Macroeconomic policies Flashcards
What are the 3 purposes of fiscal and monetary policy?
Price stabulity,avoid prolonged recessions, smooth boom to bust cycles.
What is the debt to GDP ratio of the budget constraint?
(Gov debt of the year/Real GDP of the year) + (real i -real growth)x (gov debt of year/real gdp of year) + budget deficit/real gdp.
How to decrease the government budget constraint?
Run a surplus ( increase T or decrease G), increase real GDP, print more money and increase inflation (hyperinflation), default on debt.
What is Ricardian Equivalence? What disproves this?
Tax cuts today may not stimulate higher consumption as they will have to rise again in the future. Disproved by the fact that some people will just spend more today regardless, tax cuts will increase income,
What are other ways of saying ‘defaulting on debt”
Debt restructuring, debt rescheduling, private sector involvement.
What are the complications involved with fiscal policy?
Whether to change G or T
What to spend or cut on
conflicts between political parties
Consequences to demand and supply
Why does politics affect the implementation of fiscal policy?
Electoral parties countering the leading parties fiscal policy
Economic/Political wars (affect resource allocation)
Corruption (abuse money seignoriage to dilute debt e.g cost of producing money is not equal to the exchange value.
WHat is the cyclically adjusted budget? What causes it to change?
Government spending minus net taxes that would arise at the potential output with the current tax rate. Change in the government spending and net tax rate will cause it to change.
What is the structural budget?
Depends on the level of potential output - if factories close down this is permanently less tax revenue and permanently greater budget deficit unless the tax rate is increased or government spending decreases.
Why may discretionary policy become less effective?
Due to time inconsistency, by the time the optimal policy is implemented people have adjusted their expectations.
How can the CB establish credibility?
CB independence (monetary policy decisions independant of the gov), incentivise CB take the long term view of the costs of high inflation by giving them long terms in office, appoint a conservative minister who dislikes inflation to reduce effect of time inconsistency.
What is flexible inflation targeting?
Allow inflation to return to target over time not immediately at expense of large fluctuations in output.
What is the Taylor rule and its formula?
It shows the trade off between inflation and unemployment/output gaps. i= i*(natural i + target inflation rate) + a(coefficient dependent on relative importance according to bank)(inflation - expected inflation) - b(unemployment - natural rate of unemployment.
According to Taylors rule; what if:
a) inflation = expected inflation
b) inflation < expected or unemployment>expected
c) inflation > expected or unemployment < expected
a) set i=i*
b) decrease interest rate (expansionary)
c) increase interest rate (contractionary)
How does the CB act as lender of last resort?
Provides commercial banks with liquidity to pay depositers without having to sell their assets
