THEME 2, Macroeconomic objectives and policies (2.6) Flashcards
What are the 4 key macroeconomic objectives?
- Economics growth
- Low unemployment
- Low and stable inflation
- Balance of payment equilibrium on the current account
What is the aimed unemployment rate?
- 3%
What are demand-side policies aimed to do?
- Manipulate consumer demand
What is expansionary policy?
- Policies aimed at increasing AD to bring about growth
What is deflationary policy?
- Policy aimed at decreasing AD to control inflation
What is monetary policy?
- Where the central bank or regulatory authority attempts to control the level of AD
- This is done by altering base interest rates or amount of money in the economy
What is fiscal policy?
- The use of borrowing, government spending and taxation to manipulate the level of AD
What are the instruments of fiscal policy?
- Changes to GOVt policy
- Changes to taxation
When there are high levels of inflation - what policies would GOVt implement?
- Increase taxes to slow economic growth
- Decrease GOVt spending
When there is a shrink in the economy - what policies would GOVt implement?
- Increase GOVt spending
- Lower taxes to incentivise consumer spending
What is the repo rate?
- Repurchase rate for interest rates for bonds, shares etc
What does a rise in interest rates do to AD?
- Decreases AD
How does an increase in interest rates decrease AD?
- Cost of borrowing increases so investment and consumption decreases.
- High interest rates also makes savings more attractive - C decreases
- Decreases consumer confidence
- Higher rates will incentivise foreigners to hold money in British accounts - Value of £ increases - Net trade decreases
What problems are associated with demand-side policies?
- Exchange rate is affected - causing a balance of trade deficit
- Interest rates take up to 2 years to have full effect
- There are a range of different interest rates and not all of them are affected by the
Bank of England base rate. - High interest rates over a long period of time will discourage investment and decrease LRAS.
What is quantitive easing?
- When the Bank of England buys assets in exchange for money in order to increase money supply.
- Gets money moving around the economy during times of very low demand.
What effect does quantitive easing have?
- Increasing consumption and investment
- Increases AD and ensures the country meets its inflation target.
How does quantitive easing mean asset prices will rise? And how will this impact AD?
- Rise in demand and so asset prices rise.
- This will mean that there is a positive wealth effect // C increases
- Moreover, the cost of borrowing will decrease as higher asset prices mean lower yields.
- Making it cheaper for households and businesses to finance spending.
What problems are associated with quantitive easing?
- It is very risky and, if not controlled properly, could cause high inflation and even
hyperinflation. - There is no guarantee that higher asset prices lead into higher consumption through the wealth effect, especially if confidence remains low.
- Not meant to be permanent but economies particularly within Eurozone are too dependant on it
What is the role of the Bank of England?
- Controls monetary policy.
- Makes the most important decisions, including the Bank of England base rate and the actions over quantitative easing.
- Keep inflation at 2%
How many people are in the Monetary Policy Committee?
- 9 people
- 5 from Bank of England
- 4 are independent outside experts, mainly economists
What do classical economists argue about demand-side policies?
- Any demand management, whether fiscal or monetary, will have no effect on long-run output so supply side policies should be used.
What are expansionary policies?
- Policies that increase GDP
What was the growth in Q4 of 2024?
0.1%
What was the growth in Q2 and Q3 of 2024?
0%
Why might commercial banks lower interest rates in a time of quantitive easing?
- They are receiving lots of money from Bank of England so can offer lower interest rates to customers
- The increase money supply means that the price of money falls; interest rates are the price of money
- This will encourage investment so AD increases
What are the strengths of fiscal policy?
- This benefits the populace and the economy because more jobs lead to a higher standard of living.
- Reducing tax rates and increasing spending also improve the economy as they serve as incentives for entrepreneurs.
- Fiscal policies also aid in budget deficit reduction.
What problems are there when evaluating fiscal policy?
- GOVt spending impacts LRAS - This can impact other sectors of economy e.g. education
- Taxes and spending have an impact on inequality
- The government also has to worry about political issues and keeping their GOVT
- The impact of fiscal policy depends on the multiplier
What is supply side policy?
- Policies that aim to increase productivity and efficiency in the economy.
- The objective of supply-side policies is to boost aggregate supply (AS) to result in increased output.
What are market based supply side policies?
- Policies which aim to improve the long run productive potential of the economy.
What are interventionist supply side policies?
- Policies designed to correct market failure
- For example the free market under provides education and so the government provides it.
What are the key supply side policy objectives?
- Increase incentives to encourage spending and investment
- Promote competition by deregulating sectors
- Increase the occupational and geographical mobility of labour to reduce unemployment.
Examples of market based supply side policy
- Privatisation - firms have the incentive to be dynamically and productively efficient. So privatisation leads to a reduction in waste, a better allocation of resources, and causes the LRAS to shift out. E.g. Royal Mail in 2013
- Deregulating sectors - promote competition. Increase LRAS. Should be done with cause as not to trigger a financial crisis
- Increase incentives to encourage spending and investment - Reduce tax
Examples of interventionist supply side policy.
- Spend more on education and training or subsidise it - improve productivity and efficiency, which will shift the productive potential of the economy and the LRAS out.
- Improve infrastructure - HS2 rail. G+S can be transported quicker; This will reduce costs, improve efficiency. LRAS OUT
Strengths of supply side policy
- Supply side policies are the only type of policy which can deal with structural unemployment because the labour market can be directly improved with training and education.
- Encouragement of sustainable economic growth
Weaknesses of supply side policy
- Demand side policies are better at addressing cyclical unemployment since they can reduce the negative output gap and shift the AD curve to the right
- Significant time lags are associated with supply side policies
- Market-based policies supply side policies such as reducing rate of tax could lead to more wealth inequality
What is the Phillips curve?
- The supposed inverse relationship between the level of unemployment and the rate of inflation
- Can be explained by demand pull and cost push inflation
What happens as unemployment falls very low?
A positive output gap begins to emerge, which generate demand-pull inflation.
What happens as unemployment rises?
A negative output gap emerges which pulls down rate of inflation.
Who made the Phillips curve more complex?
Milton Friedman
Who created the original Phillips curve?
A W Phillips
How did Friedman adapt the Phillips curve?
He revised the model to distinguish between short-run and long-run and introduced the importance of inflationary expectations.
What is NAIRU?
Non-Accelerating Inflation Rate of Unemployment
Which Phillips curve is drawn at NAIRU?
LONG RUN PHILLIPS CURVE is drawn at NAIRU.
Which policies might cause the Phillips Curve to move lower or flatten?
- Supply side policies
- Labour market reforms
- International trade
How might supply side policies flatten or lower the Phillips Curve?
- Improving productive capacity and potential output of the economy.
- This can lead to a lower rate of structural unemployment which flattens the Phillips curve
How might labour market reforms cause the Phillips curve to move lower or flatten?
- Work incentives are improved
- Boost inward migration of skilled workers and improve labour mobility
- Competition increases in the labour market
- This brings down employment without creating extra inflation
How might international trade cause the Phillips curve to lower or flatten?
- Increased overseas trade leads to a greater contest ability and lower prices for G+S
- This leads to a lower rate of inflation and a flatter Phillips curve
Cost push explanation
- As unemployment decreases, more people in work,
- more people spending, increases consumption,
- increases AD, shifts to right, inflationary pressure
Demand pull explanation
- As aggregate demand increases, real GDP and price level increase,
- which lowers the unemployment rate. This increases wages, increases cost of production
- thus increases average price level and causes inflation
Are inflation and unemployment related in the long run?
- NO
- LR Phillips Curve - vertical line at the natural rate of unemployment, so inflation and unemployment are unrelated in the long run.
When do the SR and LR Phillips curves interest?
When the inflation rate is equal to zero
