2.6 - Macroeconomic objectives and policies Content Flashcards

Question

# 2.6 Macroeconomic objectives and policies How can QE be evaluated? quantitative easing

Answer 1

* Banks have still been reluctant to lend -> Initially banks only lent to big companies as seen as less risk -> Government introduced funding for lending scheme (FLE) (2012) -> This attached conditions to QE and encouraged lending to SME's -> FLE not entirely successful * Consumers and businesses have been reluctant to borrow -> Consumer and business confidence low after the financial crisis. * Could create inflation -> Quantity theory of money -> More money is chasing a limited number of goods. * Could depreciate the currency -> Therefore, could create imported inflation as prices of imports increase.

Answer 2

The deliberate manipulation of government expenditure and taxation to influence the economy

Answer 3

* Increase Incentives to supply - Reduce corporation tax * Reform Labour market - abolish notice period * Improve labour force quality - ↑ Education, (increases human capital). * Promote competition - reduce sunk costs - breaks up monopolies. * Improve Infrastructure - build roads.

Answer 4

The ones which increase LRAS / SRAS with minimal spending.

Answer 5

Demand-side = fiscal or monetary. Supply-side = market-based or interventionist. Either can be expansionary or contractionary.

Answer 6

Improve the LR productive potential of the economy. | Pure supply-side policies achieve this with minimal government spending

Answer 7

1. Market-based policies -> aim to remove barries to efficient working of free market eg deregulation 2. Interventionist policies -> designed to correct market failure, intervening in free market to improve efficiency directly eg state provision of education due to free market under-provision

Answer 8

* Incentives * Enterprise * Technology * Mobility * Flexibility * Efficiency

Answer 9

1. **Lower unit costs**: Cost savings for businesses can bring lower prices, encouraging higher demand, more output and an increase in employment 1. **Improved competitiveness and trade performance (BoP) ** 1. **Higher profits**: Efficiency gains are a source of larger profits for companies which might be re-invested, However not all of the profit will be reinvested. It could be payed out to shareholders 1. **Higher wages**: Businesses can afford higher wages when their workers are more efficient 1. **Economic growth**: If an economy can raise productivity then the trend growth of national output can pick up 1. **Mobility**: Productivity improvements mean that labour can be released from one industry and be made available for another

Answer 10

1. Achieve a sustained improvement in the possible trade-off between inflation and unemployment (see Phillips Curve) 1. Be more flexible in response to external demand and supply-side shocks such as rising energy prices 1. Raise living standards through stronger long term economic growth / an increase in underlying trend rate of growth 1. Reduce unemployment by lowering the natural rate of unemployment (less frictional & structural unemployment) 1. Improve competitiveness in global markets and achieve a stronger balance of trade in goods and services

Answer 11

1. Supply-side policies have long time lags – especially when they are trying to achieve structural changes 1. The level of aggregate demand is also important in making business investment and innovation viable 1. Some supply-side policies (e.g. cutting higher-rate income taxes) might lead to greater inequalities of income & wealth 1. State intervention to “pick winners” in different industries may be ineffective – there are risks of government failure 1. Sustainability issues if policies aim to raise a country’s long term growth rate – leading to increased externalities such as pollution 1. Supply-side policies look to achieve relative improvements e.g. In productivity – but other countries will be making gains too

Answer 12

* **Cutting government spending** (including welfare) and borrowing – forces people back to work * **Lower business taxes** to stimulate capital investment * **Lower income taxes** to improve work incentives – encourages people to get a full time job as they get more money to take home * **Reducing red-tape to cut the costs of doing business** – Getting things liscned to sell in the EU and EU and britan have different regulations * **Improving the flexibility of the labour market** including reforming employment laws and encouraging more part time work * **Competition policies such as deregulation & anti-cartel laws** * **Privatisation of state assets** – transferred to the private sector

Answer 13

* State investment in public services and critical infrastructure – energy, electricity, transport and health services * A commitment to a minimum wage and/or living wage to improve work incentives & productivity in the labour market * Higher taxes on the wealthy to fund public and merit goods * An active regional policy to inject extra demand into under-performing areas / regions of persistently high unemployment / low per capita income – e.g. the Government’s Northern Powerhouse Project * Selective import controls to allow domestic industries to expand – taxes on farming goods to make uk produce more competative * Management of the exchange rate to improve competitiveness * Nationalisation of and/or stronger regulation of key industries

Answer 14

1. Inflation is too high -> Assume rate of inflation is too high -> one way to reduce inflation is to lower AD for example by lowering consumer or gov spending -> this is likely to lead to a recession meaing economic growth is -ve 2. Growth is too low -> Assume rate of economic growth is too low -> can raise it with AD leading to lower unemployment and increased inflation -> also likely to increase incomes and therefore imports worsening the current account position (ceteris paribus) which is a conflict 3. Unemployment too high -> If unemployment is too high a way of reducing it is to stimulate AD, however this may conflict with policies relating to inflation and the current account 4. Current account is deeply in the red -> If imports are far greater than exports then there may be difficulties for an economy in financing this deficit -> cutting current account deficit by reducing domestic consumption and investment will conflict with unemployment targets 5. Fiscal deficit too high -> If gov borrowing is too high a % of GDP gov may raise taxation and reduce spending -> such measures will inevitably conflict with unemployment objectives

Answer 15

* One example of conflicting macroeconomic objectives * Describes the statistical relationship between the rate of employment and the rate of change of money wages (Phillps curve) Money wages are the most important cost to producers * When wage rates increase faster than productivity -> costs increase for firms -> they therefore increase their prices

Answer 16

1. **Changes in interest rates** -> Gov may use interest rates to influence AD and therefore inflation and unemployment in the short term -> however persistently high interest rates will damage long term investment and hence long term growth -> will also likely raise the value of the currency leading to a worsening of the current account 2. **Supply-side policies** -> Supply-side policies should increase the productive potential of an economy leading to a shift in LRAS and therefore a reduction in inflation in the long run -> However -> policies that encourage investment in physical capital will lead to higher AD in the short term and therefore increase inflationary pressures 3. **Fiscal deficits** -> Countries which have fiscal deficits that are too high may attempt to reduce this by cutting gov spending and raising taxes -> will lead to higher unemployment and lower growth in the short term

Answer 17

When there is spare capacity, govt. spending could lead to 'crowding in', as spending is facilitated through the multiplier. Crowding out doesn't occur in a liqudity trap / when secular stagnation theory is present.

Answer 18

When higher govt. spending leads to larger private sector investment.

Answer 19

When higher government spending, financed by borrowing causes a reduction in private sector investment.

Answer 20

* More govt. borrowing = more sales of govt. bonds = individuals have less to spend on investment. * More govt. borrowing = increased interest rates = lower MEC (expected rate of return) on private sector investment.

Answer 21

Induced saving, due to larger eco growth (H-D model).

Answer 22

Inflation characterised by high interest rates. Govt. spending G. will lessen real interest rates (Loanable funds theory). (Encouraging private sector investment). (Inflation also reduces the real value of interest rates).

Answer 23

This is only useful if interest rates are low and 'sticky' i.e. liquidity trap. (During times of deflation, real interest rates are increase, due to fisher equation: real i = nominal i - inflation).

Answer 24

It is simply the same as the positive multiplier effect:

Answer 25

Human capital flight due to excessively high top rate of tax.

Answer 26

Idea tax cuts financed by govt. borrowing doesn't change consumption as consumers anticipate future tax increase.

Answer 27

That consumers are rational and realise future taxes will have to rise. Life-cycle hypothesis - consumers want to smooth their consumption over their lifetime.

Answer 28

Consumers want to smooth consumption over life time. Therefore will save following a tax cut in anticipation to pay future tax rise. (Life-cycle hypothesis is an assumption in the Ricardian theory of equivalence).

Answer 29

If tax cuts, increase disposable income in the short-term, then it reduces disposable income in the long-term (due to expectations of future tax rises). Therefore, a rational consumer believes their lifetime income is unchanged by a tax-cut.

Answer 30

Spare capacity, so tax cuts incentivise use of spare capacity - (private sector saving). This is crowding in.

Answer 31

If taxes are high, there is little incentive for workers to work and give up benefits.

Answer 32

* If the economy is not growing and the same amount is being produced year after year, investment will remain the same * Firms will only replace depreciated capital but there will be no need to increase beyond this level * In contrast, if the world economy is expanding, firms will need to increase investment to produce more goods and services * If in a recession, demand is falling and therefore firms will not need to replace their capital which is wearing out as with lower output less capital is needed -> hence investment will fall in a recession * Idea that investment is linked to output in an economy is the accelerator theory

Answer 33

* Domestic Income: Higher incomes at home boost spending, including on imports, which may worsen the trade balance (e.g., rising U.S. incomes often increase imports from China). * Foreign Income: Higher incomes abroad drive demand for exports, which can improve the trade balance (e.g., China's economic growth boosts its imports from Germany and Australia).

Answer 34

* Depreciation: A weaker currency lowers export costs and raises import prices, boosting the trade balance. Example: Post-Brexit, the depreciated British pound boosted UK exports. * Appreciation: A stronger currency raises export costs and lowers import prices, hurting the trade balance. Example: The strengthened Swiss franc made Swiss goods more expensive abroad.

2.6 - Macroeconomic objectives and policies Content Flashcards

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