Theme 2: Macroeconomic Objectives and Policies Flashcards
The 4 main Macroeconomic objectives
- Economic growth
- Low unemployment
- Low and stable rate of inflation
- Balance of payments equilibrium on current account
What is the UK’s long run trend of economic growth goal?
2.5% of sustainable economic growth
What is the aim for rate of unemployment in the UK?
3%
What is the government’s target inflation rate? and at what point does the Governor of the Bank of England write a letter to the Chancellor of the Exchequer?
2% and if the target falls 1% outside target
Why is the balance of payments in equilibrium important for the current account?
So the country can sustainably finance the current account, which is important for long term growth.
What are the 3 additional government macroeconomic objectives?
- Balanced government budget
- Protection of the environment
- Greater income equality
Why does the government want to keep control of state borrowing?
So the national debt does not escalate. This allows governments to borrow cheaply in the future should they need to, and makes repayment easier.
What is Monetary Policy and how does it achieve their aims? Who controls it?
Used by the government to control the money flow of the economy. Through controlling interest rates and quantitate easing. It is controlled by the Bank of England.
What is Fiscal Policy and how does it achieve their aims? Who controls it?
Uses government spending and revenues from taxation to influence AD. This is conducted by the government.
How do interest rates effect aggregate demand?
As they alter the cost of borrowing and the reward for saving. The bank controls the base rate which controls interest rates. A reduction is the base rate will lead to a rise in AD.
How does quantitate easing effect an economy and when is it used??
It increases the money flow which in theory encourages more investment, more spending and hopefully higher growth. It is used when inflation is low and it is not possible to lower interest rates further.
3 Limitations of monetary policy
- Banks might not pass on the base rates to consumers.
- Banks might be more risk averse so not want to lend.
- Most only work when consumer and firm confidence is high.
What is the biggest source of tax revenue for the government in the UK?
Income tax
What 3 things does the UK spend most of the budget on?
- Pensions and welfare benefits
- Health
- Education
Expansionary fiscal policy
Aims to increase AD. Governments increase spending or reduce taxes. Leads to worsening of the government budget deficit, governments might have to borrow more.
Deflationary fiscal policy
Aims to decrease AD. Government cut spending or raise taxes, which reduces consumer spending. Improvement of government budget.
Budget deficit
When expenditure exceeds tax receipts in a financial year.
Budget surplus
When tax receipts exceed expenditure
Direct taxes
Imposed on income and paid directly to the government from the tax payer. e.g. income tax, corporation tax and inheritance tax.
Indirect tax
Imposed on expenditure on goods and services and increase the cost of production for producers. They increase market price and demand contracts.
5 Limitations of fiscal policy
- Government might have imperfect information about the economy.
- Time lag
- The effect of the multiplier depends on how large the stimulus.
- If interest rates are high fiscal policy might not be effective for increasing demand.
- If the government spends too much they might struggle to pay it back making it difficult to borrow in the future.
What caused the great depression?
- Wall street crash of 1929
- Loss of consumer and business confidence
- Government allowed banks to crash
- The USA introduced protectionism whilst the UK was committed to the gold standard, where its currency was fixed to gold and overvalued.
Response in the UK to the great depression
- Government thought balancing the budget was essential to they cut public sector wages and unemployment benefits and raised income tax.
- Interest rates were kept high to maintain the pound.
- Eventually they left the gold standard and cut interest rates.
Response in the USA to the great depression
- Roosevelt’s new deal used public sector investment, work schemes for the unemployed and fiscal stimulus to increase AD and bring about a recovery.
- Some argue that not enough spending was undertaken for it to be effective.
- They also tried to increase the money supply.
Cause of the Global financial crisis?
- Asset prices were high and rising and there was a boom in economic demand.
- There were risky bank loans and mortgages especially in the US.
- When house prices fell in 2006 many homeowners defaulted on their mortgages and required bail outs from the government.
How did the UK and USA respond to the Global financial crisis?
- Both nationalised banks and building societies and guaranteed savers their money.
- They used expansionary monetary policies including low interest rates and quantitative easing.
- UK- Cut VAT from 17.5% to 15% and saw a huge increase in government borrowing.
- USA- Expansionary fiscal policy, and perhaps why recovered faster.
What are the 2 types of supply side policies?
Market based and interventionalist
Market based polices
Limit the intervention of the government and allow free market to correct imbalances.
Interventionalist policies
Rely on the government intervening in the market.
How do market based polices work to increase incentives?
- Reducing income and corporation tax to encourage spending and investment.
- Reducing benefits to increase the opportunity cost of being out of work.
How do market based polices work to promote competition?
By deregulating or privatising the public sector, firms can compete in a competitive market, which should also help improve economic efficiencies.
How do market based polices work to reform the labour market?
- Reducing the national minimum wage or abolishing 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.
How do interventionalist polices work to promote competition?
- Stricter government competition policy could help reduce the monopoly power of some firms and ensure smaller firms can compete too.
How do interventionalist polices work to reform the labour market?
Governments could try to improve geographical mobility of labour by subsidising the relocation of workers.
How do interventionalist polices work to improve skills and quality of the labour force?
- Government could subsidise training. This also lowers costs for firms, who will have to train fewer workers.
- Spend more on education.
- Spend more on healthcare to improve productivity.
How do interventionalist polices work to improve infrastructure?
Governments could spend more eg improving roads and schools.
Strength of Supply side policies?
- Only policies that can deal with structural unemployment
Weaknesses of supply side policies?
- Demand side policies are better at dealing with cyclical unemployment.
- Significant time lags and not all will be successful
- Market based policies could lead to more unequal distribution of wealth
- Negative impacts on government budgets
- Might effect AD before AS so have inflationary effects.
- If lots of spare capacity in economy supply side policies will have no effect.
Explain why: economic growth vs inflation
A growing economy is likely to experience inflationary pressures on the average price level.
Explain why: Economic growth vs the current account
During periods of economic growth consumers have high levels of spending and consumers in the UK have a high propensity to import so there will be more spending on imports
Economic growth vs the government budget deficit
Reducing the budget deficit requires less expenditure and more tax revenue ad this would lead to a fall in AD. Therefore leading to less economic growth.
Economic growth vs the environment
High rates of economic growth are likely to result in high levels of negative externalities, such as pollution and the usage of non-renewable resources
Unemployment vs inflation
As economic growth increases, unemployment falls due to more jobs being created. However, this causes wages to increase, which can lead to more consumer spending and an increase in the average price level.
Fiscal vs monetary policy
Expansionary fiscal policies involve more government borrowing, which could cause interest rates and the inflation rate to rise.
Interest rate vs inequality
The low interest rate could affect the distribution of income. Savers only receive a small return on their savings.
Environment vs competitiveness
If ‘green taxes’ are implemented, such as carbon taxes, or if there are minimum prices on pollution permits, the competitiveness of domestic firms could be compromised. This is because they are limited in their production.
