topic 16 - theme 2

Question 1

what are the main policy objectives?

Answer 1

1. full employment
2. economic growth
3. fair distribution of income and wealth
4. stable and low inflation
5. satisfactory balance of payments
   bonus:
6. balanced government budget
7. sustainable environment

Question 2

what are the three main policy types for managing the economy?

Answer 2

1. fiscal policy
2. monetary policy
3. supply-side policy

Question 3

what is a fiscal policy?

Answer 3

the use of tax and government spending to manage the macroeconomy
- helps either stimulate economic growth (expansionary) or decrease economic growth (contractionary) by using government spending, tax and borrowing

Question 4

what is monetary policy?

Answer 4

the use of base rate, money supply and exchange rate to manage the macroeconomy

Question 5

what is a supply-side policy?

Answer 5

the use of policies aimed to improve the productive capacity of an economy

Question 6

who carries out fiscal policies?

Answer 6

the government

Question 7

what does the process of setting out plans for fiscal policy rely on?

Answer 7

the budget

Question 8

what is expansionary fiscal policy?

Answer 8

the use of government spending or a reduction in taxation in order to stimulate economic growth
- e.g. reduction in income tax. reduction in corporation tax
- increase AD
- done during a recession

Question 9

what is contractionary fiscal policy?

Answer 9

the use of a reduction in government spending or taxation to calm down an excessive increase in economic growth
- decreases AD
- done during a boom

Question 10

what are the drawbacks to expansionary fiscal policy?

Answer 10

• a budget deficit which when accumulated over time leads to an increase in the balance of payments
• risk of crowding out

Question 11

what does crowding out mean?

Answer 11

a process by which an increase in government spending has a tendency to displace the private sector

Question 12

what are the two ways in which crowding out can occur?

Answer 12

1. government deficit increases government borrowing which increases interest rates
2. the state sector increases competition for the private sector

Question 13

what does G = T mean?

Answer 13

a balanced budget

Question 14

what does G > T mean?

Answer 14

a budget deficit

Question 15

what does G < T mean?

Answer 15

a budget surplus

Question 16

what is an automatic stabiliser?

Answer 16

any policy designed to work automatically to correct or dampen either contractionary or excessively expansionary events that could eventually harm the economy
- government spending automatically rises during a recession and falls during a boom

Question 17

in a recession, what might ‘kick in’ to dampen the effects of the recession?

Answer 17

• job seeker’s allowance and other transfer payments
• lower income tac receipts (as fewer households work) and a reduction in many other tax payments

Question 18

what can tax be used for?

Answer 18

• correct market failure at a microeconomic level
• income distribution at a macroeconomic level

Question 19

what is direct tax?

Answer 19

a charge levied directly on an individuals income
- amount paid cannot be altered through consumption patterns
- tend to be progressive
e.g. income tax

Question 20

what is indirect tax?

Answer 20

a charge levied upon goods and services
- amount paid is dependant on what the individuals chooses to consume and in what quantities
e.g. VAT

Question 21

who implements monetary policies?

Answer 21

Bank of England

Question 22

what does monetary policies use to maintain inflation?

Answer 22

interest rates

Question 23

what is the target rate to maintain inflation?

Answer 23

2%

Question 24

what does the Bank of England set interest rates to do?

Answer 24

to keep inflation within 1% point of the 2% target for CPI (consumer price index) inflation

Question 25

what are interest rates?

Answer 25

rewards for saving and cost of borrowing - expressed as a %

Question 26

what is the monetary policy committee?

Answer 26

the body within the Bank of England responsible for monetary policy

Question 27

what is bank rate?

Answer 27

the interest rate that is set by the monetary policy committee

Question 28

what is the main tool used in monetary policy?

Answer 28

transmission mechanism

Question 29

what is the transmission mechanism of monetary policy?

Answer 29

the process by which a change in the bank rate affects inflation - interest rates changes will pass through various channels

Question 30

what are the goals of the Bank of England?

Answer 30

- maintain inflation - tackle unemployment - support stability of economic growth - currency markets

Question 31

what is an example of a transmission mechanism?

Answer 31

interest rates rise -> more expensive to borrow -> less incentive to borrow -> falling consumer spending -> falling AD -> falling inflationary pressure

Question 32

what are expansionary monetary policies?

Answer 32

- policies that try to increase AD by reducing interest rates - increase growth - reduce unemployment

Question 33

what are contractionary monetary policies?

Answer 33

- policies that try to reduce AD by increasing interest rates - protecting the financial sector - reduce current account deficit

Question 34

what is quantative easing?

Answer 34

when the central bank (Bank of England) digitally creates funds and uses these to buy assets from retail banks, increasing liquidity in retail banks

Question 35

what is the process of quantative easing?

Answer 35

1. initially retail banks have low liquidity (low levels of cash) 2. this means low levels of loans, restricting economic activity 3. Bank of England digitally creates funds 4. B of E use created funds to purchase bonds 5. retail banks now have high levels of liquidity 6. loans increase to firms and households 7. AD increase, Consumer spending increases, Investment increases 8. this causes economic growth