Macroeconomic policies Flashcards
What are the three main types of macroeconomic policy instruments?
- fiscal policy
- monetary policy
- supply-side policies
Define fiscal policy.
decisions made by government on its expenditure, taxation and borrowing
How will the aggregate demand curve move if government increases expenditure?
Shift to right
What will be the effect on inflation if the government increases expenditure?
increases (as AD curve moves right so average price level increases)
What will be the likely effect on the current account of the balance of payments if the government increases expenditure?
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).
When does a government budget deficit arise?
when government revenue is less than government expenditure
How does UK government borrow?
by issuing Treasury bills or gilt-edged securities
What was the effect of Covid-19 on UK government borrowing?
Increased borrowing (as higher government spending, eg furlough payments, Nightingale Hospitals, and lower taxation eg lower leisure spending)
Give two examples of UK direct taxes.
- income tax
- national insurance
Give two examples of UK indirect taxes.
- VAT
- excise duties
Is UK income tax a progressive or regressive tax?
Progressive (ie higher % generally paid by those with higher incomes)
Is UK VAT a progressive or regressive tax?
Regressive (ie higher % generally paid by those with lower incomes, as higher paid spend lower % and save rest)
Why do cigarettes have high excise duties?
Market failure: significant negative externalities, eg secondary smoke, NHS costs, so aim to reduce demand below market equilibrium
Why does petrol have high excise duties?
Market failure: significant negative externalities eg pollution, greenhouse gases, so aim to reduce demand below market equilibrium
Define monetary policy.
decisions made by government about monetary variables eg money supply and interest rates
What is the opportunity cost of holding money?
interest rate
What effect will higher interest rates have on aggregate demand?
It reduces, as less investment expenditure and household consumption (as either choose to save or to not borrow)
Name the UK’s central bank.
Bank of England
State three functions of a central bank.
- issuing coins and banknotes
- acting as banker to commercial banks
- regulating financial system
What is the Monetary Policy Committee (MPC)?
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
What is the Bank Rate?
interest rate paid by Bank of England on commercial bank reserves, set by MPC to influence inflation
If the Bank Rate increases, what is likely to happen to mortgage interest rates?
also increase
Define transmission mechanism of monetary policy
process by which a change in Bank Rate affects inflation
Define quantitative easing.
process by which liquidity in economy is increased when Bank of England purchases assets from banks
How does quantitative easing work?
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.
What happened to aggregate demand during Covid-19 pandemic?
reduced (curve shifted left) due to lockdowns
What fiscal policy changes were made in UK in response to the 2008/9 financial crisis?
- increased government expenditure
- reduction in direct and indirect taxes
What monetary policy changes were made in UK in response to the 2008/9 financial crisis?
- cuts in interest rates
- quantitative easing
Why was UK government spending cut during the Great Depression?
Its income fell (fewer taxes) and it was determined to have a balanced budget so had to cut spending.
How and why was US government spending increased during the Great Depression?
It tried to stimulate demand through the New Deal programme, improving infrastructure and creating employment
How has war in Ukraine affected UK economy?
- 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
Define supply-side policy.
measures intended to directly impact aggregate supply and specificallly the potential capacity output of the economy
Define market-based policy.
policy relying on allowing markets to work more freely and providing incentives for enterprise and initiative
Define interventionist policy.
policy by which government intervenes to stimulate aggregate supply
Will a progressive tax system lead to more or less incentives to work?
Less, as beyond a certain level of employment income, may be seen as not worth the effort given high proportion taken as tax
How is privatisation of nationalised industries aimed at increasing aggregate supply?
Theory is that better incentives and accountability in private sector so can increase efficiency.
What effect does existence of trade unions have on the economy?
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
What should be considered when setting the rate of unemployment benefit?
- not too high that significant disincentive to work
- not too low that those out of work have an unacceptably low standard of living
Why might government need to provide incentives to employers to provide training?
Because benefit to employers may not be as much as cost, particularl if workers could use the training then leave.
Why might governments promote market competition?
Likely to lead to higher supply / lower prices
More incentive to firms to be more efficient or to innovate
Give an example of government policy in plugging information gaps.
Provision of job centres so workers have adequate information on job opportunities. encouraging worker mobility eg between industries or regions
What does the Philips curve show?
emprical relationship showing trade-off between unemployment and inflation
Explain the link between unemployment and inflation.
When unemployment low, firms will increase wages to attract labour, and increased wages leads to higher prices.
Define stagnation.
situation were both unemployment and inflation high at same time
Give an example of stagnation.
UK in 1970s
How does stagnation relate to the Philips curve?
Likely that Philips curve has moved, ie still relationship between unemployment and inflation but it’s shifted.
