2.6.1 Possible macroeconomic objectives & 2.6.2 Demand-side policies

What are the 7 possible macroeconomic objectives

1) Economic growth

2) Low unemployment

3) Low & stable rate of inflation

4) Balance of payments equilibrium on current account

5) Balanced government budget

6) Protection of the environment

7) Lower income inequality

Distinction between monetary & fiscal policy

• Monetary: policy by Central Bank, change cost/amount of money to affect AD

• Fiscal policy: policy by government, change government spending/borrowing & tax revenue to affect AD

Fiscal policy instruments: government spending & taxation / Distinction between government budget (fiscal) deficit & surplus

• Balanced government budget: government spending = tax revenue with no budget deficit nor a budget surplus

• Budget deficit / fiscal deficit = government spending exceeds tax revenue

• Budget surplus / fiscal surplus = government spending is lesser than tax revenue

Distinction between, and examples of, direct & indirect taxation

• Direct tax = tax on income, for example, corporation tax (tax on firm’s profits), income tax, national insurance, business tax, council tax

• Indirect tax = tax on goods/services, for example, VAT (firms pay when consumers pay their products)

Use of AD/AS diagrams to illustrate demand-side policies (just for fiscal for now)

For Fiscal policy

• change government spending - shift of AD curve - economic growth

• change in tax revenue caused by change in direct tax/indirect tax

  • direct tax - (ie. affect disposable income) shift AD curve - economic growth / inflation

  • indirect tax - shift SRAS curve (firm’s cost of production) - economic growth / inflation

2 goals of Demand side policy

• Expansionary (AD increases)

• Contractionary (AD decreases)

• Both are shown by shifts in AD or extension or contraction of AD

• Expansionary is targeting economic growth objective

• Contractionary is targeting inflation or budget deficit to reduce debt

Common chain of reasoning for corporation tax on the AD/AS diagram (Direct tax)

• Corporation tax increases = tax on profits of firms increases = firms have less profits = less incentivized to invest = Investment decreases = AD decreases = Contractionary = inflation decreases / economic decline

Common chain of reasoning for VAT on the AD/AS diagram (Indirect tax)

• VAT increases = tax on g&s on producer increases = cost of production increases = SRAS decreases = AD contracts = Contractionary = Price level increases = inflation increases

Strengths & weaknesses of demand-side policies (EVALS)

• Take long time to work?

• Very expensive?

• Does it affect other objectives?

Meaning of discretionary fiscal policy

When there are deliberate changes in government spending or taxes which can result in either expansionary / Contractionary