2.6 macroeconomic objectives and policies

macroeconomic objectives

• environmental protection

• economic growth

• low inflation (2.0%)

• low unemployment(Keynes - 3% labour force)

• current account

• balanced fiscal budget(G=T)

• greater income equality

policy areas for Govt to achieve these objectives

• demand side policies - designed to impact AD

• supply side policies - designed to impact AS

demand side policies

• monetary policy

• fiscal policy

monetary policy instruments

• interest rates

• quantative reasoning

how are interest rates used in monetary policy

monetary policy commitee (bank of england) meet 8x a year to set a loose rate - UK 4.75% - target CPI of 2%

e.g. if inflation forecast is above target then:

increase IR - increases saving - deflationary

if inflation forecast is below target then:

decrease IR - increases consumption -inflationary

why is quantative easing used

sometime the MPC beleive that a decrease in IRs alone wont be able to stimulate AD

so mpc decide to inject liquidity(cash) into financial markets

increase cash - increase loans - increase borrowing by business + consumer - increase I + C - increase AD

how is quantative easing used in monetary policy

the bank of england create money electronically which is used to buy bonds from the financial sector - i.e giving loans to banks

increase in price of bonds - decrease in interest rate on bond(yield)

e.g. £1000 bond - £80 a year 8%

£2000 bond - £80 a year 4%

commercial banks now have more money to lend because they have sold bonds in return for cash

fiscal policy instruments

• government expenditure

• taxation

expansionary fiscal policy

Govt intends to increase AD in the economy and spur econ growth

budget deficit - G>T

i.e spends more than it raises - injection>leakage

contractionary fiscal policy

Govt intends to decrease AD to slow down an economy, often to combat inflation

budget surplus - G<T

i.e saves more then it spends -

injection<leakage

balanced budget fiscal policy

Govt intends to have its revenue mathc its expendiutre to acheive fiscal stability and reduce risk of debt

G=T

types of taxation

• direct taxes - tax on income

• indirect taxes - tax on expenditure

examples of direct taxes

• income tax

• corporation tax

• capital gains tax

• inheritence tax

examples of indirect tax

• VAT

• excise duties

• customs duties

supply side policies

• market based policies

• interventionist policies

market based policies

indirect way - remove barriers to productive capacity but doesnt directly increase it

reducing government intervention and letting market forces like supply and demand guide economic activity

• decrease corporation tax

• removing regulations

• increase privatisation + deregulation

interventionist policies

policies were the government will directly intervene to raise producitivty capacity

• improve education - knowledge and skills - alsp reduces occupational mobility

• improved + new infrastructure - capital goods - attracts businesses which increase I

supply side policy affect on LRAS

shift right

strengths of supply side policies

• avoids conflict with other objectives

• increase productive capacity of economy

• lower unemployment

• reduce economically inactive population

• some are not expensive

weaknesses of supply side policies

• tax cuts often facour high earners - increase waelth inequaility

• welfare cuts - impact low earners

• time-lag - takes time to have effect

• can be expensive e.g. infrastructure

• supply side policies that increase LRAS will only beenfit the economy if there is sufficient AD

conflicts and trade - offs between objectives

econ growth vs price stability:

• rapid econ growth lead to d.pull inflation

• phillips curve - shows trade off between unemployment and inflation

low unemplotment vs price stability:

• policies to reduce unemployment - increase inflation

econ growth vs environmental stability:

• pursuing high growth - environmental degradation

econ growth vs balanced balance of payments:

• high growth can lead to increase imports

unemployed vs balanced budget:

• decrease unemployment - increase in G, budget deficit

short run philips curve

inverse relationship between rate of inflation and rate of unemployment

as umployment falls - TU’s and workers more bargaining power - increase wages - increase C - increase D.pull inflation

and vice versa

potential policy conflicts and trade offs

• low interest rates vs contractionary fiscal policy

• high interest rate vs expansionsary fiscal policy

• contractionary fiscal policy vs interventionist supply side policies that require increase in G