2.6 - Macroeconomic objectives and policies Flashcards

Theme 2: The UK economy – performance and policies (55 cards)

1
Q

What are the main macroeconomic objectives of a government?

A

Economic growth

Low unemployment

Low and stable inflation

Balance of payments equilibrium on the current account

Balanced government budget

Protection of the environment

Greater income equality

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2
Q

What is the government’s target inflation rate? And at what point does the Governor of the Bank of England write a letter to the Chancellor of the Exchequer?

A

2% and if the target falls 1% outside target

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3
Q

Why is the balance of payments in equilibrium important for the current account?

A

So the country can sustainably finance the current account, which is important for long term growth.

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4
Q

Why does the government want to keep control of state borrowing?

A

So the national debt does not escalate. This allows governments to borrow cheaply in the future should they need to and makes repayment easier.

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5
Q

What is monetary policy, and how does it achieve its aims? Who controls it?

A

Used by the government to control the money flow of the economy. Through controlling interest rates and quantitative easing. It is controlled by the Bank of England.

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6
Q

What is fiscal policy, and how does it achieve its aims? Who controls it?

A

Uses government spending and revenues from taxation to influence AD. This is conducted by the government.

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7
Q

How do interest rates affect aggregate demand?

A

As they alter the cost of borrowing and the reward for saving. The bank controls the base rate, which controls interest rates. A reduction in the base rate will lead to a rise in AD.

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8
Q

How does quantitative easing affect an economy, and when is it used?

A

It increases the money flow, which in theory encourages more investment, more spending and hopefully higher growth. It is used when inflation is low and it is not possible to lower interest rates further.

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9
Q

3 Limitations of monetary policy

A

Banks might not pass on the base rates to consumers.

Banks might be more risk averse, so they don’t want to lend.

Most only work when consumer and firm confidence is high.

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10
Q

What is the biggest source of tax revenue for the government in the UK?

A

Income tax

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11
Q

What 3 things does the UK spend most of the budget on?

A

Pensions and welfare benefits
Health
Education

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12
Q

Expansionary fiscal policy

A

Aims to increase AD. Governments increase spending or reduce taxes. Leads to worsening of the government budget deficit; governments might have to borrow more.

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13
Q

Deflationary fiscal policy

A

Aims to decrease AD. The government cuts spending or raises taxes, which reduces consumer spending. Improvement of government budget.

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14
Q

Budget deficit

A

Government spending exceeds tax revenue.

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15
Q

Budget surplus

A

Government tax revenue exceeds spending.

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16
Q

Direct taxes

A

Imposed on income or profits (e.g., income tax).

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17
Q

Indirect taxes

A

Imposed on spending (e.g., VAT).

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18
Q

How were demand-side policies used during the Great Depression and the 2008 Global Financial Crisis?

A

Great Depression: Initially tight policy, later Keynesian stimulus

2008: Stimulus packages, low interest rates, QE used in the US and UK

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19
Q

What are some strengths and weaknesses of demand-side policies?

A

Strengths: Effective during recessions, quick to boost AD

Weaknesses: Can cause inflation, time lags, can increase government debt

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20
Q

What are the 2 types of supply-side policies?

A

Market based polices
Interventionist policies

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21
Q

Market based policies

A

Reduce government intervention and increase efficiency

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22
Q

Interventionist policies

A

Direct government involvement to correct market failure

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23
Q

How do market based policies work to increase incentives?

A

Lower income/corporation tax

24
Q

How do market based policies work to promote competition?

25
How do interventionist policies work to promote competition?
Competition policy
26
How do market based polices work to reform the labour market?
Reduce union power
27
How do interventionist policies work to reform the labour market?
Training programmes
28
How do interventionist policies work to improve skills?
Education reform Vocational training
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How do interventionist policies work to improve infrastructure?
Investment in transport and technology
30
What are some strengths and weaknesses of supply-side policies?
Strengths: Boost long-run growth, reduce unemployment and inflation Weaknesses: Time lags, high cost, uncertain effects
31
Explain why: economic growth vs inflation
A growing economy is likely to experience inflationary pressures on the average price level.
32
Explain why: Economic growth vs the current account
During periods of economic growth consumers have high levels of spending and consumers in the UK have a high propensity to import so there will be more spending on imports
33
Explain why: Economic growth vs the government budget deficit
Reducing the budget deficit requires less expenditure and more tax revenue, and this would lead to a fall in AD. Therefore leading to less economic growth.
34
Explain why: Economic growth vs the environment
High rates of economic growth are likely to result in high levels of negative externalities, such as pollution and the usage of non-renewable resources
35
Explain why: Unemployment vs inflation
As economic growth increases, unemployment falls due to more jobs being created. However, this causes wages to increase, which can lead to more consumer spending and an increase in the average price level.
36
Explain why: Fiscal vs monetary policy
Expansionary fiscal policies involve more government borrowing, which could cause interest rates and the inflation rate to rise.
37
Explain why: Interest rate vs inequality
The low interest rate could affect the distribution of income. Savers only receive a small return on their savings.
38
Explain why: Environment vs competitiveness
If ‘green taxes’ are implemented, such as carbon taxes, or if there are minimum prices on pollution permits, the competitiveness of domestic firms could be compromised. This is because they are limited in their production.
39
What does the short-run Phillips curve show?
An inverse relationship between inflation and unemployment in the short run—reducing one may increase the other.
40
Can policies conflict with each other?
Yes. For example, expansionary fiscal policy to reduce unemployment may conflict with inflation targets or budget balance.
41
How did Brexit affect the economy?
Increased uncertainty, reducing investment Disruption to trade with EU, especially for small firms Increased costs due to tariffs/customs Reduced labour supply due to lower EU migration Long-term impact on growth potential and productivity Trade-offs: Protection of sovereignty vs economic efficiency/trade
42
How did COVID affect the economy?
Sharp fall in GDP due to lockdowns Unemployment rose, especially in hospitality and retail Government fiscal support: furlough scheme, grants, loans Rise in government debt and budget deficit Long-term pressure on public services and NHS Trade-offs: Saving lives vs economic activity
43
Discretionary policy
Government policies that are actively changed or introduced in response to economic conditions.
44
Contractionary policy
Policy that aims to reduce aggregate demand, usually to control inflation.
45
Automatic stabilisers
Economic policies that automatically adjust without new government action to stabilise the economy.
46
What is hot money?
Hot money refers to short-term, speculative capital flows that move quickly across borders in search of the highest interest rates or returns.
47
How does hot money affect the exchange rate?
Hot money inflows increase demand for the currency, causing it to appreciate; outflows cause depreciation.
48
Why does hot money matter in macroeconomic policy?
It affects the balance of payments and exchange rates, and can be influenced by interest rate changes through monetary policy.
49
Increasing incentives by reducing taxes on income
Reducing income tax and National Insurance can increase incentives to work by raising the reward for extra effort, especially through lower marginal tax rates. This makes work more attractive compared to leisure and can encourage people to work more hours or take up jobs. Free-market economists argue this is effective if labour supply is elastic, but others point out that for many fixed-salaried workers or when tax changes are small, the impact on incentives is minimal.
50
Increasing incentives by reducing welfare benefits
If welfare benefits are too high compared to wages, they can reduce incentives to work, as individuals may prefer to remain unemployed. This lowers aggregate supply by keeping more people out of the labour force. Cutting unemployment benefits or making them conditional on actively seeking work can increase the gap between benefits and wages, encouraging people to take up jobs, especially low-paid ones.
51
Increasing incentives by increasing subsidies for workers
Subsidising workers, such as through income tax credits, increases incentives to work by boosting the take-home pay of low earners. In the UK, low-paid workers may receive tax rebates instead of paying income tax, which reduces their effective marginal tax rate. This helps lessen the poverty trap by making work more financially rewarding and encouraging people to take on or increase work hours.
52
Increasing incentives by reducing poverty and unemployment traps
Poverty and unemployment traps occur when earning more leads to little or no increase in take-home pay due to high taxes and benefit withdrawal. In the poverty trap, working more brings a very small or even negative net gain, discouraging effort and skill-building. In the unemployment trap, taking a job leaves someone no better off than staying on benefits. These traps reduce incentives to work. Solutions include cutting benefits (which risks increasing poverty) or reducing taxes and tapering benefit withdrawal more slowly (which is costly for the government).
53
Increasing incentives by reducing taxes on profits
Taxes on profit, such as corporation tax, can reduce incentives for firms to invest by lowering the funds available for reinvestment and reducing the expected return on future profits. Free market economists argue that high taxes discourage business growth and innovation. However, critics suggest that small changes in tax rates (e.g. from 30% to 20%) are unlikely to affect investment decisions significantly, and only large tax cuts are likely to have a real impact on incentives.
54
Increasing incentives by increasing research and development
Research and development (R&D) boosts productivity by creating new or more efficient goods and services. To encourage R&D, governments can use market-based policies like tax breaks, allowing firms to deduct R&D costs from taxable profits. This increases the reward for innovation. Alternatively, interventionist policies involve direct government funding of research or targeted subsidies for selected projects. While tax cuts broadly support innovation, interventionist methods risk inefficiency if the government fails to choose the most effective projects.
55