2.6 - Macroeconomic objectives and policies Flashcards
(47 cards)
What are the macroeconomic objectives? (7)
1- Economic growth: sustainable growth at 2%
2- Low unemployment: Governments aim for an unemployment at 4%
3- Low and stable rate of inflation: Government target is 2%
4- Balance of payment equilibrium on the current account: Avoid large deficits or surpluses in trade.
5- Balanced government budget: spending = revenue, so national debt doesn’t escalate.
6- Greater income equality: This reduces the gap between the rich and the poor.
7- Protection of the environment: It ensures resources are not exploited and that they are used sustainably
What is a Demand-side policy?
It is any deliberate action taken by governments or monetary authorities to shift the AD curve.
What are the two types of demand side policies (with a small explanation) ?
1- Fiscal Policy: the manipulation of government spending and taxation in order to influence AD
2- Monetary Policy: where the central bank or regulatory authorities influences the level of AD, by altering interest rates or the level of money in an economy.
What is an interest rate?
It is the cost of borrowing money or the reward for saving.
What are the 2 monetary policy instruments?
1- Interest rates
2- Asset purchasing
What is the base interest rate?
The base interest rate is the interest rate that the central bank will charge commercial banks for loans.
How are interest rates used to reduce aggregate demand and therefore inflation? (use a AD/AS diagram)
When interest rates are increased the cost of borrowing increases for consumers and firms as repayments of loans rise, the reward for saving increases due to greater repayments. As a result consumption and investment are likely to fall thus reducing AD and decreasing the price level. This is known as a deflationary monetary policy
How are interest rates to increase AD?
The MPC may reduce the base interest rate. This means there is a reduction of the costs of borrowing for consumers and firms, meaning consumption and investment are likely to increase. Additionally saving is less attractive as repayments are lower. As a result AD increases and the price level may increase.
What is Quantitative easing?
It refers to the the purchasing of government bonds or other financial assets in exchange for money by the central bank as a means to increase the supply of money and stimulate the economy.
Explain how quantitative easing can increase AD.
The central bank buys government bonds (or similar assets) from banks and investors in exchange for money it creates electronically.
Banks now have more money which means they can loan more money to consumers and firms. This increases consumption and investment. As AD = C+I+G+ (X-M).
Asset prices rise due to the increased demand. This causes positive wealth effects meaning an increase in consumption. Moreover the rise in asset prices results in the yield falling (yield is the return on a bond), consequently lower interest rates are offered which decreases the costs of borrowing, leading to an increase in spending and thus AD.
What is a problem with quantitative easing?
1- It is very risky and if not controlled properly could cause high inflation
What are the 2 fiscal policy instruments?
1- Government expenditure
2- Taxation
What are the 2 forms of taxation?
1- Direct taxes: taxes on incomes such as income tax and corporation tax.
2- Indirect taxes: taxes on spending such as VAT.
How would Fiscal policy be used to reduce AD?
Reduce government expenditure which is a factor of AD.
Increase taxes: an increase in income tax, would reduce disposable income for consumers and thus reduce consumption. An increase in corporation tax would reduce investment which is a factor of AD.,
How would Fiscal policy be used to increase AD.
Increase government expenditure which is a factor of AD.
Decrease taxes: A decrease in income tax means consumers take home more money and thus consumption increases. A decrease in corporation tax means firms can increase investment.
What is the name for when fiscal policy is used to increase AD?
Expansionary Fiscal Policy.
What us the name for when fiscal policy is used to decrease AD?
Contractionary Fiscal Policy
When does a government budget (fiscal) deficit occur?
When government spending is greater than the revenue it receives from taxation.
When does a government budget (fiscal) surplus occur?
When government spending is less than the revenue it receives from taxation.
Why does AD rise when there is a government budget deficit?
There will be an increase in AD, as a deficit means government spending is greater than taxation, thus implying government spending has increased which is a factor of AD, or that taxation has decreased which means consumers have more income and firms keep more revenue. As a result consumption and investment increase.
Why does AD fall when there is a government budget surplus?
A government budget surplus implies government spending is less the the revenue it receives via taxation. This implies that there is a decrease in government expenditure which is a factor of AD meaning AD will decrease. It may also suggest that taxation has increased which means a decrease in disposable income and thus a decrease in consumption / investment.
What is the role and operation of the Bank of England’s Monetary Policy Committee
The monetary policy committee (MPC) of the Bank of England sets the base interest rates. The MPC meets every month to look at the factors that are likely to influence the rate of inflation over the coming 18 months. As it is a monthly meeting, the MPC votes to determine whether to raise, lower or leave the base interest rate. The MPC is required to use its monetary tools to meet the governments inflation target of 2%. If the target 2% is missed by 1% either side, the Bank of England is required to explain the reasons why and how it intends to restore the rate of inflation to 2%.
What were the causes of the Great Depression of 1929.
The Great Depression was set off by the Wall street crash of 1929 when there was a sharp fall in share prices on the New York stock exchange. Economists had different views in what they believed caused the depression:
1- Loss of consumer and business confidence.
2- Caused by the 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: It reduced world trade which decreased AD and lowered confidence. Firms involved involved in exports were no longer able to pay their bank loans which caused bank failures in the USA. America introduced the Smoot-Hawley Tariff act in 1930 which decreased imports into the USA. Countries which traded with America saw a reduction in exports which decreased AD in their countries. America also faced a fall in exports as other countries retaliated.
4- The UK was affected by its commitment to the gold standard. The re-joining of the gold standard meant the pound was appreciated rapidly and exports fell as they became more expensive. The UK went into the great depression with an overvalued exchange rate.
What were the policy responses to the Great Depression in the USA.
1- The initial response of the US government in 1929 was to do very little. But they believed in balancing the government budget.
2- President Hoover increased 900 import tariffs by between 40% and 48% which probably worsened the Great Depression. And he allowed a limited public works programme.
3- When President Roosevelt came to power in 1933, unemployment had reached 10million, to address this he introduced his New Deal. This involved a looser monetary policy, millions of dollars for infrastructure, a larger public sector and price support for agriculture.
