Macroeconomic Policy Instruments Flashcards
Fiscal Policy
Demand-side policy - Taxation & Gov SpendingUsually used to influence AD (=macroeco effect)/smooth out fluctuatoions in eco cycleBoost demand in recession to stim eco growth/reduce unemploymentReduce demand during boom - control inflation/avoid inflation
Eco cycle graph
draw graph
How can fiscal policy be used to increase AD
Reflationary fiscal policyIncrease gov spendingIncr. welfare payment = more disposable incomesBuilding new infra e.g. schools/hosps = more jobs/higher incs = more disp incomesLowering taxesDecreasing inc tax = more disposable inc to spendDecr. indirect taxes e.g. VAT = less exp goods so buy moreLess withdrawals/grter injections from CFofI
How can fiscal policy be used to increase AD
Reflationary fiscal policyIncrease gov spendingIncr. welfare payment = more disposable incomesBuilding new infra e.g. schools/hosps = more jobs/higher incs = more disp incomesLowering taxesDecreasing inc tax = more disposable inc to spendDecr. indirect taxes e.g. VAT = less exp goods so buy moreLess withdrawals/grter injections into CFofI Shifts AD to rightNew equ = higher price level = demand-pull inf incr’dOutput increased = unemployment decreased + eco growth
How can fiscal policy be used to increase ADPoint 1 (3)Point 2 (3)Effect (4+1)Decrease AD = same/opposite
Reflationary fiscal policyIncrease gov spendingIncr. welfare payment = more disposable incomesBuilding new infra e.g. schools/hosps = more jobs/higher incs = more disp incomesLowering taxesDecreasing inc tax = more disposable inc to spendDecr. indirect taxes e.g. VAT = less exp goods so buy moreLess withdrawals/grter injections into CFofI Shifts AD to rightNew equ = higher price level = demand-pull inf incr’dOutput increased = unemployment decreased + eco growth Negative output gap reduced
Changes in AD affect…
Current account of Balance of PaymentsHigher incomes = more spent on imports = more money leaves CFofI
Changes in AD affect…
Current account of Balance of PaymentsHigher incomes = more spent on imports = more money leaves CFofI
Fiscal policy - complications (2)
Gov spending = takes long time to org; state of eco could change before any gov action is takenGov has imperfect info about eco (missing/wrong) = could do wrong thing because theyre making decisions based on inacc info
Effects/Impact of Increasing AD depend on…
Current state of the economy Expansionary fiscal policy can help reflate eco/increase output but inflation…- Depends on current conds
Effects/Impact of Increasing AD depend on…Effects…*? + Expl?
Current state of the economy Expansionary fiscal policy can help reflate eco/increase output but inflation…*How much of these 2 things you get depends on how much spare capacity in ecoLots of spare capacity/unused machines&workers = can easily increase supply so little demand-pull inflation But if eco’s working close to full capacity/few spare workers = prices forced up because supply can’t keep up w demand
Another problem with fiscal policy
Stop-go cyclesGov could use fiscal to boost eco in recession but by then eco could overshoot/cause high inflation before gov can change its policy Gov may ‘apply the brake’ to eco with defl. fiscal = another recession
Another problem with fiscal policy (3)
Stop-go cyclesGov could use fiscal to boost eco in recession but by then eco could overshoot/cause high inflation before gov can change its policy Gov may ‘apply the brake’ to eco with defl. fiscal = another recession
Another problem with fiscal policy (3)
Stop-go cyclesGov could use fiscal to boost eco in recession but by then eco could overshoot/cause high inflation before gov can change its policy Gov may ‘apply the brake’ to eco with defl. fiscal = another recession
What can affect tax cuts/fiscal policy being used to solve recession (4)
ConfidenceIf people feel confident about eco future/not worrying about job, then consumer tax cuts/xtra disp inc = likely to increase consumption=eco growthNot confd = save rather than spend + Firms invest more/incr. productive potential of eco If confd otherwise delay/save money
What can affect tax cuts/fiscal policy being used to solve recession (4)
ConfidenceIf people feel confident about eco future/not worrying about job, then consumer tax cuts/xtra disp inc = likely to increase consumption=eco growthNot confd = save rather than spend + Firms invest more/incr. productive potential of eco If confd otherwise delay/save money=leakage
Effects of too much gov spending (increase in IR)
Crowding out = gov spending replaces priv sector spending
Crowding out? (2)
May use resources that priv sector could have otherwise employed = may be no overall incr in ADTo pay for more spending, gov may need to increase IR to encg people to lend more money => discg firms from borrowing = gov investment crowds out priv sector invstm
Trad Keynsian approach
Smoothing out eco cycleCan lead to var trade-offsIncrease in AD = higher inflation More jobs/higher incs -> b of payments probs
Fiscal Policy - diff approach/nowadays…(4)
Ag supplyMicroecoSpecific regionProg taxation
Nowadays - how is fiscal policy used to help gov achieve their objs?Aim?Adv?Example?
Influence AS/supply-side fiscal policyIncr prod potential of eco to create long-term eco growthDoesn’t cause inflation & improve current account on b of paymOffering tax-cuts to entrep to encg to start up new bus to incr prod potential
Fiscal policy - microeco levelE.G (3)
To try to influ how indv consumers/firms behaveDemerit goods/alcohol - can be taxesMerit - subsidised to incr consmpCan help gov achieve env policy e.g. ‘green taxes’ to discg coal/oil//subsidies to renewable energy firms
Fiscal policy - specific regs?
Directed at specific regions needing help e.g. if reg loses big employer, gov could invest in that region to create jobs
Fisc policy - tax
Progressive taxation = takes larger amount of tax from p on higher incs = allows gov redistrb wealth from those better off to those less well off (benefits)
Monetary policy - type of policy
Demand side policy
Monetary policy:
Controlling amount of money in economy/money supply (notes/coins/bank accounts/loans) & how expv it is to borrow
3 components of monetary policy…Involves manip’ing
Interest ratesExchange rateMoney supply to affect AD
Changes to IR affect (4)
Borrowing/spending/saving/investment
Link between 3 components of monetary policy?
Change in IR affects money supply & exchange rate e.g. high IR = restricts money supply - lower demand for loans + exchange rate stronger - incr demand for currency to take advg
Types of monetary policy
Cont -> reduce ADExps -> incr AD
Contractionary monetary policy?How? (3)
Reduce ADHigh IRRestrictions on money supplyStrong exchg rate
Graph for contr monetary policyExpl (4)
check rev guideAD shifts leftPrices fallOutput falls=> higher unemployment + slowdown in eco growth
Exps monetary policy
Lower IRLess restrictions on money supplyWeak exchg rate
Interest rates set byUsed toCurrent target
Monetary Policy Commitee (MPC) of Bank of Eng IR used to control inflation - meet targ set by gov’s macro polc obj of low inflation/stable prices2% CPI
Effects of increasing IR (4)
Cost of borrowing money - up = ppl/firms less likely to borrowP with mortg/overdraft/credit card= higher repayments = less left to spend/consmp goes down (=AD down)Investment by firms goes down - most investments = using borrowed money (=AD goes down)Savers = bigger return on saving so people likely to save more
Higher IR - effect
Worsens bal of payments on current account
High IR - effect*(4)
Large banks want to buy £s/ take advg of high rewards for savers *short term movement of money = hot moneyMore demand = price goes up//£ value/exchg rate risesHigh exchg rate = UK exports more expensive for othersExports goes down = worsens b of paym Imports, chepaer for UK = worsens current account = leakage/AD reduction
Low IR(6)
Improves b of p/current accountLow IR = put hot money somewhere else to get better reward from high IR= lowers demand for £ + exchg rate falls (cheaper to buy pounds)= exports go up/imports down = AD upImprovement in current account of bofp
Effectiveness of monetary policy - evaluationMPC had to consider … when making eco decisions?
Output gapsNeg output gap/lots of spare capacity = inflation less likely to increase - so MPC can decrease IR
IR & spare capacity (3)
Firms might delib not be working at full capacity - having diffcs selling goods (=stockroom full) => unlikely to put prices upDuring recession/recovery, MPC could use exp. monetary pol. - keep IR low to encg growth/employmentBut no spare capacity (demand>supply/posv. output gap) = upward pressure on inflation so MPC incr IR
MPC changing IR effects
Knock-on effects which conflict with gov objvs (tackling inflation but eco growth/unemply??)
Low IR - spending & investment exceptions (2)
Low IR = cheaper for consms to spend/firms to inv but depends on CONF- even when IR’s low, recession = uncertain about future so could still choose to save (despite low rewards)Firms only invest if confd about future income - few orders/lots of surplus stock - won’t spend more money
High IR leads to/prob
UnfairnessHigh IR = more money to those with money already/take away from those that have borrowed => widens gap betw rich/poor
IR - effect? (3)
Takes time to affect people’s behaviour - firms plan investment projs v carefully (months/yrs before money’s spent)House-buying takes time Fixed-rate mortg holders = don’t notice IR change until fixed-rate period ends
IR = unexpected effects (3/5)
High IR = £ value rises -> GB goods, more expv overseas = firms will buy usual GB goods from elsewhere but takes time to find altv prods + contracts(yrs)…= could still buy GB goods= some goods price inelastic so value of exports may fall by less/rise+ if high inflation in other country importing UK goods then those UK imps = might still be compt’vely priced despite out exchg rate risingWhen £ = strong/high exchg rate, imports cheaper; normally bad/leakage but good for UK firms that import lots of raw mats/ costs reduced + lower prices for consumers (dom+abroad)
Rising IR doesnt always reduce inflationUsually?(3)
Higher IR reduces demand-pull inflationBut if demand already q low then increasing IR = not much/exp effectFirms may raise prices if they have to pay more interest on loads = cost push inflationHigher prices may cause workers to demand higher wages - leading to wage-price spiral pushing prices up higher = inflation worse
Supply-side policies
Shift AS curve to right/increase how much firms willing to supply at each £
Types of s-s policies (3)
increasing productive capacity of eco by incr quant/qual of FOPs e.g making it more diffc to claim JSA = more ppl workincrease prod’vity of firms/employees e.g. training/education = more skilled/effective = incr’d labour prod’vitygovs can s-s policy to change personal incentives e.g. reduction in inc tax could encg workers to work longer/harder for promotion
Supply-side policies
PrivatisationDeregFlexibility of labour market
*s-s can make workers more efficient/competitiveDefinitionsExamples
Privatisation & DeregulationPrivatisation = when firm/industry changes from being run by public sector/gov to private - priv.sect more efficient/less wasteful than pub.secDereg = getting rid of rules imposed by gov that restrict level of competition in market e.g stopping priv firms entering market which contains only state-owned monop/reduce ‘red tape’..planning permiss- more comp/efficient in market = prod’vity should incr
Increasing flex of labour markets (3)
Reduce power of trade unions used to be maj s-s polcstrong unions can neg higher wages/incr firm’s cost + make harder for firm to lay off workersless union power = more flexb workforce (short-term flex contracts) - can hire&fire accd to current demand of buesiness
s-s powerful effects (4) examples
medium-long-term e.g. education policies, benefitstend to be microeco - affect way indv/consm’s behave e.g. encg firm to train workforce diff’ly but usually s-s like privatisation work on macroeco levelimproving s-s = not just by gov; businesses can take initiative/improve themselves by inv in new machinery/extra staff trainingfree market = in firm’s own interest to improve prod’vity/comptv’ness e.g. s-s polc’s by firm could incr comptvness/qual of its prods.exports could rise = current account improves on bofp
why s-s rather than demand-side
help grow eco without inflation
effects of s-s - graph(3)
shift as curve right= eco producing more/national output incr’d = eco growth/jobsbut price levels fallen = no inflation
supply-side fiscal policies (more pop than fiscal polc) (4)
tax/benefit cuts = incentives for individual eco agents (consumers/firms) to act in way to help eco/not just affect ADincome tax cuts = incentive to work hard/not directly incr disposable increduction in business taxes = incentive for entrep to take risks/invest more = succ compsreduction in welfare befs = incentive to work than stay on benfts
supply side fiscal policieseffect + overall effect?
higher tax receipts:more people in work = less gov welfare benefitspeople working longer = more inc tax overallbusiness, more successful = more profits to tax=> should reduce budget deficit/incr budget surplus
main advantage of s-s policies
fewer trade-offs between eco objs
s-s polc graph
price same - supply kept up with demand + no demand-pull inflation+ firms more prod/efficient, low risk of cost push inflation
s-s advgs (2)
doesnt lead to incr in national debteco less dependent on imports
s-s - national debt (5)
no increaseexps fiscal/monetary polcs = budget deficits (more gov. spending than tax)but many s-s polcs - implt’d by private sector + incr’d tax receipts = helps decr any budget deficits= less risk of ‘crowded out’ - gov doesn’t have to borrow heavily to pay for its spending
s-s - imports (3/4)
eco less dep on importsif eco can produce high qual g/s at low prices then less imports boughtkeeping exports competitive = vital for future growth. foreign export markets = becoming more & more important for UK firms (ecos of China/Ind = growing quickly/demand incr’ing)
s-s prob/circum (2)however?
polc’s dont work without sufficient AD = during recession/weak demand, s-s not apprrptake time to work/->recession may need more immd help so demand-side = more immd effectbut s-s = eco more resilient/better able to cope with shocks e.g. more flexb workforce in recession helps
downsides to s-s policies (3)
not all benefitwidens gap betw rich/poor - rich=incentives to make money & poor on welfare benfs=thrtned with more povfavour employers over employees - weakening trade unions=good for employers e.g. less press to raise wages. + without fear of union action, can treat workers unfairly, hire&fire => favours employers - recruit more easily/cheap **but firms m likely to take on workers during good times at least
downside to s-s policies - example(3)
market-oriented = competition in free market will provd most efficient outcomes overall e.g removing nat min wage = improve labour flexb ==>shifts AS curve to right = policy workedBut some would be paid less than without min wage = not all benefit…
Fiscal policy + monetary policy - conflict (2)
refl fiscal to incr AD = gov has to borrow money (can issue treasury bill) = extra £s spent by gov could risk inflation=> MPC -> contrc monetary polc = slows down eco+ crowd out investment by private sector = decrease prod potential of eco
Fiscal polc + supply side conflict
refl fiscal polc to incr AD = spend money on health/educextra spending = inflation in short term but long-term - improvement in ASBut defl fiscal (spend less on health/ed = shift AS left = higher prices/infl) to reduce infl = conflict between fiscal/s-s
monetary + comptvness
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