2.6 - macroeconomic objectives and policies Flashcards
(111 cards)
1
Q
2.6.1 - [ possible macroeconomic objectives]
all 7 possible macroeconomic objectives?
A
-economic growth
-low unemployment
-low and stable rate of inflation
-balance of payments on the current account
-balanced gov budget
-protection of the environment
-greater income inequality
2
Q
economic growth?
A
~a central macroeconomic aim
~target of 2%
~2% is considered sustainable growth –> less likely to cause demand pull inflation
~has positive impacts on confidence, consumption, investment, employment, incomes, living standards and gov budgets
3
Q
what is the definition of economic growth?
A
Economic growth refers to an increase in the production of goods and services in an economy over a period of time, typically measured as the percentage increase in real GDP.
4
Q
benefits of economic growth?
A
Higher Living Standards: Increased income and improved quality of life.
Example: Rapid growth in China lifting millions out of poverty.
Employment: More job opportunities as firms expand.
Example: Technology sector growth creating jobs in the U.S.
5
Q
costs of economic growth?
A
Inflation: Rapid growth can lead to rising prices.
Example: Hyperinflation in Venezuela.
Environmental Impact: Increased production can harm the environment.
Example: Deforestation in the Amazon.
6
Q
low unemployment?
A
-UK target is 4-5%
-this is close to full employment level of labour
-there will always be a level of frictional employment
-unemployment tends to be inversely proportional to real GDP growth
7
Q
definition of low unemployment?
A
Low unemployment means that a large proportion of the labour force is employed, leading to higher income and production levels in the economy.
8
Q
benefits of low unemployment?
A
Higher Income: More people earning wages.
Example: Low unemployment rates in Germany contributing to high standards of living.
Social Stability: Reduced poverty and social unrest.
9
Q
costs of low unemployment?
A
Inflation: Low unemployment can drive wages up, leading to inflation.
Example: Phillips Curve theory where lower unemployment leads to higher inflation.
Skill Mismatches: Over time, job types change, and not all workers may have the skills needed.
10
Q
low and stable rate of inflation?
A
-UK target of 2% using consumer price index [CPI]
-low rate indicates economic growth
-different causes of inflation require different response from the gov
-high inflation rates reduce the purchasing power of consumers
-low and stable inflation allows confidence in planning investments and price stability
11
Q
definition of low and stable inflation?
A
A low and stable rate of inflation means that prices of goods and services rise slowly and predictably over time.
12
Q
benefits of a low and stable rate of inflation?
A
Predictability: Helps businesses plan for the future.
Example: The European Central Bank targeting 2% inflation.
Maintained Purchasing Power: Protects consumer savings.
13
Q
costs of a low and stable inflation rate?
A
Interest Rates: Low inflation can lead to low-interest rates, which may not always stimulate investment.
Example: Japan’s experience with low inflation and near-zero interest rates.
Deflation Risk: If inflation is too low, the economy may slip into deflation, which can be harmful.
14
Q
balance of payments on the current account?
A
-the BoP for a country is a record of all the financial transactions related to exports and imports that occur between that country and the rest of the world
exports > imports = surplus
exports < imports = deficit
-deficits cause a problem in the long run
15
Q
definition Balance of Payments Equilibrium on Current Account?
A
This refers to a situation where the value of exports of goods and services is roughly equal to the value of imports, avoiding large deficits or surpluses.
16
Q
benefits of balance of payments equilibrium on the current account?
A
Economic Stability: Reduces reliance on foreign debt.
Example: Germany’s balanced current account contributing to economic stability.
Exchange Rate Stability: Avoids large fluctuations in currency value.
17
Q
costs of balance of payments equilibrium on the current account?
A
Export Dependency: Too much focus on exports can make the economy vulnerable to global downturns.
Example: South Korea’s dependence on exports makes it sensitive to global market changes.
Consumption Sacrifice: May require reduced domestic consumption to balance trade.
18
Q
balanced government budget?
A
-the gov budget is presented annually and includes the forecasted revenue and expenditure
-
19
Q
definition of a balanced government budget?
A
A balanced budget occurs when government revenues equal government expenditures over a fiscal period.
20
Q
benefits of a balanced government budget?
A
Debt Control: Prevents the accumulation of national debt.
Example: Sweden’s fiscal policies aimed at balancing the budget.
Investor Confidence: Attracts foreign investment by showing fiscal responsibility.
21
Q
costs of a balanced government budget?
A
Public Services: May require cuts in public services or higher taxes.
Example: Austerity measures in Greece leading to public unrest.
Flexibility: Reduces government’s ability to respond to economic crises.
22
Q
protection of the environment?
A
-in April 2021, the UK gov stated their environmental aim was to reduce emissions by around 78%
~broader environmental aims include ;
a focus on sustainability
100% energy from renewable sources
23
Q
definition of protection of the environment?
A
This involves policies aimed at reducing pollution, conserving natural resources, and promoting sustainable practices.
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Q
benefits of protecting the environment?
A
Sustainable Development: Ensures resources are available for future generations.
Example: Denmark’s investment in renewable energy.
Health Benefits: Reduces pollution-related health issues.
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costs of protecting the environment?
Economic Trade-Offs: Environmental regulations can increase production costs.
Example: Restrictions on fossil fuels affecting energy industries.
Competitive Disadvantage: Stricter regulations can make domestic firms less competitive internationally.
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greater income equality?
-high levels of income inequality creates social unrest
-perfect income equality is not desirable as it removes the incentive to work
-unchecked capitalism has a natural outcome of high income inequality
-concentration of ownership becomes more narrow
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definition of greater income equality?
Greater income equality means a more equitable distribution of income across society, reducing the gap between the rich and the poor.
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benefits of greater income equality?
Social Cohesion: Reduces social tensions and promotes fairness.
Example: Nordic countries with low Gini coefficients and high social trust.
Economic Stability: More equal societies tend to have more stable economies.
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costs of greater income equality?
Incentives: High redistribution may reduce incentives to work and invest.
Example: Debate over high taxation in France leading to wealth flight.
Government Spending: Requires significant government intervention and spending
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2.6.2 - [demand-side policies]
what do demand-side policies aim to do?
-aim to shift aggregate demand
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2 main categories of demand-side policies?
-fiscal policies
-monetary policy
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what is fiscal policy?
-involves the use of gov spending and taxation to influence AD
-gov are responsible for fiscal policy
-adjusting government spending or taxation in order to effect the macroeconomy. Fiscal policy is undertaken by the government administration.
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what is monetary policy?
-involves adjusting interest rates and the money supply to influence AD
-bank of England responsible for for setting monetary policy
-adjusting the supply or price of money in order to effect the macroeconomy. Monetary policy is usually undertaken by the Central Bank.
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2 main monetary policy instruments?
-incremental adjustments to interest rates
-quantitative easing which increases the money supply in the economy
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transmission mechanism?
the process(es) by which changes in monetary policy end up affecting the real the economy.
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Policy tools or “instruments?
these are the specific actions taken by the bank or government in order to affect the economy.
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what does monetary policy involve?
Monetary policy involves the actions taken by a country's central bank to influence the availability and cost of money and credit to achieve macroeconomic objectives such as controlling inflation, maintaining employment, and achieving economic growth.
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Lowering Interest Rates?
Encourages borrowing and spending by consumers and businesses, stimulating economic growth.
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definition of interest rates?
The interest rate is the cost of borrowing money or the return on savings, set by the central bank to influence economic activity.
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Raising Interest Rates: ?
Discourages borrowing and spending, aiming to cool down an overheated economy and control inflation.
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Short-term Impact interest rates?
Immediate influence on borrowing costs and economic activity.
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Long-term impact interest rates?
Influences expectations about future inflation and economic condition
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A rise in interest rates causes a fall in AD through four key mechanisms:
-increase costs of borrowing
-less confidents
-rise in the value of the pound
Increased MPS/
Decreased MPC
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A rise in interest rates causes a fall in AD through three key mechanisms: increase in borrowing costs
This will lead to a fall in investment , reducing AD. . Higher interest rates require higher rates of return for investment. It also makes savings more attractive, as the interest earnt on them will be higher
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A rise in interest rates causes a fall in AD through four key mechanisms: Increased MPS/
Decreased MPC
Increased MPS/
Decreased MPC
= decreased consumption as less spending so decrease in AD
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A rise in interest rates causes a fall in AD through
four key mechanisms: less confident
-less confident about borrowing and spending if interest rates
rise. The fall in consumer and business confidence leads to a fall in consumption and
investment, causing a fall in AD. On top of this, other loans, such as mortgages, will
become more expensive to repay and so consumers have to dedicate more of their
income to paying back these debts. This means they have less income to spend on
goods and services, so consumption will fall, causing AD to fall.
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A rise in interest rates causes a fall in AD through
four key mechanisms: rise in the value of the pound
higher rates will increase the incentive for foreigners to hold their money in British
banks as they can see a higher rate of return. As a result, there will be increased
demand for pounds and the value of the pound will rise . This means that imports
will be cheaper, and exports will be more expensive. This decreases net trade and
therefore AD.
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problems with changing interest rates?
-Time lags - Delayed Effects: Monetary policy decisions, especially those involving interest rates, may take several months to fully impact the economy. For example, changes in interest rates can take time to influence consumer spending and business investment.
Uncertainty: Time lags make it difficult to predict the exact impact of monetary policy, potentially leading to over- or under-reactions.
-Liquidity Trap: When interest rates are very low, further reductions may have little effect on stimulating demand, as people and businesses may prefer to hold onto cash rather than spend or invest it.
Deflationary Pressures: In a deep recession, deflation can set in, making monetary policy less effective as consumers and businesses delay spending in anticipation of lower prices.
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what is a Liquidity Trap?
A situation in which low or zero interest rates fail to stimulate economic activity.
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what is quantitative easing?
The Central Bank can create new money and then “swap” it (or “asset purchase”) bonds held by Banks.
These banks now have more money
They therefore want to lend it out hence increasing the supply of money.
Therefore, leading to a decrease in the market rate of interest rate.
BoE creates new money to buy bonds.
New money increases money supply
Increased money supply lowers interest rates.
Lower interest rates change:
Consumption
Investment
Exchange rates
supply of money shifts right
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definition Asset Purchases to Increase the Money Supply (Quantitative Easing)?
Quantitative easing (QE) is a non-traditional monetary policy tool where the central bank buys financial assets to inject liquidity into the economy.
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What are the main aims of quantitative easing?
The main aims of quantitative easing are to support the level of aggregate demand so that real output can be maintained and inflation can be kept close to the published target.
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quantitative easing mechanism?
Purchasing Assets: Central banks buy government bonds and other financial assets, increasing the money supply and lowering interest rates on these assets.
Encouraging Investment: Lower yields on bonds push investors towards riskier assets like stocks, stimulating economic activity.
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effectiveness of QE?
Liquidity Injection: Increases bank reserves, encouraging lending.
Market Confidence: Signals the central bank's commitment to supporting the economy.
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definition of intervention in currency markets?
Currency market intervention involves the buying or selling of a country’s currency by its central bank to influence the exchange rate.
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intervention in currency markets mechanism?
Buying Domestic Currency: Reduces money supply, increasing its value.
Selling Domestic Currency: Increases money supply, decreasing its value.
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how does QE work in the currency market?
. An increase in the supply of money with domestic interest rates falling may lead to an outflow of hot money from the commercial banking system to other countries (in search of a better return) and this may cause the exchange rate to depreciate. A weaker currency has a net expansionary effect on aggregate demand (e.g. through an increase in net exports).
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effectiveness of intervention in currency markets?
Exchange Rate Stability: Helps stabilize the currency, supporting trade and investment.
Competitive Exports: A weaker domestic currency makes exports cheaper and more competitive globally.
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Arguments for quantitative easing (UK context)
Important for the central bank to have additional policy instruments other than changing interest rates especially if the economy is experiencing a liquidity trap
Use of QE likely to have staved off the threat of a deflationary depression post 2008. Without QE, the fall in real GDP would have been deeper and the rise in unemployment greater.
Lower long term interest rates have kept business confidence higher and given the banking system extra deposits to use for lending
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There are two main ways the government can increase AD through fiscal policy...
- A rise in income tax will cause a fall in disposable income. This will lead to a
reduction in consumption and thus decrease AD. Alternatively, a rise in corporation
tax will decrease a firm’s post-tax profits. This will lead to a reduction in investment
and thus decrease AD.
● A rise in government spending will increase AD since it is one component.
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when are the govs government’s fiscal (spending, borrowing and taxation) plans announced?
outlined in the budget.
A budget deficit is when the government spends more money than they receive. A budget
surplus is when the government receives more money than they spend.
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Direct taxes?
- are paid directly to the government by the individual taxpayer
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indirect tax?
Indirect tax
is where the person charged with paying the money to the government is able to pass on the
cost to someone else
Depending on the PED and PES producers are able to pass on a proportion ofthe indirecttax
to the consumer
The lower a consumer spends the less indirect tax they pay
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There are problems which need to be considered when evaluating fiscal policy
Government spending also impacts LRAS. For example, by cutting government
spending to reduce AD, the government may be reducing the quality of education or
spending on research and technology.
o Taxes and spending have an impact on inequality, so some decisions aimed to
reduce/increase demand may increase income inequality. They also have an impact
on incentives, for example high taxes reduce incentives.
The impact of fiscal policy depends on the multiplier : the bigger the multiplier, the
bigger the impact on AD.
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what do classical economists argue about demand side policies?
, will have no effect on long-run output so supply side policies should be
used. They believe that increasing AD during a depression will have no effect other
than to increase prices. If the economy is in short-run disequilibrium, it will quickly
return to long run equilibrium, whilst Keynesians argue that it can be in long-run
equilibrium for years.
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Keynisian LRAS; opinions on demand side policies?
On a Keynesian LRAS, the impact of changes in AD d epend on where the
economy is operating : if the economy is at full employment then a rise in AD will
only lead to higher prices. However, if unemployment is very high, then a rise in AD
will only lead to higher output.
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any other disadvantages of demand-side policies?
Both policies see significant time lags between their introduction and their full effect.
● The biggest issue of demand-side policies is that, in most cases, an expansionary
policy is inflationary whilst a deflationary policy brings unemployment. This
depends on the elasticity of the curve and the curve which you perceive to be correct
(Keynesian or classical), but holds in most scenarios. Thus, through demand
management, the government cannot bring about both low and stable inflation and
high economic growth/low unemployment.
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Monetary vs fiscal policy: ?
- Monetary policy is useful as the government is able to increase demand without
having to increase their spending, which would result in a larger fiscal deficit.
Classicists argue that if demand management is going to be done only monetary
policy should be used.
- Fiscal policy can have significant impacts on the supply side of the economy, for
example increases in spending on education to increase AD will also increase LRAS.
Moreover, it is more effective at targeting specific groups and reduce poverty, for
example by increasing benefits it can increase AD and reduce inequality.
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expansionary demand-side policies?
Demand-side policies that aim to increase aggregate demand are called expansionary policies
Expansionary monetary or
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causes of the great depression?
1-it may have been caused by the loss of consumer and business
confidence: shareholders lost money in the crash, others became worried about
what would happen, and firms cut back investment which led to a downward spiral in
AD.
2-US banking system . Banks had lent too
much during the 1920s, which had created an unsustainable boom and the system
was unable to deal with issues following the crash
3- Protectionism may also have been another cause of the Great Depression. It
reduced world trade which decreased AD and lowered confidence. Firms involved in
exports were no longer able to pay bank their loans, which caused bank failures
4- The UK was also affected by its commitment to the gold standard, in which its
currency was fixed to the value of gold and therefore fixed to other currencies.
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Policy responses in the UK: [great depression]
The UK government believed that balancing the government budget was key to
recovery and that borrowing money would prevent the private sector from doing so.
They introduced an emergency budget which cut public sector wages and
unemployment benefit by 10% and raised income tax from 22.5% to 25%. This
reduced AD at a time when it needed to be increased.
-The pound came under attack from speculators and needed to be defended to
prevent the UK being forced out of the gold standard. A balanced budget meant the
UK didn’t have to borrow from abroad, which helped the exchange rate as did the
high interest rates used to defend the high exchange rate. However, the high
interest rates also decreased demand.
● The UK was forced to leave the gold standard on 21st
September 1931 due to
continued speculation against it. This caused the value of the pound to fall by 25%
compared to other currencies and allowed the Bank of England to cut interest rates
by 2.5%, both of which helped the increase AD by increasing exports or increasing
consumption/investment.
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Policy responses in the USA:
[great depression]
-● The US government originally had the same view over a balanced budget as the UK.
● However, Franklin Roosevelt was elected in 1932 with his New Deal which promised
public sector investment, work schemes for the unemployed and fiscal stimulus.
● The USA reached full employment in 1943 (two years after joining the war- the same
as Britain). Roosevelt’s New Deal is an example of Keynesian expansionary fiscal
policy but can be argued it was not large enough to be successful, although it did
have a large impact as the US unemployment figure was so high.
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definition of government budget deficit?
A budget deficit occurs when government expenditures exceed government revenues in a given fiscal year.
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implications of a government budget deficit?
The government must borrow money to cover the shortfall, increasing national debt.
Can stimulate economic activity during a recession by increasing public spending
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definition of a government budget surplus?
A budget surplus occurs when government revenues exceed government expenditures in a given fiscal year.
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implications of a government budget surplus?
Allows the government to pay down debt or save for future needs.
Can reduce aggregate demand if achieved through spending cuts or tax increases, potentially slowing economic growth
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key differences between gov budget surpluses and deficits:
economic impact
Deficit: Can boost economic activity in the short term but may lead to higher debt and interest payments in the long term.
Surplus: Can reduce debt and interest payments, providing more fiscal space for future needs, but may slow economic growth if achieved through austerity measures.
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key differences between gov budget surpluses and deficits:
policy implications
Deficit: Often used during recessions to stimulate the economy through increased public spending and tax cuts.
Surplus: Often aimed for during economic booms to prevent overheating and to build reserves for future downturns.
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Keynesian perspective; gov surplus and deficits?
supports the use of budget deficits during economic downturns to stimulate demand and reduce unemployment.
Advocates for surpluses during booms to prevent inflation and build reserves.
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classical perspective; surplus and deficit
Emphasizes balanced budgets and fiscal discipline.
Concerns about the long-term impact of deficits on national debt and interest rates.
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monetarist perspective; gov surplus and deficit
Focuses on controlling the money supply rather than fiscal measures.
Believes that fiscal policy should be predictable and sustainable to maintain investor confidence.
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Fiscal policy can play a major role in long-term economic growth by what?
promoting investment
encouraging business activity
addressing inequality
maintaining stability
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Fiscal policy can play a major role in long-term economic growth;
promoting investment?
Fiscal policy can encourage investment in infrastructure, education, and research and development, which can lead to a more productive economy in the long run.
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Fiscal policy can play a major role in long-term economic growth;
encouraging business activity
Tax incentives and other policies can encourage businesses to expand, invest, and hire more workers, leading to economic growth.
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Fiscal policy can play a major role in long-term economic growth;
addressing inequality
Fiscal policy can be used to redistribute income and wealth, which can help reduce inequality and create more equitable economic opportunities for everyone.
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Fiscal policy can play a major role in long-term economic growth,
maintaining stability?
Fiscal policy can be used to stabilise the economy during times of recession or inflation, helping to maintain economic growth in the long run.
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Fiscal policy can also be used to improve a country's infrastructure?
direct investment
tax incentives
public-private ownerships
bonds
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Fiscal policy can also be used to improve a country's infrastructure;
direct investment
The government can directly fund infrastructure projects through grants or loans, which can lead to new roads, bridges, and other infrastructure that improves transportation, communication, and trade.
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Fiscal policy can also be used to improve a country's infrastructure;
tax incentives
Tax incentives can encourage businesses to invest in infrastructure, such as through tax credits for investment in renewable energy, or deductions for research and development.
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Fiscal policy can also be used to improve a country's infrastructure;
public-private ownership
The government can work with private companies to develop and finance infrastructure projects, which can lead to faster and more efficient infrastructure development.
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Fiscal policy can also be used to improve a country's infrastructure;
bonds
: The government can issue bonds to finance infrastructure projects, which can provide a source of funding that doesn't rely on tax revenue.
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2.6.3 - [supply-side policies]
what do supply side policies aim to do?
-shift LRAS
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what are the 2 categories of supply side policies?
market based
and interventionist
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what are interventionist supply side policies?
interventionist supply-side policies require direct government intervention to increase the full
employment level of output
These are mainly used to correct market failure
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what are market based supply side polices?
Market-based supply-side policies aim to remove obstructions in the free market that are holding
back improvements to the long-run potential
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Market-Based Approach to increasing incentives?
Reducing income/corporation tax
rates
Restructuring the unemployment
bene
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Market-Based Approach to promoting competition?
Privatisation and deregulation
Trade liberalisation
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Market-Based Approach to reform the labour market?
Decreasing trade union power so
wages can be decreased
Decreasing minimum wages to lower costs of production
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interventionist approach to promote competition?
increased government
spending on innovation
Direct support to firms [subsidies] promotes international competitiveness
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interventionist approach to reform the labour market?
Increased government
spending on improving
occupational mobility
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interventionist approach to improve the skills
and quality of the
labour force?
Increasing government
spending on education and
retraining
Increasing government
spending on healthcare so
that productivity improves
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interventionist approach to improve infrastructure?
Increased government
spending on infrastructure
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strengths of supply side policies?
They increase the rate of growth of an economy
They reduce average price levels
They reduce unemployment
They often increase the value of net exports
Improvements in Infrastructure can raise the quality of life for all citizens
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weaknesses of supply side policies
The distribution of income worsens as labour market reforms and wage policies lower worker's wages
They are expensive to implement
There are significant time lags between expenditure and seeing the benefits
Vested interests can result in less effective results
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2.6.3 - [trade offs]
trade off between inflation and economic growth?
Increasing economic growth causes the economy to move closerto
full employment. Prices for remaining resources are bid up leading to inflation which may outpace the inflation target
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trade off between economic growth and environmental sustainability?
Economic growth often increases pollution, negative externalities
and the depletion of non-renewable resources. The higher the
growth, the faster the depletion
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trade off between economic growth and inequality?
During periods of high economic growth, the profits of the owners of the FOP receive are disproportionate to any increase in workers wages
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trade off between economic growth and balanced budget?
Economic growth driven by expansionary fiscal policy often requires a budget deficit
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trade off between economic growth and balancing the current account?
Economic growth usually leads to higherincomes which leads to an
increase in imports by households thereby worsening the current
account balance
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trade off between low unemployment and low inflation?
The closer an economy moves to full employment the less workers
will be available for hire and wage inflation and will help increase overall inflation
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