The Policies Flashcards
The purpose of fiscal policy
Stimulate economic growth in a period of recession
Keep inflation low- UK target of 2%
Fiscal policy aims to stabilise economic growth, avoiding a boom and bust economic cycle
Used often in conjunction with monetary policy
Fiscal policy
Fiscal policy involves the government changing levels of taxation and government spending in order to influence Aggregate Demand and the level of economic activity
AD is the total level of planned expenditure in an economy
Automatic stabilisers
Forms of government spending and taxation that change automatically to offset fluctuations in economic activity
Discretionary fiscal policy
Deliberate changes in government spending and taxation designed to influence aggregate demand
Expansionary fiscal policy
This involves increasing AD
Therefore the Government will increase spending and/or cut taxes.
Lower taxes will increase consumer spending because they have more disposable income
This will tend to worsen the government deficit and the government will need to increase borrowing
Deflationary fiscal policy
This involves decreasing AD
Therefore the government will cut spending and/or increase taxes
Higher taxes will reduce consumer spending
Tight fiscal policy will tend to cause an improvement in the government budget deficit
Criticisms of fiscal policy
Poor information- the government may have poor information about the state of the economy and struggle to have the best information about what the economy needs
Time lags-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
Crowding out- some economist argue that expansionary fiscal policy will not increase AD, because the higher government spending will crowd out the private sector. This is because the government has to borrow from the private sector that will then have lower funds for private investment
Inefficient spending- economists argue that higher government dot dung will tend to be wasted on inefficient spending projects. Also, it can then be difficult to reduce spending on the future because interest groups put political pressure on maintaining stimulus spending as permanent
High borrowing costs-under certain conditions, expansionary fiscal policy can lead to higher bond yields, increasing the cost of debt repayments
Factors that affect fiscal policy
The state of the economy- fiscal policy is most effective in deep recession where monetary policy is insufficient to boost demand. In a deep recession (liquidity trap). Higher government spending will not cause crowding out because the private sector saving has increased substantially
The size of the multiplier- if the multiplier effect is large, then changes in government spending dumb have a bigger effect on overall demand
Other factors in the economy- if the government pursues expansionary fiscal policy, but then interest rates rise and the global economy is in a recession, it may be insufficient too boost demand
Bond yields- if there is concern over the governments finances, the government may not be able to borrow to finance fiscal policy. Countries in the Eurozone experienced this problem in the 2008-2013 recessions
Monetary policy
Monetary policy involves using interest rates and other monetary tolls to influence the levels of consumer spending and aggregate demand
In the UK the target monetary policy is to keep inflation within a target of CPI of 2% (+/- 1)
They also consider other macroeconomic variables such as growth and unemployment.
UK monetary policy is set by the Monetary Policy Committee of the Bank of England
Thru are independent in setting interest rates, but have to try and meet the governments inflation target
How monetary policy works
The Bank of England study inflationary trends in the economy, this involves looking at a range of economic variables such as:
Unemployment, consumer confidence, spare capacity in the economy, exchange rate index, house prices, economic growth
From these statistics, the Bank of England decides whether inflation is likely to rise or fall.
If they expect higher inflation and higher growth they will tend to increase interest rates
If they expect lower growth and a fall in the inflation rate, they will tend to cut interest rates
Loose Monetary Policy
If the Bank of England anticipates inflation fling below the Governments target of 2% and economic growth is sluggish or the economy is facing s recession, they are likely to cut interest rates
Lower interest rates in theory, should stimulate economic activity.
This is because lower interest rates reduce borrowing costs
The reduces the disposable income of consumers with mortgage in teddy payments and should encourage spending
Tight monetary policy
If the Bank feels the economy is growing too quickly and inflation is expected to exceed the governments target, then they are likely to increase interest rates to reduce the rate of growth and inflationary pressures
Limitations of Monetary Policy
Liquidity Trap- this is when a cut in interest rates fail to stimulate economic activity, e.g. because of low confidence or banks don’t want to pass base rate cut onto consumers
Difficult to control many objectives with one tool: interest rates- a rise in oil prices causes cost push inflation and lower growth. The Bank could increase interest rates to reduce inflation but it would cause economic growth go fall as well.
Changing interest rates has an effect on the exchange rate- this leads to fluctuations that could be detrimental to other macro-economic objectives
Interest rates may effect some parts of the economy more than others- higher interests increase the disposable income of people with savings. But, this could cause homeowners to be unable to afford their mortgages
Supply-side policy
Supply side economics is the branch of economics that considers how to improve the productive capacity of the economy.
It tends to be associated with monetarist, free market economics.
These economists tend to emphasise the benefits of making markets, such as labours markets more flexible.
However, some supply side policies can involve government intervention to overcome market failure
Supply side policies are government attempts to increase productivity and shift aggregate supply to the right
Benefits of supply side policies
Lower inflation- shifting AS to the right will cause a lower price level. By making the economy more efficient supply side policies will help reduce cosh push inflation
Lower unemployment- supply side policies can help reduce structural, frictional and real wage unemployment and therefore help reduce the natural rate of unemployment
Improved economic growth- supply side policies will increase the sustainable rate of economic growth by increasing AS
Improved trade and balance payments- by making firms more productive and competitive they will be able go export more. This is important in light of the increased competition from SE Asia
Supply side policies
Privatisation Deregulation Reducing income taxes Increased education and training Reducing the power of trade unions Reducing state welfare benefits
Privatisation
This involves selling state owned assets to the private sector.
It is argued that the private sector is more efficient in running business because they have a profit motive to reduce costs and develop better services
Increasing living standards
Deregulation
This involves reducing barriers to entry in order to make the market more competitive.
BT used to be a monopoly but nod telecommunications is quite competitive
Competition tends to lead to lower prices and a better quality of goods/service
=More value for money
Reducing income taxes
It is argued that lower taxes (income and corporation) increase the incentives for people to work harder, leading to more output
However this is not necessarily true, lower taxes do not always increase work incentives
(If income effect outweighs substitution effect)
Increased education and training
Better education can improve labour productivity and increase AS
Often there is under-provision of education in a free market, leading to market failure.
Therefore, the government may need to subsidise suitable education and training schemes
However government intervention will cost money, requiring higher taxes.
It will take time to have effect and the government may subsidise the wrong types of training
Reducing the power of the Unions
This should: increase efficiency of firms Ie- less time lost to strikes reduce unemployment On the condition that labour markets are competitive
Reducing welfare state benefits
This may encourage unemployed to take jobs and is a favourite o’clock of current government
Could reduce living standards
Name of the policies
Fiscal
Monetary
Supply side
