Macroeconomic Policies Flashcards
fiscal policy
government’s manipulation of taxes and expenditures with the goal of increasing or decreasing the level of aggregate demand in an economy
automatic fiscal policy: economic growth
economies at full employment level of output with low unemployment and high income will experience automatic decrease in government expenditure (benefits, etc.)
automatic fiscal policy: recession
during recessions and periods of high unemployment government expenditure automatically increases (benefits, etc.)
graphs of automatic fiscal policy for growth and recession
- ST = stabilised
- would normally move from AD1 to AD2 but doesn’t because of fiscal policy
graph showing built in automatic stabilisers
closing a recessionary gap
tax cut and spending package
closing an inflationary gap
increase taxes or decrease government spending
discretionary fiscal policy
change in taxes and spending undertaken by government with the explicit aim of either stimulating or contracting the overall level of demand in the economy to promote economic stability and full employment
advantages of fiscal policy
prevents a ‘double dip’ recession
- if prices/wages are sticky downwards, once in deep recession do not naturally rise, worsening recession
quick fix for rampant inflation
- contractionary policy quick and easy to implement, causes prices to fall
increases aggregate demand
- reduces size of deflationary gap
- reduces cyclical unemployment
- pulls economies out of liquidity trap
disadvantages of fiscal policy
time lag
- administrative time lag: time to plan and administer tax change
- recognition time lag: time taken to recognise that policies need to change
- impact time lag: time between implementation and outcome
politics
- deflationary fiscal policy can be unfavorable politically, may be avoided before re-election
expense
- inflationary fiscal policy very expensive because need to invest in huge amounts of capital
crowding out
demand-side policies
- monetary policy
- fiscal policy
supply-side policies: encourage competition
privitisation
- can bring sucess if government monopoly ineffective and competition encourages
- ineffective if becomes market monopoly
- ineffective if government natural monopoly
- government monopoly may provide positive externalities which could be lost in privitisation
anti-monopoly legislation
- breaking up natural monopoly = bad
supply-side policies: labor market policies
labor markets
- legislation against trade unions
- education and training
- income tax rates (decrease in tax incentive for people to work harder)
- unemployment benefits (makes opportunity cost of not working too high)
deregulation
- reduction in health&safety laws reduces costs and increases output
- unsafe working conditions = negative outcome
- reduction in environmental laws reduces costs
- increased environmental degradation and other negative externalities
incentive related policies
- reduce MTR on high earners does nto have predictable outcome
- may increase or decrease tax revenue based on cultural factors (how people respond to changes)
money market graph
money demand
desire to hold money as an asset and demand for money as a means to purchase goods and services
why is money supply curve perfectly inelastic?
- central bank has authority to set the level of money supply
- operates independently of interest rate
contractionary monetary policy
actions by central bank to decrease money supply and increase interest rates
expansionary monetary policy
actions by central bank to increase money supply and decrease interest rates
reserve asset ratio
percentage of liabilities kept to cover potential withdrawals
credit multiplier
- as lent money circles through economy back to bank a specific percentage kept back and surplus lent out again
- creates new money in circulation
how to implement expansionary monetary policy?
- decrease RAR to increase MM
- government buys back bonds to increase money in circulation in open market operations
- central bank lending interest rates decreased
expansionary monetary policy graphs
how to implement contractionary monetary policy?
- increase RAR to decrease MM
- government sells bonds to decrease money in circulation in open market operations
- central bank lending interest rates increased
advantages of monetary policy
- no political constraints (central bank tends to be semi-autonomous from government)
- no crowding out (encourages investment by lowering interest rates, not government borrowing)
- easier to track money supply than government expenditure
- can be put into effect quickly
disadvantages of monetary policy
- time lag (takes a while before interest rates trickle down to general population)
- does not help liquidity trap: income elasticity of demand for investment more inelastic during recession: businesses not responding to change in interest rates
- contractionary MP ineffective against cost-push inflation: exacerbate recessionary pressure
supply side policies: labor market reforms
- reduction of minimum wage reduces labor costs and makes workers more responsive to labor market which increases output
- increases inequality
- reducing transfer payments and union power leads to more flexible labor market but increased inequality
supply side policies: government intervention
investment in human capital
- increase education and healthcare provision
- increases long run economic growth
investment in technology
- private sector research and development limited by profit motive
- government able to do this R&D without requiring profit
investment in infrastructure
- works best in areas where cost is too great for private sector but where therea are significant positive externalities
- large scale projects subject to political pressures - results in inappropriate ‘prestige’ projects at expense of useful projects
