Theme 2 - Macroeconomic objectives and policies

Question 1

Macroeconomic objectives

Answer 1

• Economic growth
• Low unemployment
• Low and stable rate of inflation
• Balance of payments equilibrium on current account
• Balanced government budget
• Protection of the environment
• Greater income equality

Question 2

Why is economic growth an objective

Answer 2

In the UK, the long run trend of economic growth is about 2.5%. Governments aim to have sustainable economic growth for the long run.
In emerging markets and developing economies, governments might aim to increase economic development before economic growth, which will improve living standards, increase life expectancy and improve literacy rates.

Question 3

Why is low and stale rate on inflation an objective

Answer 3

In the UK, the government inflation target is 2%, measured with CPI. This aims to provide price stability for firms and consumers, and will help them make decisions for the long run. If the inflation rate falls 1% outside this target, the Governor of the Bank of England has to write a letter to the Chancellor of the Exchequer to explain why this happened and what the Bank intends to do about it.

Question 4

Why is balance of payments equilibrium on current account an objective

Answer 4

Governments aim for the current account to be satisfactory, so there is not a large deficit. This is usually near to equilibrium.
A balance of payments equilibrium on the current account means the country can sustainably finance the current account, which is important for long term growth.

Question 5

Why is Balanced government budget an objective

Answer 5

This ensures the government keeps 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.

Question 6

Why is Protection of the environment an objective

Answer 6

This aims to provide long run environmental stability. It ensures resources used are not exploited, such as oil and natural gas, and that they are used sustainably, so future generations can access them too. Moreover, it means there is not excessive pollution.

Question 7

Why is Greater income equality an objective

Answer 7

Income and wealth should be distributed equitably, so the gap between the rich and poor is not extreme. It is generally associated with a fairer society.

Question 8

Demand-side policy

Answer 8

A deliberate manipulation by the government of AD in order to achieve macroeconomic objectives

Question 9

2 demand-side policies

Answer 9

• Monetary policy

* Fiscal policy

Question 10

Monetary policy

Answer 10

Monetary policy is used by the government to control the money flow of the economy. This is done with interest rates and quantitative easing. This is conducted by the Bank of England, which is independent from the government.

Question 11

Fiscal policy

Answer 11

Fiscal policy uses government spending and revenues from taxation to influence AD. This is conducted by the government.

Question 12

how is interest rate set?

Answer 12

In the UK, the Monetary Policy Committee (MPC) alters interest rates to control the supply of money. They are independent from the government, and the nine members meet each month to discuss what the rate of interest should be. Interest rates are used to help meet the government target of price stability, since it alters the cost of borrowing and reward for saving.
The bank controls the base rate, which ultimately controls the interest rates across the economy.

Question 13

Limitation of monetary

Answer 13

• Banks might not pass the base rate onto consumers - no intended effect
• Even is cost of borrowing is low, consumers might be unable to borrow because banks are unwilling to lend
• IR will be more than directive at stimulating spending and investment when consumer and firm confidence is high

Question 14

Limitation of fiscal policy

Answer 14

• G might have imperfect info about the economy - leads to inefficient spending.
• Time lag
• G borrowing form private sector, less funds available for private sector - can lead to crowding out
• if IR are high, fiscal policy may not be effective for increasing demand
• Too much G spending = difficulty paying back the debt = Difficult to borrow in the future

Question 15

Expansionary fiscal policy

Answer 15

Aim = increase AD. Government increase spending/ reduce taxes on to do this. Leads to worsening of the government budget deficit- may mean G have to borrow more to finance this.

Question 16

Deflationary fiscal policy

Answer 16

Aim = decrease AD. G cut spending / raise taxes, which reduces C spending. - leads the to an improvement of the G budget deficit.

Question 17

G budget deficit

Answer 17

A government has a budget deficit when expenditure exceeds tax receipts in a
financial year.

Question 18

g budget surplus

Answer 18

A government has a budget surplus when tax receipts exceed expenditure.

Question 19

Limitations of fiscal policy

Answer 19

o Governments might have imperfect information about the economy. It could lead to inefficient spending.
o There is a significant time lag involved with employing fiscal policy. It could take months or years to have an effect.
o If the government borrows from the private sector, there are fewer funds available for the private sector, which could lead to crowding out.
o The bigger the size of the multiplier, the bigger the effect on AD and the more effective the policy.
o If interest rates are high, fiscal policy might not be effective for increasing demand.
o If the government spends too much, there could be difficulties paying back the debt, which could make it difficult to borrow in the future.

Question 20

Supply-side policy

Answer 20

Any actions by the G intended to increase the amount that firms are willing to supply at any given price level.
Supply-side policies aim to improve the long run productive potential of the economy

Question 21

Supply-side policy : market-based methods

Answer 21

o To increase incentives
- Reducing income and corporation tax to encourage spending and
investment.
o To promote competition
- By deregulating or privatising the public sector, firms can compete in a
competitive market, which should also help improve economic efficiency.
o To reform the labour market
- Reducing the NMW (or abolishing it altogether) will allow free market
forces to allocate wages and the labour market should clears. Reducing trade union power makes employing workers less restrictive and it increases the mobility of labour. This makes the labour market more efficient.
oTo increase price flexibility and signalling in a market

Question 22

Supply-side policy : interventionist

Answer 22

o To promote competition
- A stricter government competition policy could help reduce the
monopoly power of some firms and ensure smaller firms can compete,
too.
o To reform the labour market
- Governments could try and improve the geographical mobility of labour by
subsidising the relocation of workers and improving the availability of job
vacancy information.
o To improve skills and quality of the labour force

• The government could subsidise training or spend more on education. This also lowers costs for firms, since they will have to train fewer workers.
• Spending more on healthcare helps improve the quality of the labour force, and contributes towards higher productivity.
  o To improve infrastructure
• Governments could spend more on infrastructure, such as improving
  roads and schools.
• Implementing regulation - stopping banks from taking high levels of risk or encouraging consumers to borrow more than they can manage

Question 23

Trade unions

Answer 23

Organisations of workers that exist to promote the welfare of their members

Question 24

Strengths and weaknesses of supply-side policies

Answer 24

*Supply-side policies are the only policies which can deal with structural unemployment, because the labour market can be directly improved with education and training.
*Demand-side policies are better at dealing with cyclical unemployment, since they can reduce the size of a negative output gap and shift the AD curve to the right.
*There are significant time lags associated with supply-side policies.
*Market-based supply-side policies, such as reducing the rate of tax, could lead to a more unequal distribution of wealth.

Question 25

Potential conflicts and trade-offs between the macroeconomic objectives

Answer 25

• Economics growth vs Inflation
• Economics growth vs the current account
• Economic growth vs the G budget deficit
• Economic growth vs the environment
• Unemployment vs inflation

Question 26

Potential conflicts and trade-offs

Answer 26

This occurs when one macroeconomic policy has a larger impact than another, which conflicts with the other policy or reduces its effectiveness.

• Environment vs competitiveness
• Progressive taxes vs inflation
• Fiscal vs monetary policy
• Interest rate vs inequality

Question 27

Economic growth vs inflation:

Answer 27

A growing economy is likely to experience inflationary pressures on the average price level. This is especially true when there is a positive output gap and AD increases faster than AS.

Question 28

Economic growth vs the current account:

Answer 28

During periods of economic growth, consumers have high levels of spending. In the UK, consumers have a high marginal propensity to import, so there is likely to be more spending on imports. This leads to a worsening of the current account deficit. However, export-led growth, such as that of China and Germany, means a country can run a current account surplus and have high levels of economic growth.

Question 29

Economic growth vs the government budget deficit:

Answer 29

Reducing a budget deficit requires less expenditure and more tax revenue. This would lead to a fall in AD, however, and as a result there will be less economic growth.

Question 30

Economic growth vs the environment:

Answer 30

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. This is because of more manufacturing, which is associated with higher levels of carbon dioxide emissions.

Question 31

Unemployment vs inflation:

Answer 31

In the short run, there is a trade-off between the level of unemployment and the inflation rate. This is illustrated with a Phillips curve.
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.
The extent of this trade off can be limited if supply side policies are used to reduce structural unemployment, which will not increase average wages.

Question 32

Environment vs competitiveness:

Answer 32

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.

Question 33

Progressive taxes vs inflation:

Answer 33

Taxes to reduce inequality could lead to higher rates of inflation. For example, a higher VAT rate increases the price of goods for firms and consumers.

Question 34

Fiscal vs monetary policy:

Answer 34

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

Question 35

Interest rate vs inequality:

Answer 35

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