Theme 2- Macroeconomic objectives and policies (key terms)

Question 1

Central bank policy interest rate

Answer 1

Also known as the monetary policy rate, it is the official lending rate for loans set by a nation’s central bank e.g. the Bank of England or the European Central Bank

Question 2

Cyclical budget (fiscal) deficit

Answer 2

The size of the deficit is influenced by the state of the economy: in a boom, tax receipts are relatively high and spending on unemployment benefit is low

Question 3

Demand-side policies

Answer 3

Policies to change the level of AD in the economy

Question 4

Fiscal policy

Answer 4

Policies that change the level of public spending, taxation or borrowing in order to manage the level of AD

Question 5

Expansionary fiscal policy

Answer 5

Tax cuts, spending increases designed to boost AD

Question 6

Contractionary fiscal policy

Answer 6

Tax rises/ spending cuts designed to reduce AD

Question 7

Government bonds

Answer 7

The government sells bonds to pay for its borrowing

Question 8

Automatic stabilisers

Answer 8

• Automatic fiscal changes as the economy moves through stages of the business/trade cycle
• When the economy goes into recession, government spending will rise automatically - public spending will go up because unemployment benefits increase, tax revenue falls

Question 9

Discretionary fiscal policy

Answer 9

The government deliberately decides to change taxes or spending to boost or slow down the economy - discretion means it’s an actual government decision, not an automatic change

Question 10

Direct tax

Answer 10

Taxes levied on streams of income and profits such as income tax and corporation tax

Question 11

Excise duties

Answer 11

Indirect taxes levied on specific goods, typically alcoholic beverages, tobacco and fuels.

Question 12

Expansionary monetary policy

Answer 12

Interest rate cuts which boost AD

Question 13

Contractionary monetary policy

Answer 13

Interest rate rises which reduce AD

Question 14

Expansionary monetary
policy (relaxation)

Answer 14

A relaxation of monetary policy means an attempt to use an expansionary monetary policy to boost AD, output and jobs –includes lower interest rates.

Question 15

Expenditure-switching policies

Answer 15

Policies that are designed to ‘switch’ expenditure from imports to domestically produced goods in order to improve the balance of payments and stimulate GDP

Question 16

Fine-tuning

Answer 16

Changes in monetary policy or fiscal policy designed to gradually manage the level of AD and prices e.g. small changes in policy interest rates / taxation

Question 17

Austerity

Answer 17

Economic policy aimed at reducing a government’s deficit (or borrowing) - can be achieved through increases in government revenues -primarily via tax rises -and/or a reduction in government spending or future spending commitments

Question 18

Fiscal austerity or fiscal tightening

Answer 18

Fiscal austerity refers to decisions by a government to reduce the amount of borrowing (i.e. cut the size of a fiscal deficit) over time

Question 19

Marginal rate of tax (MRT)

Answer 19

The rate of tax on the next unit (£1) of income earned

Question 20

Monetary policy

Answer 20

Decisions made by the Bank of England that change the money supply and interest rate to influence output, employment, and prices

Question 21

Monetary Policy Committee (MPC)

Answer 21

Bank of England committee of nine people (including the Governor) that meets every month to review the economy and set monetary policy interest rates for the UK

Question 22

Inflation target

Answer 22

2%, plus or minus one - measured on the CPI, symmetrical target

Question 23

Office of Budget Responsibility

Answer 23

The OBR is a non-departmental public body funded by the Treasury, that the UK gov established to provide independent economic forecasts and independent analysis of the public finances

Question 24

Patent box

Answer 24

A reduced rate of Corporation Tax applied to profits from patents –designed to stimulate research and innovation and improve the supply-side of the economy

Question 25

Progressive tax

Answer 25

With a progressive tax, the marginal rate of tax rises as income rises. I.e. as people earn more income, the rate of tax on each extra pound goes up - causes a rise in the average rate of tax

Question 26

Proportional tax

Answer 26

When the marginal rate of tax is constant leading to a constant average rate of tax

Question 27

Redistribution

Answer 27

Measures taken by government to transfer income from some individuals to others.

Question 28

Regressive tax

Answer 28

With a regressive tax, the rate of tax paid falls as incomes rise –I.e. the average rate of tax is lower for people on higher incomes. Examples: Duties on tobacco and alcoho

Question 29

Structural budget deficit

Answer 29

The structural deficit is that part of the deficit which is not related to the state of the economy. This part of the fiscal deficit will not disappear when the economy recovers

Question 30

Tax competition

Answer 30

Tax competition happens when a national government uses reforms to the tax system as a supply-side strategy to attract investment and jobs into their economy

Question 31

Timelags

Answer 31

The time it takes for one change e.g. a change in interest rates to affect other variables e.g. consumer confidence and spending

Question 32

Transmission mechanism

Answer 32

How a change in interest rates affects the behaviour of economic agents and ultimately leads to changes in aggregate demand, employment and inflationary pressures

Question 33

Competitive market

Answer 33

Where no single firm has a dominant position and where the consumer has plenty of choice when buying goods or services. There are few barriers to the entry of new firms

Question 34

Incentives

Answer 34

Incentives can be used to make goods and services markets, as well as labour markets, work more efficiently and therefore creating greater productive capacity

Question 35

Occupational immobility

Answer 35

Workers having the wrong skills for available job vacancies. This can be overcome by giving labour transferable skills

Question 36

Poverty trap

Answer 36

The poverty trap affects people on low incomes. It creates a disincentive to look for work or work longer hours because of the effects of the tax and benefits system

Question 37

State-driven supply-side policies

Answer 37

When a government believes that active intervention in markets can help achieve increased productive capacity and competitiveness e.g. State investment in public services and critical infrastructure, a commitment to a minimum wage and/or living wage to improve work incentives & productivity in the labour market

Question 38

Credit crunch

Answer 38

Events in 2007-2008 that led to the Great Recession:
- US house prices fell
- Banks around the world which had lent too much money on US mortgages began to lose money and some went bankrupt
- Business confidence fell rapidly, sparking panic - global recession

Question 39

Phillips Curve

Answer 39

The Phillips Curve shows a trade-off between inflation and unemployment - a demand-side policy to reduce unemployment could conflict with price stability

Question 40

The Non-Accelerating Inflation Rate of Unemployment (NAIRU

Answer 40

The rate of unemployment at which the inflation rate is stable - if it falls lower, inflation begins to accelerate

Question 41

Policy asymmetry

Answer 41

When a given change in interest rates affects different groups or different countries to a lesser or greater degree

Question 42

Trade-off

Answer 42

A trade-off implies that choices have to be made between different objectives of policy for example a trade-off between economic growth and inflation

Question 43

The zero-rate problem

Answer 43

• BoE can’t cut interest rates below zero
• Real interest rate is nominal interest rate minus infation
• Although BoE has cut interest as low as it can, falling prices will mean that the real interest rate is positive and it could be risinf

Question 44

Supply-side policies

Answer 44

Policies designed to boost the productive potential of the economy or shift the LRAS curve to the right