Unit 5, Government macroeconomic policy objectives, fiscal policy, monetary policy, and supply-side policy

Three main government macroeconomic policy objectives

are economic growth, low unemployment, and price stability.

price stability

governments seek to achieve a low and stable inflation rate, however not an inflation rate of zero as this may result in deflation, any measure of inflation tends to overstate any rise in prices and a low and stable rise in prices caused by higher spending is likely to encourage firms to increase their output

inflation target

the inflation rate a central bank is set to achieve

low unemployment

having a low proportion of the workforce unemployed provides the benefits of high output, high tax revenue and low expenditure on unemployment benefits, governments also aim to ensure than any unemployment experienced is short term

economic growth

governments seek to avoid slow or negative economic growth due to increased unemployment and a possible fall in living standards, however they also want to avoid too high a rate of economic growth as the economy could overheat causing inflationary pressure

factors considered when determining an economic growth rate

size of the labour force, changes in productivity, advances in technology

fiscal policy

the use of taxation and government spending to influence aggregate demand

budget

an annual statement in which the government outlines plans for its spending and tax revenue

budget surplus

government revenue exceeding government expenditure

budget deficit

government expenditure exceeding government revenue

balanced budget

government revenue equalling government expenditure

automatic stabilisers

changes in government spending and taxation that occur to reduce fluctuations in aggregate demand without any alteration in government policy

cyclical budget deficit

a budget deficit caused by a decline in economic activity

structural budget deficit

a budget deficit caused by an imbalance between government spending and taxation

tax base

the coverage of what is taxed

national debt

the total amount of government debt

specific taxes

taxes that are charged as a set amount per unit

sin taxes

taxes on products considered harmful to consumers

ad valorem taxes

taxes based on a percentage of the price of a product

direct taxes

taxes on income and wealth

tax avoidance

the legal bending of the rules of the tax system to pay less tax

tax evasion

the illegal non-payment or underpayment of a tax

regressive tax

a tax which takes a larger percentage of the income or wealth of those on low incomes

progressive tax

a tax which takes a larger percentage of the income or wealth of those on high incomes

proportional tax

a tax which takes the same percentage of the income or wealth of all income groups

marginal rate of taxation (mrt)

the proportion of extra taken in tax

average rate of taxation

the proportion of income that is taxes

advantages of indirect taxes

Indirect taxes can be changed relatively quickly and easily if needed, are cheaper to collect than direct taxes as firms do part of the administrative work, can be used to discourage the purchase of particular products and do not discourage effort, innovation and saving

disadvantages of indirect taxes

indirect taxes are regressive taxes and can also be inflationary, pushing up the price level

disadvantages of direct taxes

Direct taxes can discourage work and savings, may lead to tax evasion, and are often more complex and expensive to administer compared to indirect taxes.

advantages of direct taxes

due to a rise in direct taxes, some workers may decide work more hours to maintain their level of disposable income

reasons for taxation

to raise government revenue to finance government spending on merit and public goods, as well as to influence aggregate demand

current government spending

government spending on providing goods and services

capital government spending

government spending on investment

exhaustive government spending

government spending which makes use of resources

non-exhaustive government spending

government spending which allows other to decide how resources are used

reasons for government spending

to influence aggregate demand and increase aggregate supply, to overcome market failure, to win political popularity and to improve societal welfare

types of government spending

transfer payments, current spending, capital spending

expansionary fiscal policy

increases in government spending and cuts in taxes designed to increase aggregate demand

contractionary fiscal policy

decreases in government spending an increases in taxes designed to reduce the growth of aggregate demand

discretionary fiscal policy

deliberate changes in government spending and taxation

monetary policy

the use of interest rates, the money supply, credit regulations and the exchange rate to influence aggregate demand

interest rates

the price of borrowing money and the reward for saving

money supply

the total amount of money in a country

credit regulations

rules affecting bank lending

expansionary monetary policy

a cut in the interest rate an increase in the money supply or a reduction in any restriction in bank lending in order to increase aggregate demand

contractionary monetary policy

a rise in the interest rate, a decrease in the money supply or restriction on bank lending to reduce aggregate demand or the growth of aggregate demand

target rate for inflation

the rate a central bank is set to achieve

supply-side policy

government policy tools designed to increase aggregate supply

examples of supply-side policy tools

spending on education and training, promoting infrastructure development and support for technological improvement, cuts in corporate tax, cuts in income tax, trade union reform, privatisation, deregulation and relaxation of immigration controls

spending on education and training (supply-side policy tool)

increased spending on education and training may raise the quality of education and training, increasing workers’ skills and productivity as well as their flexibility and mobility

promoting infrastructure development (supply-side policy tool)

good quality infrastructure, including efficient transport, power, energy, and telecommunications networks, keeps the costs of firms low and allows them to get their products to market quickly

support for technological improvement (supply-side policy tool)

governments can subsidies both universities and private sector firms to encourage the development and introduction of new technology, technological improvements can enable capital equipment to produce a greater output at a lower cost

cuts in corporate tax (supply-side policy tool)

cutting corporate taxes may encourage investment as firms will have more funds to invest and the ability to keep more of any profit earned

cuts in income tax (supply-side policy tool)

cutting income tax may encourage workers to increase their working hours and accept promotion and greater responsibility

trade union reform (supply-side policy tool)

trade union reform may increase worker’s flexibility and mobility and cut down on the number of days lost through strikes

privatisation and deregulation (supply-side policy tool)

Privatisation may increase efficiency as the private sector has more of an incentive to be efficient, deregulation by removing barriers to entry and laws and regulations may decrease firms’ costs of production

encouragement of immigration (supply-side policy tool)

if a government encourages immigration of skilled workers, it can increase both the quantity and quality of labour in the country

the impact of supply-side policy tools on the macroeconomy

supply-side policy tools can potentially benefit all of a government’s policy objectives in the long term by raising economic growth, reducing inflationary pressure, and lowering unemployment

drawbacks of spending on education and training (supply-side policy tool)

Potentially high costs with delayed economic returns, risk of skill mismatches, and possible inflationary pressure in the short run

drawbacks of spending on infrastructure development (supply-side policy tool)

high costs and considerable time to construct and take effect, transport infrastructure may not alwas be well linked and also have harmful effects on the environment

drawbacks of spending on technological improvement

the benefits are not always even spread and can be harmful to some due to job losses and required job changes