Macro – Policies Flashcards by Veronica Chiaravalli

What are Demand-Side Policies?

Policies that focus on changing aggregate demand to achieve macroeconomic goals.

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What are Supply-Side Policies?

Policies that focus on changing aggregate supply to achieve macroeconomic goals.

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What are the Types of Demand-Side Policies?

1) Monetary Policy

2) Fiscal Policy

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What are the Types of Supply-Side Policies?

1) Market-based Policy

2) Interventionist Policy

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What are the Goals of Monetary Policy?

Inflation targeting (low and stable)
Low unemployment
Reduction of business cycle fluctuations
Stable economic environment for growth
External balance

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Explain how Interest Rates are Determined

The interest rate is determined by the supply of money. Central banks are able to chante the supply of money according to their needs: an increase will cause a lower interest rate, whereas a decrease will cause a higher exchange rate.

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How do Commercial Banks create Money?

Money is created through loans. Hence, the lower the minimum reserve requirement, the higher quantity of loans can be given. This increases the money created hence increasing the money supply.

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What are the Tools of Monetary Policy?

Open-market operations (bonds)
Minimum reserve requirements
Changes in central bank minimum lending rate
Quantitative easing (bonds on large scale)

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How can the Real Interest Rate be Calculated?

Nominal interest rate - rate of inflation

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Distinguish between Contractionary and Expansionary policy

Expansionary MP describes the attempt of banks to curb deflationary gaps: the interest rate will hence be decreased in order to increase AD. Contractionary MP is used to curb inflationary gaps: the interest rate will be increased to reduce AD.

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What are the Advantages of Monetary Policy?

Changes can be incremental
Flexible (can change according to needs)
Easily reversible
Short time lags
Not subject to political debate
No budget deficit or debt
No crowding out

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What are the Disadvantages of Monetary Policy?

Possibly ineffective in recession
Affects on exchange rate (political conflict)
May be inflationary (expansionary policy)
Cannot deal with cost-push inflation or stagflation

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What are the Sources of Government Revenue?

1) Taxes
2) Sales of goods and services
3) Sales of state-owned assets

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What are the Types of Government Expenditure?

1) Current expenditure (recurrent expenditures)
2) Capital expenditure (public investments)
3) Transfer payments

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What are the Goals of Fiscal Policy?

Low and stable inflation
Low unemployment
Reduce business fluctuations
Stable economic environment for growth
External balance
Equitable distribution of income

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What are the Tools of Fiscal Policy?

Government spending
Personal income taxes
Corporate taxes
Combination of government spending and taxes

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What are the Disadvantages of Fiscal Policy?

Long time-lags
Political constraints
Government debt
Tax cuts may not always be effective in recession
Cannot be used to reach a specific target of output
May be inflationary
Cannot deal with cost-push inflation/stagflation
Crowding out (caused by government taking a loan)

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What are the Advantages of Fiscal Policy

Curb recession
Can target specific sectors of the economy
Directly impacts AD
Can deal with rapid escalating inflation
Can affect potential output (investment)
Automatic stabilizers

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What are Automatic Stabilizers?

Factors that automatically (and without assistance) work towards stabilizing the economy by reducing fluctuations. They include progressive income taxes and unemployment benefits.

What are the Goals of Supply-side Policies?

Promote long term growth
Improve competition and efficiency
Reduce costs of labor and unemployment
Lower costs of production to incentivise investment
Reduce inflation for international competitiveness

What are the Three Types of Market-Based Policies?

1) Encouraging competition
2) Labor-market reforms
3) Incentive-related policies

What does Encouraging Competition involve and what are its Tools?

Increases competition between firms increasing efficiency. Uses the tools:
• Privatization
• Deregulation
• Contractual agreements with firms
• Anti-monopoly regulations
• Trade liberalization

What do Labor Market Reforms involve and what are its Tools?

Increase labor market flexibility (market responds to forces of demand and supply). Uses the tools:
• Abolishing minimum wage legislation
• Weakening labor unions
• Reducing unemployment benefits
• Reducing job security

What do Incentive Related Policies involve and what are its Tools?

Cutting different types of taxes to change the incentives of consumers/firms. Uses the tools:
• Lowering personal income taxes
• Lowering corporate taxes
• Lowering taxes on capital gains and interest income

What are the Disadvantages of Market-Based Policies?

* Long time lags * Possible unfavorable impacts on unemployment * Possible negative effects on equity * Negative impact on government revenue (tax cuts) * Possible negative effects on environment * Possible interference of vested interests

What are the Disadvantages of Market-Based Policies?

What are the Advantages of Market-Based Policies?

* Improved resource allocation * May not burden government budget (except tax cuts) * Ability to create employment * Ability to reduce inflationary pressure

What are the Types of Interventionist Policies?

1) Investment in human capital 2) Investment in technology 3) Investment in infrastructure 4) Industrial policies

What does Investment in Human Capital Involve?

Takes the form of investment in education, training, health care services and access to these. They can increase AD in the short-run and LRAS.

What does Investment in Technology Involve?

Includes promoting research and development (R&D) resulting in new or improved goods increasing potential output and economic growth.

What does Investment in Infrastructure Involve?

Includes investment in public and merit goods. This has the benefits: • Increases in efficiency due to lower costs • Time-saving (therefore lowering costs) • Improves labor productivity

What do Industrial Policies Involve?

Include government policies designed to support the growth of the industrial sector of an economy. This includes aiding small or infant business through tax exemptions, business guidance and low-interest loans.

What are the Advantages of Interventionist Policies?

* Direct support of growing sectors * Ability to create employment * Inflationary pressures reduction (increase in pot. output) * Positive effects on equity

What are the Disadvantages of Interventionist Policies?

* Long time-lags | * Negative impact on government budget

How can Cyclical Unemployment be Solved through the Use of Policies?

Can use either Monetary, Fiscal or Interventionist policy: through an increase in AD the recessionary gap is curbed, therefore unemployment decreases.

How can Natural Unemployment be Solved through the Use of Policies?

Fiscal: government spending in human capital Interventionist: investment in human capital Market-based: labor market flexibility increases

How can Demand-Pull Inflation be Solved through the Use of Policies?

Contractionary demand-side policies (either Fiscal or Monetary)

How can Cost-Push Inflation be Solved through the Use of Policies?

Market-based policies to decrease wage prices and break up market power in the case of high wages or prices. Expenditure switching policies can be used to reduce dependence on imports when the country's currency is falling.

What is the Keynesian Multiplier?

The ratio of real GDP divided by a change in the components of AD. It explains how the final increase in real GDP is likely to be greater than the final increase in in expenditure.

How is the Keynesian Multiplier Obtained?

Change in GDP / Initial change in expenditure

What is Marginal Propensity to Consume?

The fraction of additional income spent on domestic goods and services. It is used to determine the size of the multiplier (higher MPC, higher multiplier).

What is Marginal Propensity to Withdraw?

The fraction of income that leaks from the economy in the forms of saving, imports and taxes. It is found from the addition of MPS, MPI and MPT.

What is MPC + MPW?

How is the Keynesian Multiplier calculated using MPC?

1 / 1 - MPC or 1 / MPW

What is the Effect of the Multiplier over AD?

Increases in expenditure can show the effects of the multiplier. When AD increases it can be shown in two parts: autonomous spending and induced spending. The first represents the change in expenditure, the second is the effect of the multiplier over GDP.

How can the Multiplier Effect be Shown in a Diagram?

The Keynesian model is used to show the multiplier effect as it is necessary that the price level is constant. It can be shown where price level is constant so that an increase in GDP will be equal to an increase in AD. Instead, when the price increases there will be no change in real GDP showing how price increases will absorb the entire multiplier effect.