2.6 Macro objectives and policies Flashcards
State the 6 macro objectives
4 main:
1) Economic growth
2) Low unemployment
3) Low and stable rate of inflation
4) Balance of payments equilibrium on current account
other:
5) Balanced government budget
6) Protection of the environment
7) Greater income equality
How are macro objectives met
governments are able to manage demand through monetary or fiscal policies.
in a recession - govt will increase AD
to decrease inflationary pressures - decrease AD
Explain low and stable inflation
target is 2% using the CPI
low inflation is desired as it is a symptom of economic growth
inflation is cost-push or demand pull
demand-side will ease demand-pull inflation
supply-side policies will ease cost push inflation
Explain low unemployment
Aim is to have near full employment, however there is always frictional unemployment - this means that the economy cannot be at 100% YFe
Economic growth as a macro objective
UK’s is around 2.5%
considered sustainable growth
politicians may use it to judge the effectiveness of their policies
1997-2007 steady growth fluctuating between 2-4%
2008-2015 global financial crisis followed by rapid bounce back due to govt intervention and then steady growth
2016-2019 gradual disinflation potentially due to future expectations regarding brexit vote
2020-22 decreased consumption due to covid and supply chain issues - creating deep recessions but were short-lived due to govt intervention
BoP equilibrium on current account as a macro obj
govts aim for an equilibrium, the UK traditionally is in deficit
Define demand side policies
policies designed to manipulate consumer demand
expansionary: increases AD to induce growth
deflationary: decreasing AD to control inflation
What are the 2 categories of demand-side policies
Monetary and Fiscal policy
Define fiscal policy
the use of government spending and taxation to manipulate the level of AD and improve the macroeconomic performance
govt is responsible for setting fiscal policies
Define monetary policy
where the central bank attempts to control the level of AD by altering base interest rates and the money supply in the economy
What are the monetary policy instruments
- incremental adjustments to the interest rate
- quantitative easing (increasing the money supply in the economy)
Explain how quantitative easing works
Central bank decides to stimulate the economy
Central bank buys govt bonds and assets from banks
Banks get more money → may lower IR → increased lending → economic recovery
Businesses and borrowers increase investment + consumption
Explain how increased interest rates cause a fall in AD [monetary]
^IR = ^cost of borrowing = fall investment and consumption. (withdrawals>injections)
Because less people are borrowing and more are saving there is a fall in demand for assets (i.e govt bonds, stocks and shares) = a fall in price for these assets = -ve wealth effects
if IR^, confidence (investment + consumption) falls, AD falls. Other loans (i.e. mortgage) also become more expensive. Individuals dedicate a higher proportion of their income to pay higher debts, meaning they have less disposable income to spend on other goods/services = low AD
Higher IR will increase the incentive for foreigners to hold their money in British Banks as they will receive a higher rate of return for their saving. ^D for £ = value to rise
Strengths of the monetary policy
The BofE operates independently from the Government (political process)
Is able to consider the long-term outlook
Targets inflation and maintains stable prices
Depreciating the currency can increase exports
Problems with monetary policy
→ exchange rate may be affected so much that exports fall significantly and imports rise, resulting in a balance of trade deficit
→ changes in IR can take up to 2 years to have full effect
→ high IR over a long period of time will decrease investment and LRAS falls
Problems with Quantitative Easing
Very risky and if not controlled it can lead to hyperinflation, this has large effects on the housing market. No guarantee that higher asset prices = increased consumption.
2 fiscal policy instruments
Fiscal Policy involves the use of government spending and taxation to influence AD in the economy
Examples of fiscal policy outcomes
increased income tax → decrease disposable income → decreasing C and AD
decreased corporation tax → firms net profits increase → investment by firms increases → AD increases → inflation increases
universal credit allowance increases → household income increases → consumption increases → AD increases → inflation
increases
Government Budget (Fiscal)
Deficit & Surplus
balanced budget, budget deficit, budget surplus
A budget deficit is financed through public sector borrowing, this borrowing gets added to the public debt
Direct and Indirect tax (Fiscal)
Direct tax is taxes imposed on income and wealth, they are paid to the govt directly.
→corporation tax, income tax, NI, inheritance tax and capital gains tax
Indirect tax: levied by the government on expenditure, by unit of consumption
Supplier is responsible for sending tax to govt, depending on the PES/PED the firm can pass on varying proportions to the consumer
→VAT
Strengths of the fiscal policy
Spending can be targeted on specific industries
Shorter time lag than monetary policy
Redistributes income through taxation
Reduces -ve externalities through taxation
Increased C of merit/public goods
SR govt spending can increase in LRAS
E.g.Buildinga new airportimmediately increases government spendingandAD,but
when itis built,thepotentialoutputwill haveincreased
Weaknesses of the fiscal policy
Policies can fluctuate significantly as governing parties’ change
Long term infrastructure projects may lack follow-through
Increased govt spending can create budget deficits
Repaying this debt may lead to austerity on future generations
Conflicts between objectives
E.g. Cutting taxes to increase EG may cause inflation
Diagrams illustrating demand-side policies
- expansionary policies will shift AD right, increasing GDP and PL
- contractionary policies will shift AD left, decreasing GDP and PL
Examples of contractionary policy
increasing IR
Increasing T
decreasing G
decreasing/stopping QE
