2.6 Macroeconomic Objectives and Policies Flashcards

Question

Monetary Supply Quantative Easing Problems

Answer 1

Risky and could lead to hyperinflation if not controlled Only increases demand for second hand goods No guarantee that higher asset prices lead to higher consumption Rising effect on housing market and share prices Economies may become too depedent on quantative easing

Answer 2

Monetary policy is controlled by BofE rather than goverment Monetary Policy Committee (MPC) make most decisions Aim is to keep inflation at 2% If inflation drops below 1% or higher than 3% then governor of BofE writes letter to Chancellor of Exchequer explaining and ways to bring to 2%

Answer 3

Increased income tax causes fall in disposable income Leads to reduction in consumption thus AD Rise in corporation tax decreases post-tax profits leading to reduction in investment thus AD Rise in goverment spending increases AD (component)

Answer 4

Government’s fiscal plans are outlined in budget Budget deficit is when government spends more than they receive Budget surplus is when government receives more than they spend

Answer 5

Direct taxes are paid directly to the government by the individual taxpayer Indirect tax is where person charged with paying money passes cost to someone else Income tax, national insurance, VAT, corporation tax

Answer 6

Government spending impacts LRAS Taxes and spending have an impact on inequality and incentives Government has to worry about political issues Expansionary fiscal policy is difficult to undertake during a period of austerity, government needs to consider effect of policies on budget

Answer 7

Classical economists argue any demand management has no effect on long-run output so supply side policies should be used Increasing AD during depression has no effect other than increasing prices If economy is in SR disequilibrium it will quickly return to LR equilibrium while Keynesians argue it takes years to return to LR equilibrium

Answer 8

On a Keynesian LRAS, impact of changes in AD depend on where economy is operating If economy is at full employment then a rise in AD only leads to higher prices If unemployment is very high then rise in AD only leads to higher output

Answer 9

Both policies see significant time lags between their introduction and their full effect

Answer 10

Expansionary policy is inflationary whilst deflationary policy brings unemployment Depends on elasticity of curve and the curve which you perceive to be correct (K or C) Thus through demand management, government cannot bring both low and stable inflation and high economic growth/low unemployment

Answer 11

Monetary is only useful as government is able to increase demand without increasing their spending which would result in a larger fiscal deficit Classicists argue if demand management is going to be done then only monetary should be used Fiscal policy have significant impacts on supply side For example, increases in spending on education to increase AD also increases LRAS More effective at targeting specific groups and reduce poverty

Answer 12

Severe global depression in the 1930s Unemployment in UK was over 15% and over 25% in US Areas most affects in UK were primary industry and the manufacturing industry which relied on exports and so were impacted by collapse of world trade

Answer 13

Loss of consumer and business confidence Shareholders lost money in crash Others became worried Firms cut back investments Led to a downward spiral in AD

Answer 14

Banks lent too much during 1920s Causes unsustainable boom System was unable to deal with issues following crash Government allowed banks to fail after crash Decreased confidence further and reduced loans to businesses and consumers Fall in AD

Answer 15

Reduced world trade which decreased AD and lowered confidence Firms involved in exporting were no longer able to pay back loans Causes bank failures in USA America introduced Smoot-Hawley Tarrif Act in 1930 Decreased imports to USA Countries that traded with America saw a reduction in exports causing AD decreases America also suffered from fall in exports as other countries retaliated

Answer 16

UK commitment to gold standard in which its currency was fixed to value of gold and therefore fixed to other currencies Left gold standard in 1914 but rejoined in 1925 at the 1914 level and value despite value of pound had fallen Rejoining of gold standard mesnt pound was appreciated rapidly and exports fall as they became more expensive UK went into Great Depression with an overvalued exchange rate

Answer 17

Government believed balancing government budget was key to recovery and borrowing money prevents private sector from doing so Introduced emergency budget which cut public sector wafes and unemployment benefits by 10% Raised income tax from 22.5% to 25% Reduced AD at a time when it needed to be increased

Answer 18

Pound came under attack from speculators and needed to be defended to protect UK being forced out gold standard Balanced budget meant UK did not have to borrow from abroad helping exchange rate as did the high interest rates used to defend the high exchange rate High interest rates also decreased demand

Answer 19

UK was forced to leave gold standard on 21st September 1931 due to continued speculation Caused value of pound to fall by 25% Allowed BofE to cut interest rates by 2.5% Helped increased AD by increasing exports or increasing consumption/investment

Answer 20

Recovery in London and South East Wales, the north and Scotland did not reach full employment until 1941

Answer 21

US government originally had the same view over a balanced budget as the UK

Answer 22

Franklin Roosevelt elected in 1932 with his New Deal which promised public sector investment, work schemes for unemployed and fiscal stimulus

Answer 23

USA reached full employment in 1943 Roosevelt’s New Deal is an example of Keynesian expansionary fiscal policy but it can be argued it was not large enough to be successful Although it did have a large impact as the US unemployment figure was too high

Answer 24

Many parallels between Great Depression and Global Financial Crisis Both started in US and spread throughout the world and both had large, long term effects on the economy Global Financial Crisis was less severe than Great Depression

Answer 25

Crisis started by issues in morgage lending in USA In early 2000s, poor people were encouraged to take our mortgages to buy their homes Example of moral hazard Given low interest rates for first few years Many no longer able to continue paying with higher repayments Houses were repossessed, demand fell, prices fell thus value of houses was no less than the mortgage of the house Negative Equity

Answer 26

Banks had been grouping prime mortgages (people likey to pay back loans) and sub-prime mortgages (people unlikely to pay back loans) Sold packages to other banks and investors if they were all prime mortgages Aim was to reduce risk since it meant no bank was highly dependant on risky mortgages Increases risk as many were now holding assets worth less than they had paid for them Spread effects of the housing crash and unpaid loans

Answer 27

When mortgage grouping was revealed, there was a fall in confidence and banks stop lending between each other fearing they would lose money if the other bank was to collapse Similar events occured in Europe

Answer 28

Both governments forced to nationalise banks and building societies and guarantee savers their money in order to prevent chaos of a collapsed banking system

Answer 29

Recorded low interest rates and quantative easing BofE said the QE led to lower unemployment and higher growth than would otherwise have been the case

Answer 30

USA government had mroe of a expansionary fiscal policy Perhaps why USA recovered faster In 2010, UK prioritised reducing National Debt over providing a fiscal stimulus USA did not make this decision until 2013

Answer 31

Government policies aimed at increasing productive potential of economy and moving supply curve to the right Over time, tends to be supply side improvements independant of the government through actions of private sector such as investment Government is able to use supply side policies to increase and speed up improvements May be across whole economy is in certain markets

Answer 32

Policies which are designed to remove anything that prevents free market system working efficiently causing lower output and higher prices These barriers include those which reduce willingness of workers to take jobs or lead to inefficient production, high prices or a lack of risk taking

Answer 33

Policies designed to correct market failure Girms may only look into short term and look to maximise short run profits to give shareholders instead of investing Government may take actions to encourage investment

Answer 34

Free market economists argue for market-based policies as they want government to have as small as a role as possible Economists who support interventionist policies suggest free market is not as efficient as people believe and so government needs to intervene to improve

Answer 35

Increasing incentives to go to work increases size of workforce meaning increased productions Increase incentives to take risks to invest People argue small change in any tax has little impact on people’s incentives to work Reductions of tax on high income earners leads to more income inequality and rediciotns means governments have less revenue leading to decreased spending or increased borrowing

Answer 36

Reduction in benefits/taxes increases opportunity to work Reduction in benefits prevents poverty/unemployment trap Women could be offered free childcare/flexible hours Taxes on firms when they take on new staff decreases incentivising increased employment Reduction/removal of minimum wage increases incentives to employ

Answer 37

Privitisation or deregulation makes firms more competitive Competition policy used to prevent monopolies and cartels Belief is that competition is necessary to make firms efficient as have tothey offer cheaper/better service than if there is no competition However, deregulation and privitisation may lead to poorer quality service and environmental issues

Answer 38

Increasing retirement age increases workforce Labour market could become flexible to make it efficient to respond to external changes - weaken trade unions, flexibility for chanigng employment contracts, higher mobility of labour Minimum wage scrapped prevents real-wage inflexibility unemployment Reduction of benefits incentivies work However, all methods could have a reverse effect and reduce employment further

Answer 39

Increase spending on education and training - more educated/skilled thus employable workforce Introduce regulations forcing businesses to continuously train staff Increase in high skilled migrants improves quality of workforce Improvements in skill makes workers more efficient However, education/skills need to be relevant otherwise it is a waste and opportunity cost is set on government as money on education can be spent elsewhere

Answer 40

Offer tax incentives or subsidies for investment Government spend money to improve infrastructure themselves Leads to technological advances thus more efficient However, tax breaks/subsidies could negatively affect government budget and put government in a deficit

Answer 41

Able to both increase output and decrease prices More long term policies leading to long term economic growth Can be direcred at exports improving BOP Allow two different types of approaches meaning both types of economists accept and use polciies

Answer 42

Keynesian LRAS curve shows no impact when LRAS is elastic so demand side policies are required to fix problem in SR Not all supply side policies work at increasing supply Government increases spending thus budget deficit Actions may have undesirable impacts on AD causing higher unemployment and inflation Time lag on effect on output is great

Answer 43

As economy grows, more resources are used As more resources are used, increased production of pollution and noise and destruction of natural habitats Economic growth can be achieved without damaging environment but growth is likely to be slower and have higher costs

Answer 44

Some countries have seen rapid economic growth leading to BOP problems Country is so large that industry is largely producing for its own people and wealth of people led to increased demand for imported goods Other countries may have increased production for increased exports thus BOP is in surplus

Answer 45

Phillips found a trade-off between inflation and unemployment, Phillips Curve Found existence of an empiral regularity, rate of change in wages rises unemployment fell Generalised to relationship between unemployment and inflation by arguing firms can pass on rise in wages to customer by increasing prices Reason is businesses know if there is high unemployment then low wages can be offered High employment thus scarcity of skilled labour thus high wages offered

Answer 46

Initially, the Phillips curve seemed to accurately show the relationship well. However, during the 1970s, we saw high levels of unemployment and low inflation, called stagflation.

Answer 47

Expansionary policies increase AD, to increase output, employment and economic growth but lead to increased finlation and worsen BOP as some of increased demand is met by imports However, delfationary policies decrease AD to improve inflation but will decrease employment and economic growth

Answer 48

Increase in interest rates will be used to decrease deflation Continuously high rates damage long term investment as less businesses want to invest decreasing long term growth Value of pound rises, decreasing exports and increasing imports, worsening BOP Interest rate affects distribution of wealth Low rates increase income inequality

Answer 49

Intend to increase AS and therefore improve long term economic growth Also able to decrease long term inflation but may increase in short term if they encourage investment as this increases AD Policies which decrease trade union power, reduce eages, lower benefits and change taxation may increase income inequality as these negatively affect poorest in country Some policies have adverse effects on budget or environment

Answer 50

In order to reduce fiscal deficits, government may decide to reduce government spending and increase taxes Will reduce AD and decrease short term economic growth and higher unemployment The higher the fall in output, the higher the fall in tax revenues therefore more ineffective they policy is Likely to affect income equality as poor are the ones who use government services