Topic 4 - The Uk Economy - Policies Flashcards
What are the government macroeconomic objectives ?
Sustainable economic growth
Price stability (stable inflation)
Low unemployment
Sustainable fiscal deficit and national debt
Low income inequality and poverty
Stable current account
What is economic growth as a macroeconomic objective ?
an increase in real GDP. That is an increase in the real value of goods and services produced in an economy in a given period of time.
Governments aim for sustainability - in terms of the environmental impact, but also in terms of promoting long-term growth that avoids busts.
Higher economic growth leads to rising real incomes and a higher standard of living.
What is price stability (stable inflation) as a macroeconomic objective ?
Most governments aim to keep inflation, or the rate of increase in prices, low and stable.
Price stability can be measured in different ways. The most common of which is changes in CPI (The Consumer Price Index).
What is the inflation target in the uk ?
UK government target for inflation is 2%
What is the inflation target in India ?
Indian government target is 4%.
What is low unemployment as a macroeconomic objective ?
Governments aim to have low unemployment.
Full employment is not 0% unemployment because there will always be some people temporarily unemployed.
What is a fiscal deficit and why has there been one in the uk since 2000-2001 ?
A fiscal deficit is when a government spends more than it receives in tax revenue in a given time period.
So, governments must borrow. Governments will aim to reduce this amount of borrowing.
If interest payments on the national debt are high, this has a high opportunity cost – this is money that could be spent on education or hospitals.
What is government debt known as ?
‘public debt’
What is debt owned by households known as ?
‘consumer household debt’
What is low inequality and poverty as a macroeconomic objective ?
Governments do not tend to have explicit targets for inequality and poverty but they do not want it to get too large.
High inequality and poverty can lead to social unrest as well as impact the standard of living.
Inequality can be measured in different ways, the most popular of which is known as the Gini Coefficient.
What is a stable current account as a macroeconomic objective ?
Although governments do not have explicit targets for the current account, they do try to improve their international competitiveness.
So exports are promoted
Who set the ‘base rate of interest’ for the uk economy ?
The Monetary Policy Committee (MPC)
What is the Bank rate ?
The Bank Rate is the Central Bank interest rate, also sometimes known as the Base Rate
What is the effect of lowering the bank rate ?
If the Bank Rate was lowered (the Bank Rate is the Central Bank interest rate, also sometimes known as the Base Rate), it should lead to a lower LIBOR (London Inter-bank Offered Rate). This is the rate at which commercial banks lend/borrow from each other
They then pass this on (in theory!) to consumers/firms via a decrease in mortgage rates/loans. This then has effects on the various components of AD/AS.
What’s are the main ways the central bank tries to achieve its inflation targets (of 2%) ?
Through interest rates and quantitative easing, which is when the central bank introduces new money into the money supply
If the bank rate falls (and therefore base rate of interest) what are some things that are effected ?
Housing market and consumption
Consumption
Government spending
Trade and exchange rates
Business investment
If interest rates fall how is the housing market and consumption effected ?
And when did this happen in the uk ?
Mortgages become cheaper because the interest rate charged by banks falls. This allows first-time house buyers take out more mortgages. The housing market booms.
As the housing market booms, existing homeowners experience a positive wealth effect because houses go up in value. They may take out larger mortgages giving them more to spend now (equity withdrawal effect).
Existing mortgage holders have lower monthly repayments so they may spend more elsewhere in economy.
Happened in the Uk after 2008 inflation rate was dropped to 0.5%
If interest rates fall how is consumption effected ?
Loans are cheaper. So people borrow more to finance consumption, especially consumer durables. AD rises, with ensuing positive multiplier effects.
The return on savings falls when the interest rate falls, and the opportunity cost of consuming falls, so can spend more.
If interest rates fall how government spending effected ?
Lower corporate borrowing rates means that the government can borrow money at an even lower interest rate.
The government can borrow more cheaply, so running a fiscal deficit (spending > tax revenue) is less negative (or important) than when interest rates are high.
But in a booming economy, tax revenues may rise, making a fiscal budget deficit less likely.
If interest rates fall how is trade and exchange rates effected ?
Lower interest rates means hot money (speculative money flows that chases the highest rate of return) flow out, which means there is an increase supply of sterling, and a fall in demand for sterling, causing the currency to depreciate.
This means imports become more expensive in domestic currency terms, exports become cheaper in foreign currency terms; ceteris paribus demand for M falls and X rises , so value of X rises and M falls and the trade deficit falls, so AD rises.
If interest rates fall how is investment effected ?
Loans are cheaper now, so easier to meet hurdle rate of return projects. This means more projects are undertaken, e.g. construction, so real GDP rises
Previously unprofitable projects now become profitable
What is quantitative easing (QE) ?
The central bank creates new money (adding zeros to their bank account).
They then use this new money to purchase bonds.
By selling the bonds to the central bank, commercial banks or pension funds now have more cash to spend elsewhere in the economy. So the new money is injected into the economy.
The BoE’s demand for government bonds increases their price, which brings down their yield (return). This means that the pension funds and banks go in search of a higher yield. For example, housing or the stock market.
But the pension funds or banks may hoard the money or invest it abroad.
What are issues of quantitative easing (QE) ?
Increasing the money supply could give rise to inflationary pressure because there is now more money chasing the same amount of goods - potentially causing prices to rise.
A criticism has been that it allowed financial institutions to hoard this money rather than invest it into the ‘real economy’ after 2008, another form of bail out.
But it is seen as a useful tool to stimulate the economy when interest rates are virtually as low as they can go (at a zero rate bound).
What’s the central bank of the uk ?
The Bank of England (BoE) is the central bank of the UK and was made operationally independent from the government in 1997
What are factors affecting the MPCs decisions ?
Inflation expectations.
Consumer spending forecasts.
Real GDP growth rate.
Exchange rate.
Trade balance
Consumer and firms’ confidence.
State of labour market, full employment, wage pressures – unemployment and employment trends.
How many percentage points of the inflation target (2%) is the BoE allowed to be in a range of before it has to write a letter to the Chancellor explaining why inflation is away from target ?
+/- 1
Can be inflation of 1% or 3% no above no under before the letter is sent
When was the last time the uk government set a target for exchange rate ?
The UK government has not set a target for the exchange rate since 1992.
What is the MPCs job ?
The MPC is the body within the Bank of England that is in charge of achieving price stability.
How many members are part of the MPC ?
It is made up of nine members – the Governor, the three Deputy Governors for Monetary Policy, Financial Stability and Markets and Banking, the Chief Economist and four external members appointed directly by the Chancellor
How often do the MPC meet and what do they vote on ?
They normally meet once a month to vote on whether there will be a change to monetary levers or not. The vote is determined by a simple majority with every member having an equal vote.
Buiter proposed creating digital currencies. This would mean that Central Banks can cut interest rates below 0%. They would be able to digitally reduce the amount of money in people’s bank accounts if the economy used a digital currency.
Buiter
What’s the issue with Buiters idea of a digital currency and being able to cut interest rates to below 0%
However, with the current system, if interest rates fell to -5%, people would just stop putting their money in the bank.
Why are negative interest rates unlikely to work in the traditional currency system?
People wouldn’t put money into banks
What is a government budget deficit ?
Budget deficit: When government spending exceeds government income (tax revenue)
What is a government budget surplus ?
When government spending is less than government income (tax revenue)
What are the macroeconomic functions of fiscal policies ?
Governments levy taxes so they can, among other things, redistribute income and wealth by giving out transfer payments (e.g. benefits) to reduce inequality.
What are the microeconomic functions of a fiscal policies ?
Governments levy taxes so they can, among other things, provide merit goods (e.g. NHS), provide public goods (e.g. clean drinking water, infrastructure), reduce negative externalities (e.g. pollution), and reduce consumption of demerit goods (e.g. cigarettes).
