Macroeconomic Objectives ✅ Flashcards
Macroeconomic objectives
Economic growth Inflation Balance of payments Government budget Environment Unemployment Equal distribution of income
Demand side policy ( 2 types)
manipulation of AD to achieve macroeconomic objectives ( expansionary or deflationary)
Fiscal policy- increase in government spending, or a reduction in tax
Monetary policy- uses monetary instruments such as interest rate and quantitative easing
How does increasing interest rates effect economic growth
Exam Q
monetary policy
- cost of borrowing increases, people are less keen to spend their savings as the opportunity cost is greater ( saving is more attractive)
- mortgage repayments will rise and therefore people will have less disposable income, spending decrease
- housing prices fall as mortgages become less affordable, this causes a negative wealth effect where lower asset prices mean that people are less inclined to spend
- firms find investment unattractive due to increased cost of borrowing reducing AD
- higher interest rates leads to an inflow of ‘hot money’ causing the pound to appreciate, this makes importing cheaper and exporting more expensive relatively.
AD shifts inwards
decrease in investment and exports would cause downwards multiplier effects on GDP
Process of quantitative easing
purchase of gifts and other liquid assets as a means of making credit easier to access
Large purchases of government bonds, this pushes their price up and their yield down
These lower interest rates feed through the economy reducing the cost of borrowing, leading to an increase in consumption and investment
lower mortgage costs makes housing more attractive increasing asset prices, positive wealth effect which boosts spending
Banks are more willing to lend, meaning investment can increase
All of these factors shift AD out, increase in price level, inflation
Why would the government run a budget surplus/deficit
When gov spending is greater than tax revenue to leads to budget deficit, this is done to pump spending power into the economy, multiplier effect boosts AD
When government spending is less than taxation there is a budget surplus which takes spending power out of the economy, done usually to curb inflation during a boom
Distinction between indirect and direct taxation
Direct- taxes on income, effect disposable income and therefore consumption, effects AD
Indirect- VAT taxes added onto spending, more obviously effects AS as VAT effects the price firms can sell at
Effectiveness of monetary policy
Shorter time lag than fiscal policy
Inappropriate as a means of cost push inflation, people who are in debt suffer badly as asset prices rise
Effectiveness of fiscal policy
Slow to act
Fixed mortgages delay spending changes
Only implemented in the annual autumn budget
If government tries to act using fiscal policy the effect will not be seen until the economy is out of that stage of the cycle
Government spending reduces the likelihood of private investment in a similar area
Objectives and types of supply side policy
Increase LRAS meaning to improve the productive potential of the economy
Market based policy- increasing effectiveness of market allowing more flexibility as determined by supply and demand
Interventionist policies- government reducing market deficiencies
Market based methods
Increasing incentives- cutting income tax or cooperation tax
Increased price flexibility and signalling in the market- stops poor pricing allocating resources inefficient, excess supply/demand
Labour market reforms- reducing minimum wages, reducing benefits would make the labour market more competitive
Increase competition- promoting the entry of small firms into the market, removing barriers to entry
Interventionist methods
Improving education and training - more skilled workforce
Improving infrastructure - HS2 railway
Improve healthcare and introducing performance related pay
Inflation and unemployment
Shortage of labour leads to higher wages as firms need to attract workers.
Higher wages leads to higher spending and higher production cost
AD shifts out while AS shifts in leading to inflation
Economic growth and the balance of payments
Usually economic growth would worsen the current account as people are likely to demand more imports as their incomes rise
This does not happen if growth it export lead
Or if growth is caused by an expansion of AS due to increase investment leading to higher productivity and lower costs of production
Low unemployment and environment
If more workers are employed congestion will be higher, co2 emissions will be higher due to greater manufacturing, energy usage, offices being used
On the other hand high employment means high tax revenue which could be used to help the environment. Green taxes such as those on diesel cars
Depends what sectors people are working in
Economic growth and income equality
As economy grows wages for those at the top rises quickest with bonuses for chief executives
Government redistribute incomes through tax
Increased demand for low skilled labour will eventually lead to higher wages
Low inflation and balance of payments
Low inflation comes from a high interest rate, which leads to a high value of the pound, meaning exports become more expensive imports become cheaper.
X-m current account worsens
However low inflation means low prices in a global economy, could increase the demand for uk exports bettering the balance of payments
How do fiscal and supply side policy conflicts
Increased government spending could be used to stimulate AD growth but much of this spending will be towards health and education meaning there is not a conflict
Supply side effects may reduce any negative inflationary effects
If government is using contractionary fiscal policy as a means to control the price level AS will shit in , contrast
Monetary and supply side policy conflicts
Tight monetary policy means that interest rates are high. This can harm the supply side as the costs of borrowing increases meaning investment will decrease. However as the UK import almost all their raw materials a stronger currency, due to the high interest rates, will decrease the costs of production shifting AS outwards
problems with using interest rates as a method of demand management
if exchange rate is effected drastically it could lead to a balance of trade deficit
changes in interest rates are very low to have their full effect, 2 years
sometimes interest rates are already so low that they cannot be lowered to stimulate demand
not all interest rates are effected by the bank of England’s base rate
lack of confidence could mean people don’t want to spend or banks don’t want to lend
high interest rates discourages investment
problems with QE
could lead to extreme inflation
if confidence remains low higher assets prices will not lead to more consumption
if housing prices go up this increase inequality
some countries are becoming dependant on QE
fiscal policy
rise in income tax will cause a fall in disposable income leading to a reduction in consumption and a fall in ad
a rise in government spending will increase AD as it is a component
evaluation of demand side polices
classical economists will argue that demand management will have no effect of long run output so supply side policies should be used
both policies see significant time lags
on Keynesian LRAS impact of AD depends on where the economy is operating, if economy is at full capacity AD shifting out will be purely inflationary, if not AD shift will lead to higher output.
expansion in monetary policy brings inflation where a contraction brings unemployment
strength and weaknesses of supply side polices
able to increase output and decrease price
more long term polices aimed at long term economic growth
can be directed at increasing exports which will improve the balance of payments
government has to spend for interventionist policies leading to budget deficit ( and opportunity cost of spending)
these actions may have undesirable effects of AD causing higher unemployment or inflation
extreme time lag
if there is insufficient demand in the economy there will be zero effect
