Theme 2 Flashcards
(22 cards)
What is reflationary/ expansionary fiscal policy?
- boosting aggregate demand by increasing government spending or lowering taxes.
- involves the government having a huge budget deficit
- used during a recession/ negative output gap. Increases economic growth and reduces unemployment
- however, it increases inflation, worsened the current account
What is deflationary fiscal policy?
- reducing aggregate demand by reducing government spending or increasing taxes
- may result in a budget surplus
- used during a boom/ positive output gap. Reduces economic growth and increases employment
What are automatic stabilisers?
- some parts of the governments’ fiscal policy may automatically react to changes in the economic cycle.
- during a recession, government spending automatically increases as the government increases benefits and receive less tax revenues
- automatic stabilisers create a budget deficit
- during a boom, government spending decreases and therefore the automatic stabilisers create a surplus
A budget deficit caused by an expansionary structural budget position ( spending is more than revenue) will add to national debt. This is a structural budget deficit
What is a structural budget position?
A governments long term fiscal stance. Their budget position over a period of the economic cycle.
Budget deficit caused by an expansionary cyclical budget position is known as cubical budget deficit. This is balanced out by a surplus during booms
What is a cyclical budget position?
- a governments fiscal stance in the short term, affected by where the economy is in the economic cycle
What is progressive taxation?
+ where an individuals tax rate increases as their income rises.
+ redistributes income and reduces poverty
+ follows the ability to pay principle
What is regressive taxation?
- where an individuals tax rate decreases whilst their income increases.
+ used by governments to encourage supply side growth
+ regaonomics: trickle down economics
+incentives people to work harder - increases inequality
What is proportional taxation?
Everyone pays the same proportion of tax regardless of their income level
+ some people argue it would simplify the taxation system
Why is a large budget deficit a problem?
- a budget deficit must be paid for by public sector borrowing
- borrowing from uk banks: create deposits that the government needs to pay off
- borrow from foreign financial markets
- excessive borrowing can lead to demand pull inflation due to increased money supply
This may lead to an increase in interest rates, discouraging investment, making the currency rise in value and therefore becoming less price competitive. - if debt becomes too large governments and institutions can stop lending to the government, constraining their ability to grow the economy in the future
- moral hazard: future taxpayers will be lef with large interest payments on debt to pay off. Debt repayments also have opportunity cost of public spending
- crowd out private sector spending. However, if the borrowing boosts government spending there may be a crowding in effect, firms will invest more
- makes country less attractive to FDI, uncertainty about the country’s debt future
Why is a budget surplus a problem?
- suggests taxes are too high and the government isn’t spending enough on public spending
How does the monetary policy affect the exchange rate?
- when interest rates are high financial institutions’ demand for the pound increases, this is called hot money inflows
- this causes the exchange rate to increase and exports become more expensive whilst imports are cheaper. This means that BoP has worsened
How does monetary policy experience a lag?
- monetary policy needs to look 2 years into the future, the effects are not felt straight away
- reduction in interest rate wont immediately increase investment/ investment of housing
People on fixed rate mortgages wont notice a difference until their fixed rate period ends
What are demand side policies?
- aim to expand productive potential/ increase the trend rate of growth of the economy
+ government needs to create the right conditions for market forces to create growth
+ make structural changes
+ fre market: increase efficiency by removing things that interedere with the free market.
+ interventionist policies correct market failure
What are the flaws of supply side policies?
- takes a long time to see potential benefits
- unintended consequences: deregulation of the financial market contributed to the Big Bang in the 80s however led to excessive risk taking which contributed to 2008 recession
- can be unpopular and inequitable: benefit cuts will impact teh poorest in society. Greater flexibility in the labour market and trade union reforms could result in less job security
How was monetary and fiscal policy used to deal with the 2008 financial crash?
+ temp cut to VAT for increase consumer spending
+ spending increased due to automatic stabilisers
+ bringing forward planned capital expenditure to raise national income
+ expansionary monetary policy: lowered base rate to 0.5%
+ quantatitive easing
+ Uk government used public money to recover banks
+ this meant the impact of teh crisis was less severe than the Great Depression, however did have high national debt levels and a large budget deficit
- government used tax increases, austerity from 2010 onwards
How was QE used?
+ QE is used to stimulate demand and create upwards pressure on inflation when interest rates are very low
+ increases teh money supply. Bank of England created more money to buy assets owned by institutions
- QE was slow to work because banks were reluctant to lend money aster the credit crunch and instead used it to increase their reserves of money
+ eventually banks began to lend money and this increased confidence and AD
+ using QE to increase inflation rather than decreasing interest rates meant that the currency would remain weak, allowing competitiveness and exports to increase simultaneously
- danger is that financial institutions may use QE money to increase their reserves and only begin to leng money when the economy improves. This extra lending when there is already upwards pressure on inflation could mean that demand-pull inflation is harder to control
What is the interest rate?
The reward for saving money and the cost of borrowing it
What are primary macro objectives?
+ economic growth
+ low and stable inflation
+ low unemployment
+ balanced current account
What are secondary government objectives?
+ achieving equality
+ environmental protection
+ balanced budget
+ stable exchange rate
What is the trade off between employment and inflation?
- as employment decreases and the economy reaches full capacity, there is a smaller supply of labour. This means that there is an increase in wages and the extra cost is passed onto consumers: cost push inflation
- low employment may cause consumers to spend more because they feel confident in long term job prospects
- prices may rise due to demand pull inflation
What is the trade off between economic growth and environmental protection?
- new factories and increases in production will cause air and water pollution and waste to increase
- growth may be using non-renewable natural resources
- ecosystems may be damaged by the constuction of new factories
- low inflation means low prices. Exports to other countries may increase meaning a reduction in imports= surplus
