase quantity

• Offer subsidies to encourage investment
• Lower business taxes so firms have more money to invest
• Create more competition (eg through privatisation) as this will lead to an increase in efficiency

Increase quality
-Encourage more innovation and R&D- either through subsidies or by reducing the other costs businesses face

Question 16

How can supply side policy affect enterprise(2+1)

Answer 16

Increase quantity
-More business loans and
grants/enterprise schemes
-Tax allowances and relief for new businesses

Increase quality
-Improved enterprise education in schools

Question 17

Evaluate supply side policies(1+3)

Answer 17

Advantages:
-It is theoretically possible to achieve improvements in all 4 macro-economic variables

Disadvantages:
-Supply side policies take a long time to implement
-They are often seen as putting efficiency ahead of
fairness (eg cutting benefits, reducing direct taxes)
-They may make the poor more vulnerable

Question 18

Compare fiscal, monetary and supply side policies(5)

Answer 18

Supply side policies are likely to be more long term than fiscal and interest rate policies
-take several years to be effective whereas rise in government spending and fall in interest rates have a fairly immediate effect

Fiscal and supply-side policies are not flexible enough to react to changes in the short term as they are only changed annually
-Bank of England meet every month to set interest rates so it is more flexible

Bank of England has to place price stability at the heart of its interest rate policy - interest rate policy may be less effective in achieving other objectives