Macroeconomic Policies

Define fiscal policy

the manipulation of public spending, taxation and borrowing to achieve the government's macroeconomic objectives

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What are the main objectives of taxation? (5) (should be able to explain each)

Funding government spending, managing the economy as a whole, redistribution of income, correcting market failure, tariffs/custom duties to discourage imports

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Give 9 principles of taxation. (should be able to explain at least 4)

Economical, equitable, convenient, certain, efficient, flexible, inflation adjusted, non-incentive-reducing, politically acceptable

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Define indirect taxes.

a tax levied on good/service such as VAT or value excise duties

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Define direct taxes.

A tax levied directly on an individual or organisation e.g. income tax

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List 6 advantages of indirect taxes compared to direct taxes (should be able to explain/evaluate each)

Influences spending patterns, corrects externalities, incentive effects, flexibility, choice, people unaware what they're paying (=good for government)

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List 4 disadvantages of indirect taxes compared to direct taxes (should be able to explain/evaluate each)

Distributional effects, inflationary effects, crime and lack of announcement effect

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List 4 advantages of direct taxes compared to indirect taxes (should be able to explain/evaluate each)

Equitable, economical, certain and productive

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List 3 disadvantages of direct taxes compared to indirect taxes (should be able to explain/evaluate each)

Inconvenient, evadable, disincentives

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How else can taxes be separated (4 ways)

Progressive/regressive, macro/micro, demand/supply-side, automatic/sicretionary

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What is a progressive tax?

when the proportion of a persons income paid in tax increases as income increases

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What is a regressive tax?

When the proportion paid in tax falls as income increases e.g. VAT

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Proportional tax

When the proportion of income paid in tax stays the same as income increases

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What are the 5 purposes of government spending

To improve the productive capacity of the economy, to influence AD, to provide public goods, to subsidise merit goods, to improve the distribution of income and reduce poverty

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What are the three types of government spending?

Current- day to day salaries e.g. policeman, capital investment projects e.g. HS2, transfer payments- payments for which there is no corresponding output e.g. welfare benefits

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Give the 6 factors effecting the level and distribution of government spending

size of deficit, size and age of population, stage of business cycle (automatic stabiliser), discretionary fiscal policy (i.e. manipulation of AD), changing priorities e.g. spending on defence during the war, level of interest on debt

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What is a cyclical budget deficit?

The component of the deficit which rises and falls with the economic cycle

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What is the structural budget deficit?

The component of the deficit which will not change throughout the economic cycle

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What is public sector borrowing equal to?

The difference between public expenditure and revenue

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What is public debt?

The cumulative total of past borrowing

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What is the public deficit?

A flow, changes every month

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Give 5 causes of an increase in borrowing in recent years

stimulus to get out of recession in 2008, public sector employment increased in 2000-2010, government bailed out the banks, the war (funding troops in Iraq), large amount of tax evasion

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What are the two main rules in the code for Fiscal Stability (1998-2008)

The golden rule and the sustainable investment rule

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What is the golden rule?

Governments should only borrow money to incest in new social capital e.g. schools and hospitals

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What is the sustainable investment rule?

Over the economic cycle, public sector debt is to be held at a 'stable and prudent' level of less than 40% of GDP

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What did the publication of this code signal?

That fiscal policy should NOT generally be used as a demand-management tool.

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what is a condition of membership of European Monetary Union? (stability and growth pact)

Borrowing cannot exceed 3% of GDP and debt cannot exceed 60% of GDP (note UK do not have to stick to these rules, giving our gov. more flexibility in terms of how much we can borrow)

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Up until 2013 what was the Chancellor's reason for cutting borrowing?

To keep our AAA credit rating

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What do free-market economists argue?

The private sector is more efficient than the public sector therefore the economy works best when public borrowing+spending is low

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What does whether government borrowing matters depend on? (4 things)

How its spent, how it will be financed, the proportion of GDP, whether its structural or cyclical

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Give 5 arguments for why government borrowing matters (should be able to explain/evaluate each)

Inflation, crowding out effect, growing national debt, cost for future generations, if debt is growing faster than national income

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Give 5 arguments for why government borrowing doesn't matter (should be able to explain/evaluate each)

If spent on investment, if used to manage demand, if its cyclical, a method of 'spreading out', its been higher in the past

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What are supply-side policies?

Policies used to increase the productive capacity of the economy. They do this by increasing the quality and quantity of the factors of production, and the efficiency with which they are combined.

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If successful...

...output can increase without inflationary pressure

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They are ____-term in nature

Long

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They can be split into what three categories?

Labour market, product market and enterprise

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Give 4 examples of labour market measures (should be able to explain/evaluate each)

lowering rates of income taxes, reducing state welfare benefits, education and training, trade union reforms

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What are product market measures designed to do?

Increase the competition and efficiency of an industry

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Give 2 examples of product market measures

privatisation, competition policy

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Give 4 examples of policies to encourage enterprise.

cutting corporation tax for small businesses, allowing tax relief on capital spending, loan guarantees for new start-ups, and reduced regulation of businesses.

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Give 3 examples of current and recent supply-side policies

Top rate of income tax cut to 45%, HS2- construction set to begin in 2017, 'New Deal'= programme of active labour market policies introduced in 1998 to reduce unemployment by providing training, subsidised employment and voluntary work to unemployed

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Give 4 advantages of supply-side policies (should be able to explain evaluate each)

Reduces inflationary pressure, positive effect on labour productivity + competitiveness, less conflicts between the main objectives, allows enterprises to flourish (why UK has had steady growth)

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Give 4 disadvantages of supply-side policies (should be able to explain each)

time-lags, costly, resisted by interest groups, negative impact on equity

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Give 4 examples of ineffectiveness or lack of success of supply-side policies

not effective in a recession e.g. cutting benefits won't make people work if there aren't jobs. Productivity + int. comp. haven't improved noticeably in UK despite yrs of ** policies- UK labour market still has structural weaknesses

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What is monetary policy?

The manipulation of the money supply, interest rates and exchange rates in order to achieve the government's macroeconomic objectives

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What 3 things does a contractionary/tight monetary policy involve?

High interest rates, strong exchange rate, restricted money supply

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What are the 4 functions of money? (should be able to explain each briefly)

Medium of exchange, a unit of account, store of value, standard of deferred payment

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give 5 characteristics of money

divisible, durable, scarce, difficult to forge, portable

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What is liquidity a measure of?

The ease at which an asset can be turned into cash

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What are the two main measures of the money supply?

M0 (narrow money) --> consists of notes, coins and current accounts. M4 (broad money) --> consists of money that is not immediately accessible e.g. deposits held by private sector for transaction and saving purposes

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What do interest rates measure?

The rate of return on savings and the cost of borrowed money. Therefore they affect both demand of, and supply for, money

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What does the B of E do?

Sets the official base rate for the economy, which influences other interest rates

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Draw the demand and supply curves for money

(see page 38 of macro notes)

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A fall in interest rates tends to increase demand for money. However...

...people won't necessarily borrow more money (depends on consumer confidence), even if bank of england lowers their rates- commercial banks may not follow

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What does a rise in interest rates do to a) consumption, b) investment

a) FALLS- due to a rise in saving, fall in effective disposable incomes due to higher mortgage payments, fall in demand for consumer durables purchased on credit. b)FALLS- cost of investment increases relative to yield (some projects = unprofitable)

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c)confidence and d) X-M

c) FALLS, d) FALLS- due to a rise in the exchange rate

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All these mechanisms are known as? and will?

the transmission mechanism, affect AD

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What is quantitative easing?

When the central bank buys assets from commercial banks using 'new' money that it has created electronically in order to pump money directly into the financial system

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The hope is that: (4 things)

bank lending starts to flow again --> confidence rises , AD increases and economy moves out of recession, inflation target achieved, high money supply lowers interest rates, which reduce exchange rate and UK more internationally competitive

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What do critics say about QE? HOWEVER? BUT?

concerns that banks would just sit on money, and about high inflation. HOWEVER to this date this had not happened (inflation has actually continued to fall). BUT there would be a time lag

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What is funding for lending and when was it introduced?

July 2012- a scheme which allows banks and building societies to borrow from the Bank of England at cheaper than market rates, on the condition that they will lend onto businesses and house-buyers

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How many sessions of QE have we had?

3 since 2009

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What is is thought to have done?

Prevented the UK from going into double-dip recession, despite us not having a rapid revovery

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How have they used QE in America?

A steady programme of QE each month, which has been successful so far- known as 'drip feeding'

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Where else has QE proven to be effective?

In Japan- economy has been stagnant for over 20yrs. One of Shinzo Abe's (the president of Japan's) policies (3 arrows) is an attempt to reflate economy = QE (initial signs of success as CPI up to 0.3%)

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How are interest rates and exchange rates interlinked?

If interest rates rise higher than in other countries, there is likely to be an inflow of 'hot money'. This will boost demand for the currency and cause an appreciation of the exchange rate

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What effects does this have?

fall in AD (restricted demand-pull inflation), and raw materials are cheaper (restricted cost-push inflation)

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What are the 2 main objectives of monetary policy?

an instrument of demand management (prevents economy from overheating/there being spare capacity), to control inflation

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History of monetary policy: What did they target in a) 1979-mid80's, b) late80's-1992, c) 1992

a) the money supply (monetarists who believed in fisher equation influenced the government)- but they found it too difficult to control how much banks lend, so inflation came down due to massive recession instead. b) exchange rate c) inflation

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what happened in 1997?

The bank of england became independent and monetary policy committee was set up

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What has happened very recently?

FORWARD GUIDANCE- Mark Carney (governor of B of E) said the Bank wouldn't consider raising interest rates until unemployment had fallen to 7%- gives companies and mortgage holders a feel for how long interest rates will be at their current low levels

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What does this suggest that monetary policy is now targeting?

bank will keep all the main macroeconomic indicators within reasonable bounds rather than trying to hit a precise target

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What does the MPC consider when making decisions about interest rates? (7 things- should be able to explain)

Growth rate in relation to long-run trend (2.5% a year) and position in economic cycle, labour market, commodity prices, movements in the exchange rate, recent inflation performance and forecast, monetary growth and asset prices

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What have the outcomes been of independence of B of E?

Up to 2007, very successful at keeping within inflation target

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Evaluation of this success... may have been due to? (4 things)

globalisation, greater labour market flexibility, technological change, role of the internet

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When has the inflation target been overshot?

september 2008 at 5.8% and in september 2011 at 5.2%- due to oil and commodity prices BUT may have beendue to an attempt to boost AD to recover from recession

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Summary: why MP effective (should be able to explain)

flexible (monthly), affect AD (C and I and X through exchange rate), Affect most people (lenders and borrowers)- effect on housing market particularly important, successful 1997-2008 (not open to political manipulation, credibility), no debt

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EFFECTIVE CONTINUED...

very influential on confidence, QE may have prevented UK going into double/triple recession, success in Japan and america, funding for lending (but shouldn't be helping people buy houses- should increase supply)

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HOWEVER...

takes time to take effect- 1yr to reduce demand, another to reduce inflation, difficult to control lending by banks, undesirable side-effects e.g. interest rates up, people unable to pay mortgages-repossessions + deters investment

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HOWEVER CONTINUED...

Uncertain results- e.g. string can't push or liquidity trap, QE may be inflationary, can't achieve all objectives at once, change in exchange rate may not have an effect, banks might sit on money,

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Evaluation points/questions (5) (should be able to explain)

Is inflation targeting most appropriate in a prolonged recession or would unemployment/GDP targets be better? how effective is loose monetary policy with tight fiscal? strong ** policies needed for sustainable recovery. Is growth achieved balanced?

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Macroeconomic Policies

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