Macroeconomic Policies Flashcards
What is Monetary Policy?
Refers to the use of interest rates, money supply & exchange rates in order to influence the level of economic activity in a country
What are the inflation targets for:
a) UK
b) EU
c) US FED
a) 2% Bank of England allows +/- 1%
b) Below 2%
c) Adopted 2%
What is Inflation Targeting?
Monetary policy strategy designed to maintain inflation at a certain rate or within a target range
Evaluate the use of inflation targets on controlling inflation.
1) Countries without targets don’t appear to suffer significantly higher rates of inflation
2) Inflation target based on CPI too narrow should be wider on range of variables e.g commodity prices, asset prices in order to prevent asset price bubbles from occurring
3) Following slow rates of GDP occurred after financial crisis more desirable to have higher inflation target
What are the disadvantages of using Interest Rates?
1) The full effect of an increase in rate of interest takes 18-24 months to work through economy
- business costs rise
- exchange of currency may increase
- making country’s good less price competitive
What is Quantitative Easing (QE)?
Process by which the Bank of England increases the money supply by buying government bonds & corporate bonds from commercial banks & other financial institutions.
What effect does QE have?
1) Increases liquidity in the banking system
2) Banks have more deposits & so better position to lend to private & business customers
What are the disadvantages of QE?
1) Ineffective if banks are risk adverse & remain unwilling to lend unless loan is risk free
2) Danger that increased supply of money in economy could unleash serious bout of inflation (quantity theory of money)
3) Cause depreciation in exchange rate which, in turn, result in an increase in net-X & so increase AD
What good has QE done for the UK?
1) Helped to increase UK’s annual economic output by 1.5-2%
2) Increase in price of bonds & consequently a fall in their yield (market rate of interest)
3) Major reason why deficits in company pension schemes have increased (because yield on pension funds invested in bonds has fallen)
4) Fall in bond yields also means annual income for pensioner on an annuity has fallen
What are the problems facing policy makers?
1) Statistical data given never accurate therefore hard to make predictions for what happens from month to month
2) Economists never agree on what is seen as most important
3) Data is often contradictory
e. g some show increase in inflationary pressures others don’t
3) Risks & uncertainties: e.g. considerable uncertainty about possible impact of QE
What is Fiscal Policy?
Refers to the use of G & taxation in order to influence the level of economic activity in a country
What are automatic stabilisers?
Changes in G & tax revenues which occur independently of any specific action by the government. They’re determined by any changes in the state of the economy (rise or fall in GDP)
- help to reduce fluctuations in the level of economic activity caused by the trade cycle
Give examples of automatic stabilisers?
During recession:
Welfare payments
- unemployment pay & various means-tested benefits e.g pension credits for the elderly living on low incomes
During long periods of rapid growth:
Progressive taxation - workers pay more tax proportion of their income
Welfare payments fall
What is discretionary fiscal policy?
Deliberate changes in G & taxation in order to influence AD & therefore the level of economic activity
What factors does the effectiveness of reflationary or expansionary fiscal policy depend on?
1) The value of the multiplier
2) In case of a cut in Y tax rates, people may save their extra disposable income rather than send it or may spend on M
3) Time lags involved
4) In case of deflationary/ contractionary fiscal policy may be significant effects when tax rates are increased
e. g corporation tax increased might cause reduction in FDI while an increase in Y tax rates might discourage unemployed workers from seeking work
