Macroeconomic policies

Question 1

What are the three main types of macroeconomic policy instruments?

Answer 1

• fiscal policy
• monetary policy
• supply-side policies

Question 2

Define fiscal policy.

Answer 2

decisions made by government on its expenditure, taxation and borrowing

Question 3

How will the aggregate demand curve move if government increases expenditure?

Answer 3

Shift to right

Question 4

What will be the effect on inflation if the government increases expenditure?

Answer 4

increases (as AD curve moves right so average price level increases)

Question 5

What will be the likely effect on the current account of the balance of payments if the government increases expenditure?

Answer 5

Some of increase in aggregate demand will be spent on imports so likely to be increase in current account deficit (or reduction in current account surplus).

Question 6

When does a government budget deficit arise?

Answer 6

when government revenue is less than government expenditure

Question 7

How does UK government borrow?

Answer 7

by issuing Treasury bills or gilt-edged securities

Question 8

What was the effect of Covid-19 on UK government borrowing?

Answer 8

Increased borrowing (as higher government spending, eg furlough payments, Nightingale Hospitals, and lower taxation eg lower leisure spending)

Question 9

Give two examples of UK direct taxes.

Answer 9

• income tax
• national insurance

Question 10

Give two examples of UK indirect taxes.

Answer 10

• VAT
• excise duties

Question 11

Is UK income tax a progressive or regressive tax?

Answer 11

Progressive (ie higher % generally paid by those with higher incomes)

Question 12

Is UK VAT a progressive or regressive tax?

Answer 12

Regressive (ie higher % generally paid by those with lower incomes, as higher paid spend lower % and save rest)

Question 13

Why do cigarettes have high excise duties?

Answer 13

Market failure: significant negative externalities, eg secondary smoke, NHS costs, so aim to reduce demand below market equilibrium

Question 14

Why does petrol have high excise duties?

Answer 14

Market failure: significant negative externalities eg pollution, greenhouse gases, so aim to reduce demand below market equilibrium

Question 15

Define monetary policy.

Answer 15

decisions made by government about monetary variables eg money supply and interest rates

Question 16

What is the opportunity cost of holding money?

Answer 16

interest rate

Question 17

What effect will higher interest rates have on aggregate demand?

Answer 17

It reduces, as less investment expenditure and household consumption (as either choose to save or to not borrow)

Question 18

Name the UK’s central bank.

Answer 18

Bank of England

Question 19

State three functions of a central bank.

Answer 19

• issuing coins and banknotes
• acting as banker to commercial banks
• regulating financial system

Question 20

What is the Monetary Policy Committee (MPC)?

Answer 20

the body within the Bank of England responsible for conduct of monetary policy, in particular setting interest rates to keep inflation within 1% pa of the 2% pa inflation target

Question 21

What is the Bank Rate?

Answer 21

interest rate paid by Bank of England on commercial bank reserves, set by MPC to influence inflation

Question 22

If the Bank Rate increases, what is likely to happen to mortgage interest rates?

Answer 22

also increase

Question 23

Define transmission mechanism of monetary policy

Answer 23

process by which a change in Bank Rate affects inflation

Question 24

Define quantitative easing.

Answer 24

process by which liquidity in economy is increased when Bank of England purchases assets from banks

Question 25

How does quantitative easing work?

Answer 25

Bank of England creates electronic money and uses it to buy government and commercial bonds, so banks can’t buy bonds as much so consider lending to firms again.

Question 26

What happened to aggregate demand during Covid-19 pandemic?

Answer 26

reduced (curve shifted left) due to lockdowns

Question 27

What fiscal policy changes were made in UK in response to the 2008/9 financial crisis?

Answer 27

• increased government expenditure
• reduction in direct and indirect taxes

Question 28

What monetary policy changes were made in UK in response to the 2008/9 financial crisis?

Answer 28

• cuts in interest rates
• quantitative easing

Question 29

Why was UK government spending cut during the Great Depression?

Answer 29

Its income fell (fewer taxes) and it was determined to have a balanced budget so had to cut spending.

Question 30

How and why was US government spending increased during the Great Depression?

Answer 30

It tried to stimulate demand through the New Deal programme, improving infrastructure and creating employment

Question 31

How has war in Ukraine affected UK economy?

Answer 31

• higher prices of grain (normally big Ukrainian export)
• higher prices of oil (supply disruption)
• financial support to Ukraine
• sanctions on Russia so reduced income to UK from Russia

Question 32

Define supply-side policy.

Answer 32

measures intended to directly impact aggregate supply and specificallly the potential capacity output of the economy

Question 33

Define market-based policy.

Answer 33

policy relying on allowing markets to work more freely and providing incentives for enterprise and initiative

Question 34

Define interventionist policy.

Answer 34

policy by which government intervenes to stimulate aggregate supply

Question 35

Will a progressive tax system lead to more or less incentives to work?

Answer 35

Less, as beyond a certain level of employment income, may be seen as not worth the effort given high proportion taken as tax

Question 36

How is privatisation of nationalised industries aimed at increasing aggregate supply?

Answer 36

Theory is that better incentives and accountability in private sector so can increase efficiency.

Question 37

What effect does existence of trade unions have on the economy?

Answer 37

Tend to lead to higher wages than market equilibrium so lower aggregate supply
But tend to reduce inequality via ensuring everyone paid at least a minimum wage and has decent working conditions

Question 38

What should be considered when setting the rate of unemployment benefit?

Answer 38

• not too high that significant disincentive to work
• not too low that those out of work have an unacceptably low standard of living

Question 39

Why might government need to provide incentives to employers to provide training?

Answer 39

Because benefit to employers may not be as much as cost, particularl if workers could use the training then leave.

Question 40

Why might governments promote market competition?

Answer 40

Likely to lead to higher supply / lower prices
More incentive to firms to be more efficient or to innovate

Question 41

Give an example of government policy in plugging information gaps.

Answer 41

Provision of job centres so workers have adequate information on job opportunities. encouraging worker mobility eg between industries or regions

Question 42

What does the Philips curve show?

Answer 42

emprical relationship showing trade-off between unemployment and inflation

Question 43

Explain the link between unemployment and inflation.

Answer 43

When unemployment low, firms will increase wages to attract labour, and increased wages leads to higher prices.

Question 44

Define stagnation.

Answer 44

situation were both unemployment and inflation high at same time

Question 45

Give an example of stagnation.

Answer 45

UK in 1970s

Question 46

How does stagnation relate to the Philips curve?

Answer 46

Likely that Philips curve has moved, ie still relationship between unemployment and inflation but it’s shifted.