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.