Macroeconomics Government Policies Flashcards
(44 cards)
Government policies - Fiscal Policy
Government adjusts the economy by changing either government spending, taxation or both.
[Taxes include both direct taxes and corporate taxes]
Expansionary Fiscal Policy
When the government intervenes in the economy and either decreases taxation, increases government expenditure or both
Deflationary/Contractionary Fiscal Policy
When the government intervenes in the economy and either increases taxation, decreases government expenditure or both
Expansionary Fiscal Policy - Sources of Revenue
- Direct and indirect taxation
- Sale of goods and services from state-owned enterprises
- Sale of government assets
They can also adjust their expenditures:
- Current expenditures
- Capital expenditures
- Transfer payments
Expansionary Fiscal Policy - Sources of Revenue 2
Printing money - not good, inflation
Borrowing from overseas - government borrows from international sources
Borrowing domestically (open market operations) - government buys and sells bonds in the market
- Government bonds: a security in which investors pay a premium today, earn interest over a period of say, five years, after which the original premium is repaid
Goals of Fiscal Policy
- Low and stable inflation
- Low unemployment
- Promote a stable economic environment for long-term growth
- Reduce business cycle fluctuations
- Equitable distribution of income
- External balance
- Close deflationary/recessionary and inflationary gaps
Evaluating the Effectiveness of Fiscal policy
Pros:
- Gov’t spending boosts AD directly; monetary policy = indirect.
- Can focus on specific sectors hit hardest in a recession.
Cons:
- Takes time to implement and have an effect → not ideal for immediate relief.
- If the multiplier is small, impact on income/output takes longer.
- Gov’t control can lead to decisions driven by politics, not economics.
- Gov’t borrowing may reduce private investment ➝ could cancel out AD increase.
- Doesn’t fix supply issues ➝ less effective if recession is supply-driven.
Keynesian Multiplier - HL Only
- Ratio of change in real income to the injection that created the change
- Injections boost income, which is partly spent, multiplying effects through the economy.
It assumes:
- That the government is increasing expenditures or businesses are increasing investment
- That we are only looking at one instance, not a continuous flow
- That AD rises
- Explain the multiplier effect of injections on national income
Crowding Out (HL)
When public sector spending replaces private sector spending.
Gov. Spending increase → help GDP and economic growth → more money to spend → consumers either spend more or take out loans → since people take out more loans, banks can raise interest rates → makes borrowing more expensive for private sector
Automatic stabilizers (HL)
A system that automatically helps cushion the economy during ups and downs
In a recession: People earn less or lose jobs → pay less tax + get unemployment benefits → more money to spend → boosts economy.
In a boom: People earn more → pay more tax → slows spending → prevents overheating.
Government policies - Monetary Policy
- Government adjusts the economy by changing the interest rate or the money supply
- A very important component of AD is investment (AD = C + I + G + (X - M)).
Goals of Monetary Policy
- Low and stable inflation rate
- Low unemployment
- Reduce business cycle fluctuations
- Promote a stable economic environment for long-term growth
- External balance - export earnings = import expenditure
Expansionary Monetary Policy
- Increasing AD by decreasing interest rates
- Decrease in interest rates → lower investment costs → incentive to invest/more investment → AD increase
- More investment → more capital stock → expanding the economy’s capacity → LRAS increase
Advantages of expansionary Monetary Policy
- ↓ interest rates → lower investment costs → incentive to invest/more investment → AD↑
- Investment ↑ → capital stock ↑ → the capacity to produce in LR↑ → AS↑
- Investment ↑ → more labour is replaced by capital → free up labour resources that can be used elsewhere in the economy
- Used to control inflation and manage the private sector
Pros + Cons of Monetary Policy
Pros:
- Central banks operate independently → focus on objectives.
- Small rate changes help adjust AD precisely.
- Rates can be changed easily
Cons:
- Effects take time to show in the economy.
- Low confidence → Low interest rates may not increase spending.
- Can lower inflation but raise production costs → unemployment risk.
Real vs. Nominal Interest rates
- Interest rate is the price of money, expressed as a percentage, and represents the cost of borrowing or the return for savers.
- Nominal interest rate - the actual rate that is agreed between a bank and the customer
- Real interest rate - the impact of inflation on the return to savers and the cost of debts to borrowers.
- Real interest rate = nominal interest rate - inflation rate
Example: If bank pays savers nominal interest rate of 2% but inflation is 1.5% then the real return is only 0.5%.
The process of money creation by commercial banks (HL Only)
Credit creation - the process by which banks create money from the deposits of savers and borrowers
What is Supply Side Policies?
Government measures that improve the quantity or quality of production factors, boosting potential output of the economy, and promoting competition for greater efficiency.
What are Market based Policies
- Aim to improve the quality or quantity of FOPs by promoting freer market operation
It does this in two ways:
- Encouraging competition
- Making the labour market more flexible
What are Interventionists policies
- Gov’t-Led ➝ Strong gov’t role instead of relying on market forces.
- Boosts Potential Output ➝ improves quality or quantity of FOPs.
- Increases AD ➝ Gov’t spending ↑G; lower costs → ↑exports (↑X).
- Targeted Support ➝ Gov’t can focus on specific struggling sectors.
Goals of Supply-side policies
- Long-term growth by increasing the economy’s productive capacity
- Improving competition and efficiency
- Reducing labour costs and unemployment through labour market flexibility
- Reducing inflation to improve international competitiveness
- Increasing firms’ incentives to invest in innovation by reducing costs
Supply Side Policies (Market based & Interventionist) (12)
Market based policies:
- Removing labour market rigidities
- Incentive related policies: Encouraging firms to increase output and individuals to work
- Privatisation
- Deregulation
- Trade liberalization
- Anti-monopoly regulation
- Measures to encourage small business start-ups
Interventionist policies: Requires $ and Gov. Intervention
- Increased spending on Education and Training
- Improving quality, quantity and access to health care
- R&D
- Provision of infrastructure
- Industrial policies
Removing labour market rigidities
Refers to removing the rigidities that may stop labour markets from moving into equilibrium
- Reduce the power of trade unions
- Reduce unemployment benefits
- Remove/abolish minimum wage
Incentive related policies: Encouraging firms to increase output and individuals to work
- Personal income tax cuts
- Cuts in business tax and capital gains tax
- Decrease profit tax
- Offer tax deductions on the purchase of capital goods
