Policy Objectives & Measures Flashcards
What is the stable inflation rate?
2%
Why are high inflation rates bad?
In consumers perspectives, their purchasing power weakens, and if prices are rising faster than their incomes (which are mostly fixed, especially those from lower-income families and older citizens on state pensions), then their real incomes will decrease
Why is negative inflation also bad?
Deflation is bad for businesses in the long term, because as prices steadily fall (as a result of demand decreasing), they’ll have less opportunity to make profits, and will instead make losses (increasing the risk of these businesses going bust)
(Look at shift of the AD curve to the left to show decrease in price levels and output demanded/produced)
How can alternating interest rates affect inflation rates?
By rising interest rates (as a result of high inflation), it can discourage consumer spending and therefore lead to lower prices (as a result in the decreased demand) and therefore a drop in inflation (e.g in oct 2022 where interest rates had to be increased as a result of inflation reaching as high as 11.2%)
What does it mean if a country is running on trade surplus?
If their exports are greater than imports (e.g china)
What does it mean if a country is running on a trade deficit?
If their imports are greater than exports (e.g UK)
What are think tanks?
These are research institutes that provide advice on a range of policy issues (e.g ONS & OBR)
What are issues with using GDP as a measure of economic growth?
-It’s not 100% correct (as it’s an estimate)
-Goods or services may be double counted (e.g people buy second hand products)
-There’s informal activity, such as black markets and unregistered companies making transactions (these go unrecorded)
-GDP data may be inaccurate as it’s from various sources (therefore it has to be reviewed)
-Living standards may not have improved as a result of GDP going up (as we’re not told what’s being sold, so this could include de-merit goods, which could decimate our living standards, and therefore our productivity levels, meaning economic growth could ultimately be harmed, as output would decrease)
-Merit goods such as healthcare and education aren’t included in GDP, but de-merit goods such as alcohol and cigarettes are
-FDI and remittances may be involved, but these may have a different purpose than improving living standards (e.g remittances for family and profits from FDI may be repatriated)
-It overlooks the distribution of income, as proceeds mainly go to the rich (it may mask the inequalities and not truly represent the well being of the average citizen)
-It doesn’t account for sustainability of growth and ignores factors like pollution or damage to species (Green gdp may be a better measure)
How can government expenditure encourage demand for goods and services?
1.) Direct spending on public services (healthcare, infrastructural projects) increases demand for services within those retrospective sectors (e.g more spending on healthcare increases demand for medicinal supplies and equipment)
2.) Providing unemployment benefits, welfare payments and social security provide those unable to work an income, meaning they can then use this money to buy necessities and services
3.) Investment in education and healthcare leads to a more healthy and educated workforce that are more capable of working high income jobs, meaning they’ll have more disposable income to spend on goods and services
What is the difference between economic growth and economic development?
-Economic growth looks at the value of goods & services produced within a year (looking at the increase in GDP value / a rise in a country’s productive capacity)
-However economic development is a broader term which may be an aftermath of economic growth: it looks at the quality of life & social/economic opportunities available. It uses measures such as HDI.
Why doesn’t economic growth inevitably lead to economic development?
-Corruption (proceeds only go to the top/rich): therefore rising income & wealth inequality, meaning the quality of life isn’t improved for the majority, especially in low income countries (e.g Equatorial Guinea)
-There may be threats to environmental sustainability with an increase in production as a result of the investment into capital stock (maybe Green GDP is a better measure)
-Investment from FDI may dominate the consumption of goods & services in the calculation of GDP (and we know profits from FDI can be repatriated instead of being re-invested into the local economy)
What are measures of economic development?
-HDI (mean years of schooling to measure education; life expectancy at birth to measure healthcare; GNI per capita to measure standard of living)
-Levels of corruption (linked to the strength of government/civil services) Look at “Corruption Perceptions Index” (CPI: 0 being highly corrupt and 100 being perfectly clean)
-Access to basic financial services (e.g bank accounts) and infrastructure (e.g transport, healthcare, education)
How may economic growth lead to improved living standards?
If GDP rises, then there’s more money in the domestic economy (because there’s increased consumption in goods & services), meaning businesses make more profits, and therefore pay their employees higher wages / even hire more employees.
This means employment and GNI per capita/household rises. Thus meaning people can afford more goods & services, ultimately improving their living standards.
How can high economic growth lead to a budget surplus?
With the rise in AD curve, this represents an increase in the output in the economy, and therefore the incomes earned by businesses individuals increase, meaning the government can raise more tax revenue, thus leading to a budget surplus
Examples of UK Supply side policies trying to encourage capital investment as a % of GDP
-The Labour Party in April 2025 are to increase the starting point at which small businesses pay NIC, from £5000 to £10500, therefore allowing them to retain profits in order to reinvest into capital stock for starting business
-Labour’s budget has confirmed that £1bn will be invested into the British business bank to enhance access to finance for small firms through start up loans (making it easier to invest)
What is the best way for a low-budget country to increase their GDP?
To encourage foreign investment:
1.) Foreign investors bring money into the domestic economy and bring technology & equipment for their businesses
2.) This creates jobs for locals (and they learn from these foreign companies), and therefore increases production in the country
3.) When production (output) increases, the GDP increases
4.) Government revenue then increases, meaning they can invest more into human capital such as education (focusing on the skills of its future workforce)
5.) More educated workers lead to higher productivity, more innovation and higher salaries
What is an example of foreign investment rescuing a country from poverty?
Japan when it was destroyed in WW2 (after Hiroshima and Nagasaki nuclear bombings)
-They went on to use the USA’s investments & aid to steel and electronics industries
Now they lead in automotive & tech exports (with a GDP of $4.2 trillion)
What is an example of GDP not representing the quality of life?
Equatorial Guinea has a PPP GDP/capita of $17,400 in 2023 (according to the world bank this was one of the highest in Africa) ;
However it’s high GDP is due to oil production that’s completely controlled by the corrupt government.
But about 70% of the population lives in poverty, meaning they got no benefits from the oil economy due to unequal distribution (because of the corruption)
What are the benefits of government expenditure? (Give examples)
1.) It can increase demand for goods and services within sectors (e.g direct spending in healthcare sector can increase demand for medicinal supplies and equipment, therefore contributing to production and therefore real GDP)
2.) It can provide a safety net for those unable to work (e.g ubi and universal credit)
3.) Subsidies for businesses (can make production cheaper, thus enabling economies of scale, therefore cheaper prices can be passed onto consumers)
4.) Investing into human capital such as education ensures a more innovative workforce over time
Drawbacks of government expenditure
1.) Taxpayers have to contribute more
2.) State dependency arises:
-Crowding out effect: Firms may become less innovative (meaning they won’t be as motivated to improve the quality of their goods and services);
-And welfare claimants will solely rely on the state for their income instead of searching for employment (leading to a less productive economy)
What are supply side policies?
They are policies which seek to increase the quality and quantity of the factors of production - therefore increasing the productive capacity/potential of the economy
These can be divided into categories of interventionist and free marketist
Why would GDP be higher than GNI in low income countries?
-Because foreign owned companies generate more income than the locals do, especially in countries like South Africa
-Also due to corruption, where proceeds are unequally distributed
Examples of free marketist supply side policies
1.) Lower income tax (incentive for those out of work to start working; those already in work will have the incentive to work harder for pay rises, as they’ll have more disposable income)
2.) Lower corporate taxes / easing NIC contributions: Firms can retain more profits, leading to dynamic efficiency and economies of scale (contributing to disinflation and the increased output in the economy)
3.) Reduce welfare benefits (to reduce state dependency and incentivise the inactive to work)
4.) Reduce minimum wages / trade union power (to reduce long run costs of production for firms to boost productive efficiency)
5.) Increase competition through privatisation, trade liberalisation and deregulation (providing firms the profit incentive to be productively & dynamically efficient)
Criticisms of free marketist supply side policies
-Tax reforms/cuts may be costly for the government (as seen in Oct 2022 with unfunded tax cuts of £45bn, contributing to budget deficit)
-Tax cuts have a time lag before we start seeing improvements in investment / an increase in labour force
-Tax cuts may lead to demand-pull inflation
-Privatisation may cause unintended consequences (as companies may become socially inefficient and less innovative)
-Removing trade union power / reducing minimum wage may reduce labour participation as workers won’t want to be exploited
Examples of interventionist supply side policies
1.) Investing into human capital (such as education and training): Through universities and funded schemes - therefore improving labour productivity
2.) Increase geographical & occupational mobility of labour (through social housing for infrastructure projects like HS2 to provide jobs)
3.) Encouraging capital investment (e.g through subsidies) for R&D to stimulate dynamic efficiency (factory expansion, new technology & machinery that’ll enable more output)
4.) Regulation through the CMA to prevent monopolies / monopsonies, thus encouraging more start-up businesses / more labour participation
5.) Improving transport infrastructure (roads, ports, airports, bridges, railway lines) : thus making raw materials easier to access and therefore cheaper to sell goods (as productive efficiency is increased) (e.g 3rd Heathrow runway)
6.) Provision of welfare benefits in order to increase demand - More demand would lead to more supply being needed to meet this demand, therefore leading to more output
Criticisms of interventionist supply side policies
-Subsidies, spending on human capital and investment into infrastructure can be costly for the state
-State dependency:
1.) No guaranteed success of subsidies, as firms may not use them for investment purposes, but rather for their shareholders to take money
2.) Similarly, people will become state dependent on welfare benefits (such as universal credit) therefore leading to less productivity
-Investment into human capital will take a while to reap the returns / see improvements in productivity (as we’ll have to wait for the children that are being invested into now to join the labour force)
What is monetary policy?
A form of demand side policy (mainly controlled by the Central bank, I.e BoE):
It involves changing interest rates, the money supply and exchange rates in order to influence the economy
It can be expansionary or deflationary/contractionary
What are the objectives of expansionary policies?
To increase the AD curve to the right by:
-Increasing inflation (if under 2% target)
-Encouraging economic growth (e.g more consumer spending on goods and services through lower interest rates and expansion in supply of credit)
-Reducing unemployment (Lowering interest rates through increasing money supply to stimulate business activity, therefore opening up more jobs, as labour is a derived demand)
Examples of expansionary policies that shift the AD curve to the right
1.) Reducing real interest rates (to encourage more consumer spending & investment into capital stock)
2.) Depreciating currency within exchange rate systems (If exports are priority, as they’ll become cheaper for foreign importers)
3.) Expanding supply of credit through QE (as loans will be easier to provide with increased money reserves)
What are the objectives of deflationary/contractionary policies?
To decrease the AD curve to the left by:
-Reducing inflation (maintaining price stability at 2% : either by reducing money supply or increasing interest rates)
-Preventing too much borrowing in housing market (by preventing asset/credit bubbles & increasing interest rates)
-Decreasing government expenditure (more government austerity) in order to decrease demand by lowering consumer spending on goods & services (therefore contributing to deflation because of the lowered demand)
Examples of deflationary/contractionary policies that shift the AD curve to the left
1.) Higher interest rates on loans & savings (encourages less consumer spending and more saving; equally this may attract FDI meaning foreign companies may set up, thus increasing price-competition, contributing to deflation)
2.) Appreciation of currency within the exchange rate (if priority is imports, then imports will be cheaper for the country)
3.) Tightening supply of credit (so that loans are harder to get, encouraging less spending)
Pros and con of lower interest rates
Pros:
-Lower interest rates encourages less saving and more consumer spending on goods and services (therefore increasing aggregate demand)
-Lower interest rates on businesses encourages investment into capital stock (such as machinery, technology and equipment)
Con:
-Lower interest rates drive out Foreign investment (as they want the highest interest rates in order to get the best returns on their savings & investments): We want Foreign investment for tax contributions as it tends to be oligarchs that bring lots of money
-Lower interest rates can cause demand-pull inflation as they encourage more consumer spending and wage rate growth (with labour being a derived demand, meaning more people will be involved to produce more output, causing more wages to be earned, causing even more spending, meaning more demand-pull inflation!)
How may the depreciation of the currency cause inflation?
1.) The monetary policy of QE (to increase supply of credit) may lead to lower bond yields, therefore leading to foreign investors pulling their money out of the bonds as they’re less attracted to the lower rates of return, therefore decreasing the demand for the currency (thus depreciating it) ;
With QE increasing the money supply and lowering interest rates (by increasing commercial banks’ reserves) they’re depreciating the currency and increasing demand-pull inflation (respectively)
2.) Imports become more expensive as the value of the currency drops compared to other countries, therefore causing cost-push inflation (as import costs for businesses are increased, so they shift the burden onto consumers through higher prices);
There’ll be increased demand for domestically produced goods, causing demand-pull inflation
How may central banks intervene to prevent currency depreciation?
1.) Through raising interest rates in order to attract foreign investment (therefore increasing the demand for the currency in order to strengthen it)
2.) Reducing the money supply by quantitative tightening measures
3.) Through intervening in the financial markets themselves by buying the their own currency to strengthen its value
How may inflation lead to the currency depreciating?
1.) Higher inflation means the purchasing power weakens for the consumers, leading to less spending/use of the currency and therefore less demand for the currency (as there’s less consumer confidence)
2.) High inflation signals economic instability, making foreign & domestic investors wary into buying the currency and also drives away FDI as businesses won’t want to convert their local currency into the country’s currency in order to finance business operation within the unstable country (therefore decreasing the demand for the currency and depreciating it)
Why is the currency appreciating bad?
-The macroeconomic objective of economic growth may be hindered, as sales in exports may decline because they’ll become more expensive to foreign importers:
Reduced export sales means reduced revenue that can be reinvested into the economy which could mean reduced production (leading to decrease in AD as there’d be less output) and job creation (leading to decrease in LRAS as there’d be less labour productivity and more unemployment)
How can the government / the central bank intervene to prevent the currency from appreciating?
1.) The government can reduce FDI through imposing more taxes on profits repatriated (therefore discouraging the inflow of foreign capital and investments that would be facilitated by buying the local currency, therefore decreasing the demand and value of the currency)
2.) The government can cut taxes: this can cause demand-pull inflation through higher consumer spending, leading to the currency depreciating in value (because purchasing power would be weakened) (as seen in Oct 2022 lol)
3.) The central bank can lower interest rates to:
-Disincentivise foreign investment (as returns will be lowered, therefore decreasing the demand for the currency)
-Cause more consumer spending, leading to demand-pull inflation
4.) The central bank can implement QE in order to lower interest rates and increase money supply, therefore causing both inflation and depreciation of the currency
5.) The central bank can intervene in the financial markets by selling their own currency, therefore increasing the supply in the market and therefore de-valuing the currency (as the scarcity is reduced and investor confidence would be lost in the rapid selling pressure)
