Name the four main macroeconomic objectives of government
- low and stable inflation
- low unemployment
- balance of payments equilibrium
- high and stable economic growth
name three extra objectives the government might have
- fiscal/budget balance
- greater income equality
- improvements to the environment
what is meant by fiscal policy?
- government spending and taxation
- aims to manipulate predominantly AD and not LRAS
give three examples of fiscal policies
- increasing indirect taxes on cigarettes
- reducing spending by local councils
- decreasing personal independent payments
what is meant by a budget surplus?
when government taxation is greater than spending. also known as a fiscal surplus, or contractionary fiscal policy
what is meant by a budget deficit
when government spending is greater than taxation
is having a budget deficit a problem for the economy?
it is when the economy is shrinking and tax revenues are falling.
what is meant by a direct tax and give examples
direct taxes cannot be passed on to third parties, such as income tax, corporation tax and council tax
what is meant by an indirect tax and give examples
a tax on consumption that can be passed on to third parties, such as VAT and excise duty, also known as a specific tax
what is meant by monetary policy
a policy that is set by the Bank of England and aims to manipulate AD in the economy by using monetary tools such as interest rates
give three examples of monetary policy
- increasing/decreasing interest rates
- increasing/decreasing money supply
- manipulating exchange rates by buying and selling foreign reserves
what is meant by quantitative easing and how does it work?
QE is when the government purchase financial assets such as government bonds from institutions such as banks.
The money to purchase these assets is made by the Bank of England. This would create hyperinflation, but because the government must settle the bond at some point in the future, the Bank of England can remove this money from circulation when the goverment pay their bond. By buying assets from the banks, this improve their liquidity, and allows them to lend more money. when consumers and producers borrow more money, this can lead to increased consumption and production and thus stimulates the economy.
what are the advantages and disadvantages of QE?
ADVANTAGES:
- it is free (doesnt need any tax revenue)
- it can ease a credit crunch and get people spending again, boosting the economy
- can raise inflation when it is too low
- any inflationary pressure that builds up can be removed in the future when the government pays its bonds
DISADVANTAGES:
- it is inflationary
- brings about a fall in the interest rates in the short run. However, in the long run it leads to inflation which causes the interest rates to rise causing the exact opposite of financial stability. Therefore, critics of quantitative easing believe that it is a disruptive policy that creates negative effects in the economy.
- makes employment rise in the short run, but decrease in the long run
how can interest rates be used to achieve inflation targets?
when inflation is too low, they can reduce the interest rate, which reduces the reward of saving and reduces the reward for the cost of borrowing. Existing debt can be paid back, and overall these things can increase consumption and investment in the economy, and boosts AD. when the economy is close to full capacity, this puts upward pressure on prices so that inflation targets can be met.
when inflation is too high, they can increase the interest rate which increased the reward for saving. the cost of borrowing is increased and the payment on existing debt is increased. this all reduces consumption and investment, thus lowering AD and the price level. this is contractionary monetary policy
what are the advantages and disadvantages of using interest rates
ADVANTAGES:
- doesnt cost anything
- very effective
DISADVANTAGES:
- they are only effective if consumers and producers respond to changes in incentives (e.g interest rates decrease, investment and consumption may not increase as banks dont want to lend/confidence is low, so consumers/businesses may not want to borrow
- the base rate is already at 0.5%, so there is little scope to reduce it further.
show the impact of monetary and fiscal policy on AD, the price level and real output.
Expansionary monetary or fiscal policy increases AD: - two demand curves, one AS (curved) - AD1 rises to AD2 - P1 rises to P2 - Y1 rises to Y2 Decreases AD: - Y1 decreases to Y2 - AD2 decreases to AD2 - P1 decreases to P2
what is the role of the Bank of England?
maintaining financial stability in the UK.
What does the monetary policy committee of the Bank of England do?
- ensure inflation is kept to 2% ± 1 % by using interest rates and QE as their main policy tools
- there are 9 members who meet monthly to decide on QE and interest rates
what factors do the monetary policy committee consider when making interest rate decisions?
- they look at what they think inflation will be like in 2 years. this is because of the time lag between the monetary policy tools and their effect on the economy.
- spare capacity in the economy, as shown by unemployment rate
- wage growth indicates that firms costs are rising and may lead to prices rising
- consumer confidence
- retail sales and spending
describe the UK and the US economy during the great depression
- a depression is a period of sustained recession where output is falling and unemployment is high.
- in the UK the recession lasted from 1930-1932
- in the USA it was 1929-1939
- the great depression was caused by a build up of credit in the USA, and the stock market crash (‘black thursday’)
- unemployment was high during this period and there was an increase in poverty
what policies were used to help the economy recover from the great depression?
- in the UK the currency was devalued, helping to boost exports. the interest rates were cut from 9% in 1931 to 0.6% in 1933 and the government set a target of higher inflation
describe the UK and US economy during the Global Financial Crisis of 2008
- a credit bubble was created in the US economy which was caused by selling sub-prime mortgages. when people defaulted on these loans, large banks started to go bankrupt, and caused banks around the world to fail. the housing market crashed as the banking crisis was transferred to the economy. consumption therefore fell due to a reverse wealth effect. in the UK, the Royal Bank of Scotland was nationalised to prevent it going bankrupt.
- a recession lasted in the UK from 2008 to 2012 (longer than the great depression) and the economy did not grow till 2013.
- unemployment reached 10% in the US in late 2009, and in the UK it was 8.4%
what policies were used to help the economy recover from the GFC 2008?
Bank base rate in the UK fell from 5% to 0.5% in less than six months. QE was also started soon after the crash. an extremely loose monetary policy was adopted to help the economy recover.
what are the advantages and disadvantages of demand-side policies?
ADVANTAGES:
- fast to take effect, especially government spending
- can have multiplier effects to make them even more effective at stimulating AD
- monetary policy does not have a monetary cost.
DISADVANTAGES:
- fiscal policy involved opportunity cost
- monetary policy has a time lag of up to 2 years.
- can cause government failure if not designed/targeted correctly.
