Macroeconomic Policy Flashcards
What is monetary policy
Used to control the flow of money in an economy.
This is done with interest rates and quantitive easing .
This is conducted by the bank of England independent from the government
The central bank takes action to influence the manipulation of interest rates, the supply of money and credit, and the exchange rate .
Name the military policy instruments
Interest rates
Quantitative easing
Explain how interest rates is a monetary policy instrument
In the UK, the monetary policy committee alters interest rates to control the supply of money. They are independent from the government and the nine members meet each month to discuss what the rate of interest should be. Interest rates are used to help meet the government target of price stability since it alters the cost of borrowing and reward saving.
The bank controls the base rate which ultimately controls the interest rates across the economy .
When interest rates are high, the reward for savings is high and the cost of borrowing is higher. This encourages consumers to save more and spend less and is used during high periods of inflation.
Interest rates are low the reward for saving is low and the cost of borrowing is low. This means consumers and firms can access credit cheaply which encourages spending investment in the economy. This is usually used during periods of low inflation.
How is quantitative easing a monetary policy instrument?
This is used by banks to help stimulate the economy when standard monetary policy is no longer effective. This has inflationary effects since it increases the money supply and it can reduce the value of a currency.
Is usually used when inflation is low and it is not possible to lower interest rate further
It’s a method to put money directly into the economy, to stimulate the economy. The bank buys assets in the form of government bonds using the money they have created. This is then used to buy bonds from investors which encourages and increases the amount of cash flowing in the financial system. This encourages more lending to firms and individuals since it makes the cost of borrowing lower. The theory is that this encourages more investment more spending and hopefully higher growth.
Possible side effect is higher inflation
What are the factors considered by the monetary policy committee when setting bank rate?
Unemployment rate, if unemployment is high consumer spending is likely to fall this suggests the MPC will drop interest rates to encourage more spending.
Saving rates, if there is a lot of saving consumers are not spending as much interest rates might fall .
Consumer spending if there is a high level of spending in an economy there could be inflationary pressure on the price level this would cause the NPC to increase interest rates .
High commodity prices, since the UK is a net exporter of oil a high price could lead to cost push inflation. This could push the MPC to increase exchange rates to overcome inflationary pressure.
Exchange rate would cause the average price level to increase this makes UK export relatively cheap UK export increase since imports become relatively more expensive there be an increase in the export NPC might consider increasing the interest rate .
How does changes in the exchange rate affect A.D. and the macro policy objectives?
A reduction in the exchange rate causes imports to become cheaper, which increases exports. This seems that demand export is price elastic. It also causes imports to become relatively expensive. This means the UK account deficit would improve
However, this is inflationary due to the increase in the price of imported materials. Production costs for firms increase which causes cost push inflation.
What is supply side policies
To improve the long run productive potential of the economy. The economy can experience supply side improvements in the private sector, without government intervention. For example there could be improvements in productivity innovation and investment.
What are the aims of supply side policies?
To increase incentives, governments could reduce income and corporation tax to encourage spending and investment
To promote competition, by deregulating or privatising the public sector firms can compete in competitive markets which help improve economic efficiency. Could also reduce monopoly power of some firms and ensure small firms can compete to.
To reform the labour market , reducing the NMW will allow free market forces to allocate wages and the labour market should clear. Reducing trade union power makes employing workers less restrictive and increases the mobility of labour.
This makes the government market more efficient.
To improve skills and quality of the labour force, the government could subsidise training or spend more on education. This also lowers costs for firms.
To improve infrastructure, government could spend more infrastructure such as improving roads and schools
Strength of supply side policies
They are the only policies that can deal with structural unemployment, because the labour market can be directly improved with education and training.
Weaknesses of supply side policies
Demand side policies are better at dealing with cyclical unemployment since they can reduce the size of a negative output gap and shift the Ad curve to the right.
There are significant timelags associated with supply side policies
Market based supply side policies such as reducing the rate of tax could lead to a more unequal distribution of Wealth
What is fiscal policy?
Fiscal policy involves the manipulation of government spending taxation and the budget balance. Fucking hell
What is the fiscal policy instrument?
Government spending and taxation
Governments can change the amount of spending and taxation to stimulate the economy. The government could influence the size of the circular flow by changing the government budget and spending and taxes can be targeted in areas which needs stimulating.
Fiscal policy aims to stimulate economic growth and stabilise the economy
How can fiscal policy be used to influence AD
Expansionary fiscal policy
Deflationary fiscal policy
What is expansionary fiscal policy?
This aims to increase AD. Government Increase spending or reduced taxes to do this. It leads to a worsening of the government budget deficit and it may mean governments have to borrow more to finance this.
What is deflationary fiscal policy?
This aims to decrease AD governments spending or raised taxes which reduces consumer spending. It leads to an improvement of the government budget deficit.
How fiscal policy can be used to influence AS
The government could reduce income and corporation tax to encourage spending and investment
The governments could subsidise training or spend more in education, which lowers the cost for firms. They could also spend more on healthcare to improve the quality of the labour force .
Government could spend more infrastructure such as improving roads and schools
What are direct taxes?
Direct taxes are imposed on income and are pay directly to the government from the taxpayer
Income tax, corporation tax, and inheritance tax
What is indirect tax?
Indirect taxes are imposed on expenditure of goods and services and they increase production cost for producers. This increases market price and demand contracts.
Ad valorem taxes are percentages such as VAT which adds 20%
Specific taxes such as $.58 per litre fuel duty
What is a proportional tax?
A proportional tax has a fixed rate for all taxpayers regardless of income. This encourages people to earn higher incomes because the rate of tax does not increase.
What is progressive tax?
A progressive tax has an increase in the average rate of tax as income increases. This should help reduce inequality because those are lower incomes pay less tax the taxes based on the payers ability to pay.
What is a regressive tax?
It does not relate to income, but means those are lowest income. Have a higher rate of tax for example council tax. This leads to less fair distribution of income and genuinely applies to indirect taxes.
Limitations of fiscal policy
Governments might have imperfect information about the economy it could lead to insufficient spending
There is a significant time lag involved with employing fiscal policy it could take years or months to have an effect
If the government borrows from the private sector, there are a few funds available for the private sector
The size of the multiplier the bigger the affect on aggravate demand and the most effective policy
If interest rates are high, fiscal policy might not be effective for increasing demand
If the government spends too much that could be difficult difficulties paying back the debt which could make it difficult to borrow in the future
