Macroeconomic Objectives And Policies Flashcards
What are the seven main objectives that governments generally wish to pursue
Economic growth (rises in real GDP) Reduction in unemployment Control of inflation Equilibrium in the balance of payments on the current account Balanced government budget Protection of the environment More equal distribution of income
What are the order of priorities of macro objectives
It varies according to the politics of the government in office at the time and the particular economic circumstances in the country.
Priorities are also influenced by factors such as inflation targets which independent central banks are required to meet. Some governments see the control of inflation as the most important macro goal. Others, such as governments with a socialist leaning, focus on the redistribution of income and the reduction of unemployment.
What are the 2 demand side policies
Demand side policy is a deliberate manipulation by the government of AD in order to achieve macroeconomic objectives
They are fiscal policy and monetary policy
What is fiscal policy briefly
Fiscal policy is the governments management of its spending and taxation with the aim of changing total level of spending in the economy
What is monetary policy briefly
Monetary policy is decision making using monetary instruments such as the interest rate or quantitative easing.
What’s the primary objective of monetary policy
Meet the governments 2% inflation target
Who sets the base interest rate each month
The Bank of England’s Monetary Policy Committee (MPC)
What are the two major tools available to the MPC
The first is changing is changing the base rate of interest - the bank rate which is set by the MPC and is a bench mark for other interest rates in the money market.
The second is quantitative easing, which can be used as well as the manipulation of the base interest rate.
What are monetary transmissions mechanisms
Changing the rate of interest sets off a chain of reactions in the economy, many of which mean that AD will shift. We call these processes monetary ‘transmissions mechanisms’. This means that there are processes which, step by step, mean that an interest rate transmits change in demand.
How do the monetary transmissions mechanisms work with interest rates to change consumption
These mechanisms work through consumption, for example by affecting how much money people have after paying their mortgage. Also, consumers spend different amounts depending on the cost of credit and the amount they receive for their savings.
How do the monetary transmissions mechanisms work with interest rates to change investment
Investment is sensitive to interest rate changes: higher rates mean that fewer projects are deemed to be worthwhile.
How do the monetary transmissions mechanisms work with interest rates to change net exports
Net exports are affected by interest rates for two reasons. First, interest rates affect costs of production and therefore relative productivity. Second, interest rate changes are likely to affect exchange rates, which have an impact on export and import prices.
When interest rates are raised, how does this affect consumers borrowing
When interest rates are raised, the cost of borrowing rises. Consumers who borrow in order to finance their spending might be deferred from doing so and savers will be less keen to spend their savings because their is a greater opportunity cost in doing so.
When interest rates are raised, how does this affect consumers with mortgages
People with mortgages - of whom there are almost 10 million in the uk - will find their mortgage interest repayments rise and will therefore be discouraged from spending, although those with fixed rate mortgages will not suffer this immediately.
When interest rates are raised, how does this affect consumers hire purchase
Hire purchase - the method of buying major durable items, such as cars and white goods, on credit- will incur increasingly expensive monthly repayments instalments, which means that consumers might delay further major expenditures.
When interest rates are raised, how does this affect consumers house prices and wealth effects
House prices might fall as mortgages become less affordable. This can cause negative wealth effects, where lower asset prices mean that people feel less inclined to spend and less able to take out loans based on the equity of their homes.
How will increased interest rates affect firms
Firms will find that investment is less attractive in many cases and that fewer investments will make a return higher than the increased cost of borrowing. Therefore, firms will be less inclined to invest, which not only reduced current AD but also has implications for long term output prospects. The price of exports might increase because interest rates are essentially a cost of production, so exports will fall and imports will rise. This is made even more likely when we factor in a probable increase in the exchange rate, which occurs when ‘hot money’ is attracted by higher interest rates in the UK.
Increasing interest rates is likely to..
Decrease consumption, investment and reduce exports, increase imports.
Thus, all these changes shift the AD curve to the left. Decreases in investment and exports would cause downward multiplier effects on GDP. Depending on the shape of the AS curve, this may decrease both the price level and real output. Increasing interest rates can be an effective way of controlling inflation, but the cost is that economic growth is likely to fall.
Define negative wealth effect
A reduction in wealth, which results in a reduction in consumption and, therefore, a reduction in production and employment.
Tell me a dramatic example of the use of interest rate policy
It occurred in the latter part of 2008 and during 2009 as the global financial crises gathered pace. Spending in the economy slowed sharply. This threatened a downward spiral through a combination of contracting real output and price deflation.
The MPC responded decisively, cutting the Bank Rate from 5% to 0.5% - its lowest ever level - in just 5 months to reduce the risk of inflation falling below the 2% target.
The cut in interest rates was designed to stimulate aggregate demand and increase real national output.
When you consider a rise in interest rates, what usually happens to the value of the exchange rate
The value of the exchange rate is likely to change in the same direction. For example, if interest rates rise, the exchange rate of the pound is likely to rise. With a strong pound imports are cheap and exports are dear, which is remembered by the acronym SPICED.
Define quantitative easing (QE)
The purchase of gilts and other illiquid assets as a means of making credit easier to access.
Tell me some background info on quantitative easing (asset purchases by the central bank)
The MPC announced in March 2009 that it would start to inject money directly into the economy to boost spending - a policy known as quantitative easing (QE). It began purchasing financial assets (long term loans called gilts), funded by the creation of central bank reserves which are paid for by selling Treasury bills (short term 90 day loans), which are effectively cash as they are so easily turned into cash. It is what the media call ‘printing money’, but it is more honest and fair than that term implies. The banks asset purchases are designed to inject money directly into the economy to raise asset prices, boost spending and so keep inflation on track to meet the 2% target.
QE was needed in 2009 to reduce the impact of the global financial crisis. Bond purchases started at £200 billion in 2009. Further rounds have resulted in the building up of these bond purchases to £435 billion in 2016.
Explain how QE works
The central bank ( in the UKs case, the Bank of England) makes large purchases of government bonds. This pushes up their price and lowers the interest rate (yields) on these bonds. The lower interest rates feed through the economy so reducing the cost of borrowing by firms and households. In turn, this will cause an increase in consumption and investment.
In addition, QE is likely to cause a rise in asset prices (shares, houses). Consequently, there will be a wealth effect which will cause an increase in consumer spending so boosting aggregate demand.
What factors may dampen the effects of QE
One is the nature of the banking sector. For example, after the global financial crisis, banks were concerned about their financial health and as a result were less willing to lend. For this reason, the MPC did not expect QE to result in a material expansion of bank lending. Furthermore, if the confidence of consumers and businesses is low, then they will be unwilling to borrow despite the willingness of banks to lend.
When will quantitative tightening be used
As economic recovery becomes stronger and more sustained, the monetary policy measures required to deliver the inflation target will need to be changed. This means that, at some point, the Bank of England will tighten monetary policy by reselling asset purchases to the money markets. This process of reselling assets to the money markets is referred to as quantitative tightening, because the availability of credit will be reduced.
Define quantitative tightening (QT)
A contractionary monetary policy applied by the central bank to decrease the amount of liquidity within the economy. One way of achieving this is by letting the central banks bond holdings mature each month without replacing them.
What are the fiscal policy instruments
Fiscal policy is the manipulation of taxes and government spending to influence the overall level of demand in an economy.
What does expansionary fiscal policy mean
Cutting taxes (T) or raising government spending (G) or a combination of the two, so that AD rises
What does contractionary fiscal policy involve
Increasing taxes and/or reducing government expenditure, causing a fall in AD
What’s the net effect when government spending is greater than taxation
The government is operating a budget (or fiscal) deficit. The net effect is to pump spending power into the economy. This is referred to as expansionary or reflationary fiscal policy.
How does the multiplier magnify the effects of expansionary fiscal policy
The multiplier magnifies the effect of this boost in AD. For example, if the government builds a new hospital and does not pay for it through current taxation but instead borrows to finance the scheme, there will effectively be more spending power in the economy. When the government pays for the workers and building materials for this hospital, the incomes will be re spent in the economy, creating new incomes - which is the multiplier in operation. If an economy is going through a slowdown or recession then, according to Keynesian thinking, the government should spend its way out of recession.
What’s the net effect when government spending is less than taxation
There is said to be a budget (or fiscal) surplus, which takes spending power out of the economy with negative multiplier effects. The consensus among economists is that in times of boom or fast growth in the economy, the government should rein in its spending to curb inflationary pressures. This is known as contractionary or deflationary fiscal policy.
What are the two types of tax changes the government can use in fiscal policy
Governments can change fiscal policy by changing its tax or spending levels, or both, within the tax changes it can change direct tax, which is tax on incomes (eg income tax and corporation tax), or indirect tax, which is tax on spending (eg VAT)
How will changing direct tax affect AD through fiscal policy
A direct tax will have a direct impact on AD because people feel better or worse off according to how much their income changes. We make spending plans based on our disposable income, ie income after tax. Although the changes in direct tax might not have an immediate effect, there is the compounded effect of expectations and confidence. If direct taxes are raised then disposable income is likely to fall causing a decrease in consumption and, therefore, a decrease in AD.
How will a change in an indirect tax in fiscal policy cause an effect
An indirect tax has a more obvious effect on AS because it affects the amount that firms are willing to sell at any particular price. Many firms have to absorb some of the effects of a rise in VAT, for example, so will be less willing to sell when VAT is raised. We show this by a short run upwards shift in the AS curve.
You need to remember direct taxes can shift AD and indirect taxes tend to shift AS
Define direct taxes
Taxes paid directly to the government by the tax payer. They are usually imposed on income or wealth.
Define indirect taxes
Taxes that taxpayer can pass on to someone else (eg the consumer). they are usually taxes on expenditure.
What are the main purposes of the MPC
Achieve the governments target for inflation.
However, in its remit to the MPC in 2018 it is stated that the objectives of the Bank of England shall be:
Maintain price stability
Support the economic policy of her majesty’s government, including its objectives for growth and employment.
Tell me about the role and operation of the Bank of England’s MPC
The manipulation of monetary variables such as the interest rate has enormous implications across the whole economy. In the UK a group of up to 9 economists from the MPC, whose primary purpose is to control inflation. They meet at least once a month for a day and a half to examine evidence from across the country relating to inflationary pressures.
They have a target for CPI inflation set for them by the chancellor of the exchequer, currently at 2%. If inflation falls outside the range of 1-3%, the governor of the Bank of England must write an open letter to the chancellor of the exchequer to explain why this has happened. In its first 10 years of operation, this occurred only once when inflation reached 3.1% in March 2007, but between 2008 and 2011 he had to write 10 such letters (he only has to write one every 3 months if inflation remains above the ceiling). Between 2011 and 2018 the governor has had much less explaining to do although the inflation rate did fall below 1% in 2015. And the first part of 2016.
Tell me how demand side policies were used in the Great Depression
The Wall Street Crash of 1929 triggered a worldwide crash in stock markets and a global recession, much like the 2008 experience. Back in 1929 Keynes was influential in terms of policy responses both in the USA and UK. Expansionary fiscal policy was used to bring back some confidence in markets and stop the spiral downwards of demand and output. The uk did not respond as quickly as the USA, and it was not until the post war period, under a labour government elected in 1945, that demand side policies became significantly expansionary.
By 1968, however, Keynes ideas had become discredited. These demand side policies resulted in inflation, which led the government to adopt contractionary policies. During the 1970s, partly as a result of these policies and also because of an increase in oil prices, the UK experienced both inflation and unemployment at the same time.
Stagflation was the term used to describe this situation of persistent unemployment, slow or zero economic growth and high inflation. Milton Friedman in Chicago wrote that expansionary fiscal policy would only cause inflation and the effect on the jobs market would only be short term. He concluded that governments should not use demand side policies at all to influence the level of output and unemployment. Friedman’s ideas were popular on both sides of the Atlantic up until 2008
Define stagflation
Situation where the economy is stagnant (not growing) and is also suffering from inflation.
What were the demand side policy responses like in the 2008 crisis
The policy responses post the 2008 crisis were broadly similar in the USA and the UK until 2010. In the USA president Obama was clearly a Keynesian, using fiscal policy to expand the economy by increasing government expenditure on major infrastructure projects across the country. In the UK the labour government under Gordon brown was similarly seen to increase spending and cut taxes (eg VAT was temporarily reduced), and the budget deficit rose from about £40 billion in 2007-8 to over £150 billion in 2008-9. However, everything changed in 2010 when the Labour Party lost the general election and the new coalition government made the fiscal balance one of its main objectives. Since then the UKs economic growth has been subdued and below its previous long term trend.
Evaluate monetary policy to do with time lag/time scales
Monetary policy has a shorter late time than fiscal policy, although the MPC estimates that interest rate changes can take between 18 months and 2 years to have their full impact. There are further time delays because many mortgage holders have fixed rate contracts, which may delay the impact on their spending for some years. Furthermore, Monetary is a blunt tool that hits the whole economy, affecting both small and large firms, and rises in interest rates usually worsen income distribution.
What’s the most significant criticism of monetary policy
Perhaps the most significant criticism of monetary policy is that it is inappropriate as a means of addressing cost push inflation. The reason is that higher interest rates raise the costs of production. At a time of rising commodity prices, those who have to bear the brunt of this are people in debt. For this reason monetary policy is regarded as being more suitable to deal with demand pull inflation.
What has the Bank of England estimated how QE has affected GDP
It has been estimated that the first round of QE in 2009 raised the level of real GDP by 1-2% and increased the rate of inflation by between 0.75%-1%
Tell me about the time lag of fiscal policy causing it to be less effective
In the UK, fiscal policy can only be implemented in the annual autumn budget, although there is some room for manoeuvre in the spring statement. This creates a time lag in decision making for fiscal policy, added to which there is an implementation lag because many tax changes cannot begin until the start of the new fiscal year in April, sometimes 1-2 years ahead. This means that if the government tries to respond to current economic problems using fiscal policy, the effect will not become apparent until the economy has started to change tack in the normal course of the economic cycle. Furthermore, when a government deliberately sets out to expand its spending, people will try to cash in on this by increasing their pay demands, and the effect will be increased wages and costs rather than expanded output.
Evaluate fiscal policy using crowding out
There are crowding out effects of increased spending by governments. For example, if the government decides to build a new hospital, there is less scope for a private hospital in the vicinity providing essentially the same service. There is also crowding-out in the sense that when the governments runs a deficit it needs to raise finance which, in times when credit is less readily available, stifles private investment. However, it can be argued that expansionary fiscal policy simply causes inflation because the debt issued to finance the expansion, often treasury bills, is so liquid that is acts like printing money.
What are the 2 types of crowding out
Resource crowding out and financial crowding out
Define resource crowding out
When resources are fully employed. An increase in government spending will be using resources that would otherwise be used by the private sector
Define financial crowding out
When government borrowing causes an increase in interest rates (to attract buyers of government bonds) that result in a fall in private sector investment.
What are supply-side policies used for
They are measured designed to increase long run aggregate supply, so increasing the economy’s productive potential. The aim is to increase the productivity and efficiency of the economy.
What are the two fundamental approaches to supply side policies
That of increasing the effectiveness of markets (allowing more flexibility as determined by supply and demand) and the interventionist approach (governments getting involved in markets to reduce market deficiencies).
As with demand side policies, there are strong views as to which approach is more effective.
Name the two approaches to supply side policies
Market based and interventionist
List the market based supply side methods
Improving incentives
Increasing competition
Labour market reforms
Increasing price flexibility and signalling in a market
List the interventionist methods
Improving education and training
Improving infrastructure
Improving healthcare and introducing performance related pay.
Tell me about the supply side policy: improving incentives
It’s a market based method.
One way to increase incentives for workers is to give them higher rewards, for example by cutting income tax rates. This will motivate people to work harder because leisure is now more expensive (AD increases). With regard to firms, corporation tax rates could be cut. This would enable firms to keep more profit and so give them a greater incentive to take risks, for example by increasing investment.
Tell me about the supply side policy: increased competition
There are 3 ways: promoting the entry of small firms into the market, privatisation and deregulation
Market based approach
Tell me about the supply side policy: increased competition: pro,outing the entry of small firms into the market
This has happened in the UK energy market: in 2004 the Big Six energy companies supplied 99% of the market but by 2017 this had fallen to 75% as a result of measures to encourage the entry of new firms. However, in 2018 11 small energy firms went bankrupt as a result of the rising costs and the price cap imposed by the government.
Market based approach
Tell me about the supply side policy: increased competition: privatisation
Privatisation (the transfer of the ownership of a business, industry or service from the public sector to the private sector) is another means by which competition can be increased. If combined with measures to promote entry of new firms, there will be an incentive for the firms to cut costs and innovate in order to survive.
Market based approach
Tell me about the supply side policy: increased competition: deregulation
A further way of increasing competition is through deregulation. This involves the removal or reduction of state regulations in a particular market. The aim is to remove barriers to competition. Deregulation is often used to accompany privatisation so that when a state monopoly is privatised, measures are taken to enable new firms to enter and compete with the newly privatised firm.
Market based approach
Define regulation
The process of reducing government rules and restrictions on businesses
Tell me about the supply side policy: labour market reforms
These include reducing unemployment benefits (or making them more difficult to claim), reducing or removing minimum wages and reducing the power of trade unions. All of these measures would make the labour market more competitive and more responsive to market forces.
Market based approach
Tell me about the supply side policy: increasing price flexibility and signalling in a market
If prices are not used to allocate resources effectively, there will be surpluses or deficits in the market. For example, price caps on electricity and gas might encourage over consumption and so result in shortages.
Market based approach
Tell me about the supply side policy: Improving education and training
Interventionist method
This could be anything from increasing spending on pre school education to offering firms subsidies to take on apprentices. Clearly, these approaches are expensive and there can be huge time lags.
Tell me about the supply side policy: improving infrastructure
Interventionist method
A new runway at Heathrow could be argued to be a supply side policy because it will reduce costs for firms in terms of unreliable communications. Similarly, HS2 could reduce travel time.
Define Infrastructure
The physical and organisational framework needed for an economy to operate efficiently. It includes roads, railways, power, water and the internet.
Tell me about the supply side policy: improving healthcare and introducing performance related pay
Interventionist method
These policies should help to increase productivity so resulting in more output being produced at any given price level.
Tell me an issue with using an increased completion supply side policy
Although some supply side policies are clearly effective - for example, deregulation in the phone industry has resulted in greatly improved standards in terms of price levels and after service - there are some industries in which there is either no opportunity for increased competition or where the benefits are outweighed by increased costs. For example, many believe that increased competition in the NHS has merely resulted in increased management costs rather than improved efficiency.
Tell me an issue with supply side policies to do with time lag
Some policies, most notably in education, can take many years to have any effect on production costs. If anything, in the short run they increase costs because there are fewer people in the labour market.
Tell me what perhaps, is the strongest argument against supply side policies
If there is demand-deficient unemployment then the supply side policies may have no effect at all. Japan is often used as an example, where for over 30 years there has been an increase in productive capacity but a real deficiency in demand and no change in equilibrium unemployment.
This can be illustrated on a diagram with the Keynesian LRAS and the AD curve is on the horizontal part, so an increase in supply has little effect.
Tell me a con of supply side policies to do with poverty and inequality
Supply side policies can cause poverty and inequality. The policy to cut out of work benefits such as universal credit might indeed encourage some people to find a job, but if there are no jobs available or the skills do not match then the result will be no effect on the labour market and a more unequal income distribution. The same is true of cute in the national minimum wage and the policy of reducing the power of the trade unions.
Define trade unions
Organisations of workers that exist to promote the welfare of their members
How do supply side policies have side effects on the demand side
For example, cutting taxes has fiscal policy implications. However, effective supply side policies do have the benefit of resulting in both lower inflation and higher rates of economic growth.
Tell me a statistic about labour shortages in the uk
By the end of 2018, shortages of skilled workers in the construction industry resulted in wages rising at 4.6% compared with 3.1% in the economy as a whole. Similarly, labour shortages in the hotel and restaurants industry and in information technology have led to rising wages.
Tell me about the trade offs trying to achieve good levels of inflation and unemployment
A shortage of labour in a specific field can cause wage pressures to build up. The net effect in the wider economy is that, as wages go up, people start spending more, the costs of production increase because labour is a major production cost and inflation begins to rise. In other words, low unemployment or reduced spare capacity leads to higher inflation.
The basic analysis is the rationale for the short run Philips curve, which was an observation of an apparent trade off between unemployment and inflation ( measured by the rate of change in wages) in the UK between 1861 and 1913.
What’s the Philips curve
An observation of a trade off between unemployment and inflation
On a diagram, it has rate of change of wage rate (% per year) on y axis and unemployment rate (%) on x axis
Looks like a exponential decay graph, as wage rate (inflation) falls unemployment rate increases.
The Philips curve is often called short run because many economists believe that if you put any pressure on the trade off relationship, the trade off breaks down, in other words, the long run Philips curve is vertical. You do not need to know this for your exam, but it is useful to know that not everyone takes the same view of the Philips curve. But you do need to know about the Philips curve in general
Define trade off
When one factor can only improve at the expense of another
In practice, if the government tries to exploit this trade off between inflation and unemployment what will happen
It is unlikely to have the desired result. For example, because of the transparency of a governments actions, if it tries to spend its way into reducing unemployment the most likely effect will be an increase in wages to absorb the governments extra spending, I.e inflation. As inflation goes up, newly employed workers will soon realise that their wages are being eroded by inflation and firms will realise that they are not getting as much profit out of their workers because of inflation. Therefore, any increase employment is not likely to last in the long term. For these reasons, although the Philips curve is an observable phenomenon, it is not necessarily a viable tool for government.
Tell me about the trade offs with economic growth and the balance of payments on the current account
As an economy grows and Incomes rise, consumers are likely to demand more imports. Firms incentives to export will diminish as it is easier to find eager customers in the domestic market. Therefore, economic growth is likely to worsen the current account. The main exception is export led growth. A second reason why growth might not necessarily worsen the balance of payments on current account is if the economic growth is caused by an increase in AS. For example, if there are increases in investment leading to higher productivity and lower costs of production, an economy’s goods and services will become more internationally competitive. This should enable the economy to export more and import less while growing.
Tell me about the trade offs between a low rate of unemployment and protection of the environment
If more workers are employed, there is likely to be more congestion on the roads and more carbon use because of more offices, more manufacturing and greater energy usage. In addition, as people’s incomes increase, there are more likely to go abroad for their holidays and most foreign travel involves increased carbon emissions.
On the other hand, higher employment can mean that the government has more tax revenue, which may be used to improve the environment. Further, ‘green’ taxes could be introduced. The effect of higher employment also depends on whether the increase is in the manufacturing or service sector. As more people can work remotely in the service sector, it may be that an increase in employment has negligible effect on the environment.
Tell me about the trade offs between economic growth and income equality
When an economy grows, incomes are most likely to rise at the top end of the income spectrum, such as in the form of bonuses for chief executive Officers of companies. The effect is a widening of income inequality. However, over time, people at the high income end of the scale may employ people from lower income groups such as domestic staff. Increased demand for low skilled labour should eventually lead to increased wages. Also, as incomes increase, a government might be able to redistribute incomes through increased taxes on incomes and higher social benefits to those on lower incomes.
Nevertheless, many critics argue that there is a two-track labour market and those with low skills rarely benefit because, as skill shortages develop, immigration fills the gaps and the wages of low skilled workers do not rise. Another counter argument is that, even if wages rise by a constant percentage for everyone, income inequality still increases in absolute terms.
Tell me about the trade offs with a low rate of inflation and equilibrium of the balance of payments on the current account
When one of the main objectives of macroeconomic policy is to control inflation, interest rates might be tighter than they would be otherwise. High interest rates often mean that the exchange rate rises: ‘hot money’ flows in as funds move between international capital markets seeking the best interest and exchange rates. A strong currency makes a country’s exports less competitive and its imports relatively cheap, worsening the current account in the long as demand for exports and imports responds to price changes.
On the other hand, a low rate of inflation may lead to an improvement of the balance of payments on the current account. The reason is that low prices relative to other countries mean that exports become more attractive on world markets and imports are less attractive. However, if there is a current account surplus, control of inflation does not restore equilibrium in the sense of removing the surplus.
How has economic growth and inflation been affected by the credit crisis
In the years before the recession of 2008-2009, the uk saw economic growth at a trend of between 2% and 3% per annum for 15 years, and inflation hardly reaching 3%, however in 2008 growth became negative in the wake of the credit crisis and inflation was frequently above the ceiling of the inflation zone until 2012
How was unemployment affected by the credit crisis
Unemployment as measured by the labour force survey rose markedly after the credit crunch as the recession sink in - from just over 5% in 2008 to 8% in 2011 - but by May 2018 it has fallen below 4%.
How was the current account deficit affected by the credit crisis
The current account deficit as a whole was over 81 billion or 3.9% of GDP in 2018, down from 5.2% in 2016. After 2008 the pound fell around 25% against the euro, which is by far the most important trading currency for the UK. The pound has since recovered around a quarter of its fall, meaning that exporting is less easy, but there is much less pressure on inflation (a weak pound makes imports expensive, which causes cost push inflation.). However, remember that in the short run a fall in the value of a currency tends to worsen the current account because the price elasticity of demand for imports and exports is very inelastic.
Tell me about governments achieving the protection of the environment
Perhaps the least achieved government objective is the protection of the environment. The Kyoto Protocol, ratified by 170 countries (excluding the USA), expired In 2012 with no significant reduction in carbon emissions or other greenhouse gases. A new protocol is in place aiming for a level 18% below the 1990 levels of carbon emissions but, without the USAs backing, this agreement too may fail to be significant on a worldwide level. Although the UK has seen some improvement, it fell far short of its target. The EU emissions trading scheme, which was set up in 2005, has yet to lead to carbon reduction, but if the prices of permits rise (fewer are issued) this situation should improve.
What do many economists believe that too much cushioning of the unemployed results in
An inefficient labour market, and that competition and increased incentive for those out of work are a better approach to dealing with unemployment.
Why is the inflation of 2% target not thought to be a problem
As long as incomes move in line with inflation, there will be no serious side effects.
Some people’s wages, as well as pension, are adjusted in line with inflation, so reducing inflation below this level is not a priority. However, as inflation rises there comes a point where it erodes international competitiveness, discourages foreign inward investment and causes income redistribution away from savers to borrowers to such degree that its destabilising effects become a major concern.
When is a current account deficit on the BOP not a concern
When it can be financed from reserves or from a surplus on the financial account.
It is, however, a sign that the country may be overspending relative to its income and at some point the outflow of money will have to be compensated by inflows. The uk has international investments abroad with enormous earning potential, which may mean that the balance will be restored if the situation is left to itself (laissez faire)
Therefore, many economists think that the uk government should not try to rectify a current account deficit with demand management. However, most agree that supply side policies should be used to restore competitiveness in the long run.
How much does the UK government spend on social spending
Social spending on income support accounts for about 1/3 of government expenditure: five times the amount spent on defence.
What are some views on redistributing income from the rich to the poor through taxes and benefits
It’s seen as unfair to some, destroys incentives and reduces the work ethic. The main drawback with social expenditure is that it has little effect on reducing poverty; some argue that it can even create a ‘dependancy culture’. Although this might be true in general, extreme poverty is debilitating and leaves potential workers caught in a cycle of worklessness. They may be unable to sustain permanent employment at the available rates of pay because of personal circumstances, a need to care for dependants, a lack of skills or the high cost of housing.
How do fiscal policy and supply side policy conflict
Increased government spending may be used as a part of a fiscal policy to increase AD, and much of this spending will be directed to the health and education sectors. In this case, fiscal and supplyside policies are working in tandem to improve growth prospects and the supply side effects may cancel out any ill effects on the price level from the expansion in demand.
By contrast, if a government is using contractionary fiscal policy as a means of trying to control the price level, the impact might be a leftward shift of the AS curve. Therefore, prices might rise rather than fall and output might contract even further than intended.
How do fiscal policy and monetary policy conflict
Although fiscal and monetary policies are both demand side policies, if a government runs a budget deficit this has to be financed, which will affect the money markets. The budget deficit is financed by issuing government 3-month treasury bills or longer term gilt-edged securities (government bonds), both of which offer investors security and are easy to trade on the money markets. This might cause an increase in interest rates, so offsetting the impact of the reflationary effect of a budget deficit.
A looser fiscal policy can mean that the MPC favours a tighter monetary policy, taking into account the fiscal stance in deciding wether to raise interest rates.
Define fiscal stance
The position that the government takes on fiscal policy
How can monetary and supply side policy conflict
A tight monetary policy means that interest rates are higher than they perhaps need to be. Although this may control inflation, it increases costs for firms if they are borrowing money. By, contrast raising interest rates tends to make exchange rates rise. As uk firms import nearly all their raw materials, the effect on production costs may be significant. Therefore, tight monetary policy can instead imported the supply side, although higher exchange rates are not guaranteed and they harm firms trying to export. Further, higher interest rates may stifle investment which can inhibit the supply side of the economy. If there is a reduction in interest rates (loose monetary policy) then this will reduce borrowing costs for domestic firms, so providing an incentive for investment. However, if the exchange rate falls, firms will face increased import costs but gain competitiveness internationally.
What are demand side policies used for
Used to shift the AD curve, they include monetary and fiscal policies.
Monetary policy is clearly powerful in controlling AD, but it is a blunt tool and can have damaging effects on income distribution and across the supply side of the economy.
What are supply side policies used for
Used to increase the AS in an economy. They involve measures designed to increase productivity, incentives and competitiveness, thereby being able to produce more at lower prices.
Why do most governments use a combo of both demand side and supply side policies
To stabilise prices and maintain growth rates in the economy.
Evaluate supply side policies briefly
Supply side policies are now rather limited in their potential in the UK and interventionist policies can cost a great deal for the government in terms of public expenditure. However, policies aimed at increasing investment in the economy can have benefits in the future despite fiscal implications in the short run.
What is the Philips curve
The Philips curve is an empirical observation that there is a negative correlation between inflation (ie wage inflation) and unemployment.
The Philips curve is used by some to argue that there is a trade off between unemployment and inflation and that if an economy can tolerate increased inflation then there would be lower long term unemployment.
What does the priority given to the seven macroeconomic objectives depends on what
The political stance of any particular government.
Is the aim of the government to reach a zero rate, of say unemployment or inflation
No, as this would cause increased pressures elsewhere in the economy. It usually seeks a balance between the objectives.
Some analysts doubt what about expansionary fiscal policy
That is has any positive effects at all. If the LRAS is vertical, the impact will be inflation.
If interest rate changes are not working, what else can be done to achieve economic policies
There are other aspects to monetary policy, such as quantitative easing. There are also fiscal policy and supply side approaches to reach economic objectives.
Are supply side policies likely to have an impact on fiscal policy? Does this mean that they are the same thing?
Many supply side policies have an impact on the fiscal position, but this does not mean they are policies aimed to shift AD and therefore we do not call them fiscal policies. The impact on the budget is a side effect
Are changes in interest rates supply side policies
Changes in interest rates are considered to be demand side policies because interest rate changes have a direct impact on C, I and X-M. However, they do have supply side impact, for example by raising the cost of borrowing so causing the AS curve to shift to the left.
What would be the result of successful supply side policies if there were a significant amount of spare capacity in the economy
The result would be little or no change in output or the price level. A shift to the right in AS where AD crosses at the horizontal part of AS would have no impact on the economy except to increase the amount of spare capacity.
If the government wants to cut unemployment, it might find that the level of wage inflation starts to rise which might cause inflation more widely. Explain why this is.
If there is a shortage of a particular type of worker, higher wages will need to be offered to attract workers from other jobs. As wages rise for some jobs and spending more generally increases, other wages and prices will be bid upwards.
Why does relatively low inflation improve the balance of payments on the current account
It makes a country’s exports relatively cheap and its imports relatively expensive. Remember, though, that the pattern of demand might not change immediately.
Consider the effects of economic growth on the environment. Make a list of points to show why they conflict and then evaluate each point
Economic growth can damage the environment because of industrialisation, eg pollution and congestion.
Evaluation: what about if the growth is in the service sector
Depletion of natural resources
Evaluation: more efficient use of resources
Higher incomes mean more foreign travel, usually by air, increasing carbon emissions
Evaluation: higher government revenues from taxation mean there is more money to clean up and introduce carbon capping schemes or offsetting.
State one reason why unemployment benefits should be increased and one reason why they should be decreased.
There are many arguments on both sides. Increasing benefits reduced poverty and inequality; or costs of living are rising so benefits should rise or the benefits will fall in real terms. Cutting benefits might make the unemployed more eager to get back to work as they cannot sustain living standards while out of work. You might also consider the opportunity cost of benefits (eg new hospitals) or the fiscal policy implications; eg taxes might have to rise if benefits are raised, which might lead to disincentives in other parts of the labour market.
