Pack 4 Macro Policies/Conflicts Flashcards
What is a fiscal policy and what are the two types?
- use of government spending and taxation to influence the level of AD
Expansionary fiscal policy: increase AD:
- increase gov spending
- cutting taxation
Contractionary fiscal policy: decrease AD:
- decrease gov spending
- increasing taxation
How can change in taxation be used?
Direct tax: e.g income tax and corporation tax
- shift AD
Indirect tax:
- tax levied on consumption of goods/services such as Vat or tax on fuel
- shift short run AS and lead to movement along AD
- Pros:
- beneficial as does not distort incentive to work
- flexible as can be changed between budgets
- Cons:
- regressive in nature so take higher percentage of income from those on low incomes
- increase income inequality
What is a budget deficit and budget surplus?
budget deficit = gov spends more than it receives in tax revenue in a given year
budget surplus = gov receives more tax revenue than gov spending in a given year
What are the consequences of running a budget deficit?
tax rises in future: could reduce AD and economic growth
opportunity cost gov will have to pay back interest, so spend les money on other essential services e.g healthcare
Crowding out: due to higher market interest rates as gov increase demand for loans or fewer resources for private sector to use
impact on credit rating: if gov policies lead to increased national debt and has less chance of paying back the debt then their credit rating may reduce - lead to higher interest needing to be paid to reflect this risk
No one wants to lend: extreme cases investors may have little confidence that gov will pay interest back and so won’t buy bonds at all
When is a budget expansionary and when is it contractionary?
expansionary:
- if budget deficit increases: there is larger net injection into circular flow compared to last year and therefore boosts AD
- if budget surplus decreases : there is a smaller net withdrawal from circular flow compared to last year
contractionary:
- budget deficit decreases: smaller net injection into circular flow compared to last year and therefore reduces AD
- budget surplus increases: larger net withdrawal from circular flow = reduced AD
What are the strengths of Fiscal policy?
-
can be used to achieve macroeconomic objectives: demand side policies shift AD and changes in this can allow objectives to be achieved
e/g influencing economic growth and jobs
e.g managing government budget - short-run macroeconomic management: will have time lags (18-24 months) still much shorter than supply-side policies
What are the weaknesses of Fiscal policy?
Demand-side policies cannot achieve all objectives at once:
- e.g cannot increase GDP and control inflation
Inadequacy of the data, knowledge and the economic model:
- decisions often based on forecasts (may be wrong/inaccurate)
Time lags: all policies have them as time needed to recognise problem, create policy and implement it
Effectiveness of changing taxation:
Tax cuts may not boost economic growth: due to low consumer/business confidence, they may not respond either if they think change is temporary and taxes will increase in future
Tax rises may not reduce budget deficit: may not lead to higher tax revenue, e.g if income tax increased = less incentive to work and so less hours/workers to tax at higher rate
Side effects on the budget balance and national
- debt interest payments = opportunity cost for gov
- need for tax rises in future to reduce budget deficit
Conflict with other macroeconomic policies:
- fiscal and monetary policy: conflict as lead to higher market interest rates due to financial crowding out
- fiscal and supply-side policies: cutting spending on education/healthcare or raising direct taxation could reduces LRAS
What is the role of the bank of england?
- BofEs Monetary Policy committee (MPC) consists of nine members
- they meet 8 x a year to set the monetary policy
- at this meeting they set Bank rate and discuss if quantitative easing is required or should continue
- policy decided by majority vote
- can take up to 2 years for full effects of decisions to be seen in economy
- important consideration is inflation target of 2%
What factors influence decisions made by MPC?
DEMAND SIDE FACTORS:
- consumption prospects: such as incomes, employment, consumer confidence etc
- Investment prospects: such as current/future profits, corporation tax levels, availability of credit
- government spending changes such as changes announced by chancellor in budget
-Net export prospects: exchange rates, world incomes, price/quality of imports/exports
SUPPLY SIDE FACTORS:
- exchange rates: influencing costs of imports
- Commodity prices such as changes in oil prices
- changes in indirect taxation such as VAT
- firm’s wages and costs: imported raw material costs and wage costs
- changes in productivity: influence labour unit costs
What are the two types of monetary policy instruments?
interest rates
quantitative easing
How are interest rates used as an expansionary monetary policy?
Expansionary monetary policy: reduce interest rates:
increase AD:
- higher consumption: less incentive for consumers to save, more incentive to borrow as credit cheaper
- higher investment: less incentive for businesses to save and more incentive to borrow as cost lower
Higher net exports:
- fewer foreign investors putting money into UK banks due to low return on saving
- reduce demand for the pound and weaken exchange rate
- reduce price of exports and so boost net exports
Contractionary monetary policy: increase interest rates
How can quantitative easing be used as a monetary policy instrument?
- involved increasing the money supply (electronically) and using this extra money to purchase government bonds from FINANCIAL INSTITUTIONS/COMMERCIAL BANKS
- the BofE purchase of gov bonds can lead to higher consumption/investment:
- direct increase in consumption/investment: those economic agents who have gov bonds bought from them can use this money to spend/invest in economy
- bank lending increases: banks who have bonds bought from them can use that money to lend in economy (to increase profits) this stimulates consumption/investment
Quantitative easing may also boost AD due to wealth effect:
- as central bank buys gov bonds from financial institutions = price to go up but yield to fall
- as a side effect stock prices and house prices rise as investors seek higher returns in other assets
- wealth effect = higher consumption
What are the strengths of monetary policy?
can be used to achieve macroeconomic objectives:
e.g - influencing economic growth and jobs: leads to increased AD and boosted real GDP
- managing inflation target: using interest rates
Short run economic management: although demand-side policies have time lags much shorter than supply-side policies, so in short term macroeconomic objectives can be achieved by shifting AD
What are weaknesses of monetary policy (like all demand side policies)?
- cannot achieve all objectives at one
- inadequacy of data,knowledge and economic model
- time lags
What are specific weaknesses of monetary policy?
Effectiveness of monetary policy instruments at boosting AD:
- will lower interest rates work?: limit to how far they can be cut, may not result in higher investment/consumption if confidence low, banks may not pass bank rate to consumers
- will quantitative easing work?: consumption/investment may be constrained by other factors e.g confidence
Side effects of monetary policy:
- higher interest rates can increase income inequality: low income households more likely to borrow than save
- higher interest rates can reduce competitiveness: can leas to stronger exchange rate as foreigners put money into uk banks = higher price for exports
- quantitative easing can cause asset bubbles: as investors switch to higher return investments = damage economic growth if bubbles burst
Conflict between policies:
- monetary and supply side policies : BofE use higher interest rates to reduce inflation, but can lead to lower business investment and damage LRAD and conflict aim of supply-side policies
What happened during the great depression?
what happened:
- period 1929-37 where major economy saw fall in output, prices, rise in unemployment and real economic hardship
- wall street crash, 1929 caused it
- US particularly effected due to growth in credit in years leading up to it
- UK more insulated as had experienced no real credit boom in 1920s, however duet o UK economy relying heavily on trade, decline in global demand hit UK economy with lower exports and so economy went into recession
- 1931, real GDP fell 5%
What occurred in the global financial crisis?
US:
- cheap credit, inflow of capital from Asia and lax regulation all contributed to a boom in housing market
- rise in unorthodox mortgage lending - CDOs, when mortgage defaults started to rise in US, banks started having to write off bad loans and banks around world lost money and became reluctant to lend
- caused fall in house prices=decline in wealth=lower consumer spending
- result in fall in investment/spending in economy
What are supply side policies?
What are the differences between interventionist and market-based supply side policies?
- policies undertaken by gov designed to increase productive potential of economy and LRAS
Interventionist: government intervenes to try to improve economy, via higher gov spending and regulations (favoured left wing govs)
Market-based: freeing up markets to work more efficiently (increasing incentive to work), by reducing tax, government spending and regulations (right wing gov)
What are the different interventionist supply side policies?
- improving skill/quality of workforce, e.g providing courses/apprenticeships
- incentives for investment, e.g tax breaks for investment/forcing banks to lend money
- investment in infrastructure, e.g green transport systems
- finance for business start-ups, e.g start-up loans of between £500 to £25,000 in UK
- investment in new technology: AI
What are the different market-based supply side policies?
Supply side policies: increase LRAS through higher productivity/efficiency
- increased incentives for workers: cut income tax
- labour market reforms: reducing trade union power with law = less strikes = more efficient
- reduction in corporation tax: incentive to invest
- increased competition: privatisation, deregulation, lower tariffs
- removing regulation preventing firms growing, e.g allow mergers
What are the strengths of supply side policies?
- meeting macroeconomic objectives simultaneously: e.g higher economic growth, greater unemployment
- Long-term macroeconomic management
- less reliance on short-term economic data: do not require precise forecast of macroeconomic data
What are the weaknesses of supply-side policies
will policies boost LRAS? The impact on LRAS depends on the effective of the policies:
e.g success of education spending depends on quality of teaching/whether appropriate skills are taught in order to boost productivity
significant time lags: long term policies and so effects on long term growth trend
magnitude of effects: due to long term nature difficult to determine exact magnitude
Side-effects of supply-side policies:
- e.g lowering min wage, workers more open to exploitation
Gov still need to manage AD carefully: make sure growth of AD doesnt outsrip rate of og rowth of AS
What does the short run philips curve show?
Background:
- shows relationship between inflation/unemployment
- inverse relationship between the percentage change in money wages and level of unemployment
Explanation:
- rise in demand-pull inflation associated with higher real GDP and therefore employment
- fall in demand-pull inflation lead to lower employment and real GDP
Evaluation:
- short-term relationship: only held in short-term
- can be seen where relationship existed between 1971 and 1974 as well as 1980 and 1985
- evidence from the data:
- time where both is rising (2011( contradicting what phillips found
- because if supply falls, both inflation and unemployment could rise (cost-push inflation0
What are the conflicts related to inflation?
Inflation and unemployment: rise in unemployment, lead to lower incomes and consumption, lead to fall in demand-pull inflation
- shown on Philips curve
Inflation and balance of payments: increase in inflation = decrease international competitiveness, so reduce exports
