Steering the Macroeconomy Flashcards
What are the main economic aims of the government?
- low and stable inflation (price stability)
- high level of employment and low level of unemployment
- to encourage economic growth
- to encourage trade and secure a favourable balance of payments
What is Fiscal policy?
Controlling AD by altering the balance between government expenditure and taxation
-government changing the levels of taxation and government spending in order to influence Aggregate Demand (AD) and the level of economic activity.
Purpose of fiscal policy
□ Stimulate economic growth in a period of a recession.
□ Keep inflation low (UK government has a target of 2%)
□ Fiscal policy aims to stabilize economic growth, avoiding a boom and bust economic cycle.
What are some automatic stabilisers of economy?
□ If the economy is growing, people will automatically pay more taxes (VAT and Income tax) and the Government will spend less on unemployment benefits.
□ The increased T and lower G will act as a check on AD.
□ in a recession, the opposite will occur with tax revenue falling but increased government spending on benefits, this will help increase AD
what is discretionary policy?
this is a deliberate attempt by the government to affect AD and stabilize the economy,
e.g. in a boom the government will increase taxes to reduce inflation
what is the public sector borrowing requirement
(G + Ig) – T = PSBR
Current public (G) and Capital Public (Ig) Spending
Is discretionary policy effective?
fiscal policy can be used toincrease Aggregate Demand.These policies can be used tohelp close thedeflationary gap
Problem of discretionary fiscal policy
The government may have poor information about the state of the economy and struggle to have the best information about what the economy needs
Multiplier; Accelerator; Crowding out; Random shocks Adverse effects; Time lags; Uncertainty: how will people react? Destabilising policy;
fiscal policy cannot help an economy produce at an output level above potential GDP without causing inflation
how is crowding out a problem?
Some economists argue that expansionary fiscal policy (higher government spending) will not increase AD because the higher government spending will crowd out the private sector.
This is because the government have to borrow from the private sector who will then have lower funds for private investment.
why are time lags a problem
to increase government spending will take time.
It could take several months for a government decision to filter through into the economy and actually affect AD. By then it may be too late.
what is monetary policy?
Using interest rates, the money supply and the exchange rate to control AD and meet targets through
□ Inflation targeting
□ Economic growth
How effective is monetary policy?
In a recession:
- interest rates are lowered, reserve limits loosened, and bondsare purchased in exchange for newly created money
- Lower interest rates will reduce incentive to save and hence encourage consumption; reduce cost of borrowing and so stimulate consumption and investment.
- will reduce the exchange rate and hence boost exports and decrease imports. Also it reduces variable rate mortgages and so increases disposable income and boosts consumption
Inflation too high:
-the central bank will enact restrictive monetary policy to tighten the money supply, effectively reducing the amount of money in circulation and lowering the rate at which new money enters the system
What is the role of the central bank in monetary policy?
□ In a recession: an undertake unconventional monetary policies such asquantitative easing(QE)
□ when inflation is high, enacts restrictive monetary policy
What happens when interest rate is raised?
investment becomes more expensive and works to sloweconomic growtha bit.
Cons of changing interest rates
® set too low, over-borrowing at artificially cheap rates can occur
® Adding more money to the economy = out-of-control inflation
◊ if more money is available in circulation, the value of each unit of money will be worth less given an unchanged level of demand, making things priced in that money nominally more expensive.
® interest rates can only be lowered nominally to 0%, which limits the bank’s use of this policy tool when interest rates are already low
® Monetary policy tools such as interest rate levels have an economy-wide impact
define quantitative easing
refers to steps that the U.S. Federal Reserve takes in attempting to boost the country’s lagging economy
Define supply side policies
Supply-side policies are government attempts to increase productivity and shift aggregate supply (AS) to the right
