2.6 Flashcards
(20 cards)
Possible macroeconomic objectives
- Economic growth
- Low unemployment
- Low inflation
- Balance of payment equilibrium
- Balanced government budget
- Protection of environment
- Greater income equality
What are demand side policies?
Policies designed to manipulate consumer demand
What is monetary policy?
Monetary policy is where central bank attempts to control level of AD by altering base interest rates
Expansionary monetary policy is low interest rates but contractionary monetary policy is high interest rates
-High interest rates cause a fall in AD
– Increases cost of borrowing for firms and consumers. This will cause a fall in consumption and investment and makes savings more attractive
– Fall in demand for assets so fall in prices for assets. Therefore, consumers will experience a negative wealth effect leading to a fall in consumption
– People will become less confident which leads to a fall in consumption and investment
– Increases incentive for foreigners to hold money in British banks with higher rate of return. Therefore, value of pound rises so net trade decreases.
What is quantitative easing?
Quantitative easing is when the Bank of England buys assets in exchanging for money to increase money supply. It can prevent liquidity trap, when even low interest rates can’t stimulate demand.
-Asset prices rise which will cause a positive wealth effect so consumption will increase
-Money supply increases which increases consumption and investment
-Commercial banks may lower interest rates which will encourage borrowing thus increasing consumption/investment
What are the problems with quantitative easing?
-Could cause hyperinflation
-No guarantee higher asset pries will lead to higher consumption
-Rising share prices increases income inequality
What is fiscal policy?
Use of borrowing, government spending and taxation to manipulate level of AD
-A rise in income tax will cause a fall in disposable income. This will lead to a reduction in consumption thus AD falls
-Rise in government spending will increase AD
What is a budget deficit and surplus?
A budget deficit is where the government spends more money than they receive. A budget surplus is when the government receives more money than they spend.
What are direct and indirect taxes?
Direct taxes are paid directly to the government by the taxpayer e.g. income tax
Indirect taxes is where the person charged with paying the money to the government is able to pass the cost to someone else e.g. VAT
What is the role of the Bank of England?
-Bank of England controls monetary policy
-Aims to keep inflation at 2%
-Policies are decided by majority votes
-MPC contains 9 members that meet 8 times a year
Effects of great depression?
By 1932, USA unemployment rate was at 25%
In the UK, unemployment doubled and exports halved
UK:
-Government prioritises a balanced government budget
-They cut public sector wages and unemployment benefits by 10% which reduced consumption
-Raise income tax which decreased disposable income
-Pound depreciated so exports increase
-Bank rate lowered
US:
-Roosevelt’s new deal provided large government spending on infrastructure
-Protectionism increased to increase domestic production and consumption
-Bank rate cut from 6% to 4%
Effects of global financial crisis
Crisis linked to interest rates and risky lending in property market
Unemployment doubled in US
UK unemployment rose from 5.2% to 7.8%
US:
-Significant government spending and expansionary fiscal policy
-Economic stimulus act and reinvestment act increased AD and helped the economy to recover quickly
-Bank of England cut bank rate
-Several rounds of quantitative easing
UK:
-Significant government spending and expansionary fiscal policy
-Banks weren’t allowed to fail and supported by government
-Major injection by government of 35bn
-Bank of England cut bank rate
-Several rounds of quantitative easing
Strengths and weaknesses of monetary policy
Strengths:
-Bank of England operates independently from government
-Targets inflation and maintains stable prices
-Depreciating currency can increase exports
Weaknesses:
-Conflicting goals
-Time lag between policy and desired impact
-Cheaper credit can inflate asset prices
Strengths and weaknesses of fiscal policy
Strengths:
-Short time lag
-Redistributes income through taxation
-Reduces negative externalities through taxation
-Increased consumption of merit and public goods
Weaknesses:
-Increased government spending can create budget deficits
-Conflicts between objectives
What are supply side policies?
Government policies aimed at increasing productive potential of the economy
What are market-based policies?
Aim to remove role of the government to increase supply
-Tax reform
Lower income tax - motivates workers to work harder increasing productivity
Lower corporation tax - Firms have more retained profit to invest
-Labour market reform
Reduce benefits - incentivises unemployed to enter labour force
Reduce minimum wages and trade union power - reduces cost of production which boosts productive efficiency
-Competition policy
Privatisation, deregulation and trade liberalisation increase competition
What are interventionist policies?
Require direct government intervention to increase full employment level of output
-Government spending on education/training
Causes the quality of FoPs to increase
-Government spending on infrastructure
Increases productive efficiency and increases quantity of FoPs
-Subsidies to firms to promote investment
Increases quantity and quality of FoPs
Evaluation of supply side policies
-No guarantee of success
-Very costly policies which if doesn’t work, is a waste of resources
-Time lags e.g. govt. spending on infrastructure could take years
-Certain market reforms are difficult for people already living in poor living standards
Trade-offs
Economic growth and inflation - increasing economic growth causes economy to move closer to inflation. Inflation may outpace target of 2%
Economic growth and environmental sustainability - growth often increases pollution, negative externalities and depletion of non renewable resources
Economic growth and equality - the profits of owners are disproportionate to increase in worker wages leading to income equality
Economic growth and balanced budget - driven by expansionary fiscal policy causes budget deficit
Economic growth and current account - higher income leads to imports increasing so net trade decreases
Low unemployment / low inflation - less workers available to hire at full employment
What is the short-run Phillips curve?
Observes a trade-off between unemployment and inflation
-High inflation means low unemployment
-Low inflation means high unemployment
Factors considered when setting Bank rate
-Economic growth - Including GDP growth, unemployment rates and consumer spending. They aim to stimulate growth during periods of economic slowdown by lowering interest rates
-Labour market conditions - Including wage growth and unemployment rates, to gauge the potential for inflation or deflation
-Movement in consumer and business confidence - When confidence is high, MPC may consider raising the bank rate to manage potential inflationary pressures
-Movement in country’s exchange rate - A stronger exchange rate can lead to lower inflation, allowing the MPC to ease monetary policy. Whereas a weak exchange rate leads to higher inflation, so tighten monetary policy
-House prices - An indicator of overall economy. Rising house prices can contribute to inflationary pressures, so MPC may need to respond to this to keep inflation at 2%
