2.6 - Macroeconomic Objectives and Policies Flashcards
What are the seven main macroeconomic objectives?
- economic growth
- reduction in unemployment
- control of inflation
- equilibrium in the balance of payments on the current account
- balanced govt budget
- protection of the environment
- more equal distribution of income
What are demand-side policies?
Deliberate manipulations by the govt of AD in order to achieve macroeconomic objectives.
- fiscal policy: the govts management of its spending and taxation with the aim of changing the level of spending in the economy
- monetary policy: decision making using monetary instruments such as the interest rate or quantitive easing
What are the effects of raising interest rates?
- investment decreases as fewer projects are deemed worthwhile. Firms find investment less attractive in many cases and fewer investments will make a return higher than the increased cost of borrowing.
- net exports decrease: interest rates affect costs of production therefore relative productivity, interest rates changes are likely to affect exchange rates.
- consumption decreases as saving is beneficial and cost of borrowing is higher. Mortgage payments rise so will be discouraged to be spending.
- house prices may fall as mortgages become less affordable which causes negative wealth effect
- decreases in investment and net exports causes downward multiplier effects on GDP
What is quantitative easing?
The purchase of gilts and other liquid assets as a means of making credit easier to access. It’s purchasing financial assets (gilts) funded by the creation of central bank reserves which are paid four by selling treasury bills.
How does QE work?
Central banks make large purchases of govt bonds which pushes up their prices and lower interest rates. Lower IR feeds through economy so reducing cost of borrowing. This increases consumption and investment. It is also likely to cause a rise in asset prices (shares and houses), leads to wealth effect increasing consumption and AD. If the confidence of consumers and businesses is low, then they will be unwilling to borrow despite the willingness of banks to lend.
What is quantitative tightening?
A contractionary monetary policy applied by a central bank to decrease the amount of liquidity within the economy. One way is to let the central bank’s bond holdings mature each month without replacing them.
What are the types of fiscal policy?
Expansionary: cutting T or raising G, or both, so AD rises.
Contractionary: raising T or cutting G, or both, so AD falls.
What’s a fiscal deficit?
When G >T. The net effect is to pump spending power into the economy, which is expansionary or reflationary policy. The multiplier magnifies the effect of this boost in AD. The govt borrows and public sector net borrowing (PSNB) increases. According to Keynes, the govt should spend their way out of a recession.
What’s a fiscal surplus?
When G < T. Which takes the spending power out of the economy with negative multiplier effects. The govt repays and PSNB decreases. There is a consensus among economists is that is booms or fast growth, govt needs to rein in spending to curb inflationary pressures.
What is the difference between direct and indirect taxes?
Direct: taxes payed directly to the govt by the taxpayer - usually imposed on income or wealth. Disposable income, consumption and AD falls. Income or corporation tax.
Indirect: taxes that can be passed onto someone else (e.g. consumers) - usually on expenditure, which has more of an impact on AS, it affects how much firms are willing to sell at any price so SRAS increases. VAT.
What is the role of the Monetary Policy Committee?
A group of 9 economists with the goal of controlling inflation. They make IR decisions independently of the govt. They meet once a month for a day and a half to examine evidence from across the country relating to inflationary pressures. The have a CPI inflation target set by the chancellor of the exchequer, currently at 2%. If inflation falls outside 1-3% the governor must write an open letter to the chancellor. This only happened once in the first 10 years, but then 10 times between 2008 and 2011. Then not again until 2015 and the first part of 2016.
Demand-side policies in the Great Depression
Wall Street crash of 1929 caused worldwide crash of stock markets and global recession. In 1929, Keynes was influential so expansionary FP was used to increase confidence in markets and stop downward spirals to demand and output. UK didn’t respond as quickly, expansionary demand side policies only became significant in 1945. By 1968, Keynes’ ideas were discredited, DSP result in inflation which leads to govt introducing contractionary policies. In the 70s, due to contractionary policies and increased oil prices, UK experiences both inflation and unemployment. Called stagflation: the economy isn’t growing but there is inflation. Friedman thought expansionary FP causes only inflation and effect on jobs are only SR. He concluded that govt shouldn’t use DSP at all to influence employment and output. This was popular in both the US and the UK until 2008.
Demand-side policies in the global financial crisis
Policy responses in 2008 where similar in the US and UK until 2010. Obama was Keynesian, using FP to expand the economy by increasing G on major infrastructure projects. Brown was keen to inc G and reduce T. The budget deficit rose from £40 billion in 07/08 to £150 billion in 09/10. In 2010 the new govt made fiscal balance one of the main objectives. Since then, growth has been subdued and below its previous long term trend.
How effective is monetary policy?
It has a shorter time lag than FP, although the MPC estimates that IR changes can take between 18 month and two years to have their full impact. There are further delays as many mortgage holders have fixed-rate contracts, which may delay spending for years. MP is a blunt tool that hits the whole economy affecting both small and large firms. Rises in IR usually worsen income distribution. It’s inappropriate as a means of addressing cost push inflation as higher IR raise costs of production. At a time of rising commodity prices, those who have to pay the brunt are those in debt, therefore MP is regarded as more suitable to deal with demand pull inflation. First round of QE in 2009 raised GDP by 1-2% and rate of inflation increased by 0.75-1%.
How effective is fiscal policy?
Can only be implemented in autumn term budget, although some room to change in spring which causes a time lag for decision making for fiscal policy. Added to that there’s an implementation lag because many tax changes can’t begin until start of new fiscal year in April, sometimes 1 or 2 years ahead. When govt tries to expand its spending, people will try to cash in on this by increasing their pay demands and the effect will be increased wages and costs rather than output. There are crowding out effects of increased spending by govt. Could be that expansionary FP only causes inflation as the debt issued to finance expansion, often treasury bills, is so liquid that it acts like printing money.
