Theme 2: Macroeconomic Objectives and Policies

Question 1

The 4 main Macroeconomic objectives

Answer 1

• Economic growth
• Low unemployment
• Low and stable rate of inflation
• Balance of payments equilibrium on current account

Question 2

What is the UK’s long run trend of economic growth goal?

Answer 2

2.5% of sustainable economic growth

Question 3

What is the aim for rate of unemployment in the UK?

Answer 3

3%

Question 4

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?

Answer 4

2% and if the target falls 1% outside target

Question 5

Why is the balance of payments in equilibrium important for the current account?

Answer 5

So the country can sustainably finance the current account, which is important for long term growth.

Question 6

What are the 3 additional government macroeconomic objectives?

Answer 6

• Balanced government budget
• Protection of the environment
• Greater income equality

Question 7

Why does the government want to keep control of state borrowing?

Answer 7

So the national debt does not escalate. This allows governments to borrow cheaply in the future should they need to, and makes repayment easier.

Question 8

What is Monetary Policy and how does it achieve their aims? Who controls it?

Answer 8

Used by the government to control aggregate demand within the economy. Through controlling interest rates and quantitate easing. (controlled by the Bank of England MPC (monetary policy committee).

Question 9

What is Fiscal Policy and how does it achieve their aims? Who controls it?

Answer 9

Uses government spending and revenues from taxation to affect AD within the economy (controlled by the government.

Question 10

How do interest rates effect aggregate demand?

Answer 10

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.

Question 11

How does quantitative easing effect an economy and when is it used??

Answer 11

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.

Question 12

3 Limitations of monetary policy

Answer 12

1. Banks might not pass on the base rates to consumers.
2. Banks might be more risk averse so not want to lend.
3. Most only work when consumer and firm confidence is high.

Question 13

What is the biggest source of tax revenue for the government in the UK?

Answer 13

Income tax

Question 14

What 3 things does the UK spend most of the budget on?

Answer 14

1. Pensions and welfare benefits
2. Health
3. Education

Question 15

Expansionary fiscal policy

Answer 15

Aims to increase AD. Governments increase spending or reduce taxes. Leads to worsening of the government budget deficit, governments might have to borrow more.

Question 16

Deflationary fiscal policy

Answer 16

Aims to decrease AD. Government cut spending or raise taxes, which reduces consumer spending. Improvement of government budget.

Question 17

Budget (fiscal) deficit

Answer 17

When expenditure exceeds tax receipts in a financial year.

Question 18

Budget (fiscal) surplus

Answer 18

When tax receipts exceed expenditure

Question 19

Direct taxes

Answer 19

Imposed on income and paid directly to the government from the tax payer. e.g. income tax, corporation tax and inheritance tax.

Question 20

Indirect tax

Answer 20

Imposed on expenditure on goods and services and increase the cost of production for producers. They increase market price and demand contracts.

Question 21

5 Limitations of fiscal policy

Answer 21

1. Government might have imperfect information about the economy.
2. Time lag
3. The effect of the multiplier depends on how large the stimulus.
4. If interest rates are high fiscal policy might not be effective for increasing demand.
5. If the government spends too much they might struggle to pay it back making it difficult to borrow in the future.

Question 22

What caused the great depression?

Answer 22

• 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.

Question 23

Response in the UK to the great depression

Answer 23

• 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.

Question 24

Response in the USA to the great depression

Answer 24

• 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.

Question 25

Cause of the Global financial crisis?

Answer 25

• 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.

Question 26

How did the UK and USA respond to the Global financial crisis?

Answer 26

• 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.

Question 27

What are the 2 types of supply side policies?

Answer 27

Market based and interventionalist

Question 28

Market based polices

Answer 28

Limit the intervention of the government and allow free market to correct imbalances.

Question 29

Interventionalist policies

Answer 29

Rely on the government intervening in the market.

Question 30

How do market based polices work to increase incentives?

Answer 30

1. Reducing income and corporation tax to encourage spending and investment.
2. Reducing benefits to increase the opportunity cost of being out of work.

Question 31

How do market based polices work to promote competition?

Answer 31

By deregulating or privatising the public sector, firms can compete in a competitive market, which should also help improve economic efficiencies.

Question 32

How do market based polices work to reform the labour market?

Answer 32

1. Reducing the national minimum wage or abolishing will allow free market forces to allocate wages and the labour market should clear.
2. Reducing trade union power makes employing workers less restrictive and increases the mobility of labour.

Question 33

How do interventionalist polices work to promote competition?

Answer 33

1. Stricter government competition policy could help reduce the monopoly power of some firms and ensure smaller firms can compete too.

Question 34

How do interventionalist polices work to reform the labour market?

Answer 34

Governments could try to improve geographical mobility of labour by subsidising the relocation of workers.

Question 35

How do interventionalist polices work to improve skills and quality of the labour force?

Answer 35

1. Government could subsidise training. This also lowers costs for firms, who will have to train fewer workers.
2. Spend more on education.
3. Spend more on healthcare to improve productivity.

Question 36

How do interventionalist polices work to improve infrastructure?

Answer 36

Governments could spend more eg improving roads and schools.

Question 37

Strength of Supply side policies?

Answer 37

1. Only policies that can deal with structural unemployment

Question 38

Weaknesses of supply side policies?

Answer 38

1. Demand side policies are better at dealing with cyclical unemployment.
2. Significant time lags and not all will be successful
3. Market based policies could lead to more unequal distribution of wealth
4. Negative impacts on government budgets
5. Might effect AD before AS so have inflationary effects.
6. If lots of spare capacity in economy supply side policies will have no effect.

Question 39

Explain why: economic growth vs inflation

Answer 39

A growing economy is likely to experience inflationary pressures on the average price level.

Question 40

Explain why: Economic growth vs the current account

Answer 40

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

Question 41

Economic growth vs the government budget deficit

Answer 41

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.

Question 42

Economic growth vs the environment

Answer 42

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

Question 43

Unemployment vs inflation

Answer 43

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.

Question 44

Fiscal vs monetary policy

Answer 44

Expansionary fiscal policies involve more government borrowing, which could cause interest rates and the inflation rate to rise.

Question 45

Interest rate vs inequality

Answer 45

The low interest rate could affect the distribution of income. Savers only receive a small return on their savings.

Question 46

Environment vs competitiveness

Answer 46

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.