booklet 6 - Macroeconomic objectives and policies (DEMAND SIDE)

what are the macroeconomic objectives of the government

1. low and stable rate of inflation + - 2%

2. sustained growth of real gdp

3. low unemployment/ full employment

4. higher average living standard (national income per capita)

5. balance of trade on the current account of the BOP

6. achieve a more equitable distribution of income and wealth

what are the three macroeconomic policies

fiscal

monetary

supply side

define macroeconomic policy instruments

the tools an economy uses to try to achieve its macro objectives, by influencing AD and or AS

what is a stimulus policy

any monetry policy or fiscal policy aiming to stimulate higher growth or inflation.

define fiscal policy

decisions made by the government on expenditure, taxation and borowing levels in order to influence AD

what is fiscal policy

• involves the use of government spending and taxation. GIN AND TONIC

• to effect AD, output and jobs

• can also change the pattern in spending goods and services i.e healthcare and scares recourses

• it is an instrument of micro economic government intervention to correct market failure such as pollution and sub optimal merit goods

what is automatic fiscal policy

when fiscal policy automatically happens due to changes in AD.

• when AD falls , government spending on unemployment and welfare increases while tax revenue decreases.

• if the GOV allows borrowing to happen during a recession - then it is permitting automatic stabilisers

define expansionary/ reflationary fiscal policy

expansionary fiscal policy aims to encourage consumer spending and increase AD in the economy, and therefore to create actual economic growth and to reduce unemployment

define contractionary fiscal policy

contractionary/ deflationary fiscal policy is used to discourage consumer spending and reduce AD in the economy in order to reduce inflation.

why does a government use contractionary fiscal policy

1. AD to high, government needs to contract the economy. AS is too small to meet the AD, there is excess demand for the current goods and services - demand pull inflation

2. to reduce or eliminate a budget deficit

what is a budget fiscal deficit

a budget fiscal deficit arises when government spending exceeds tax revenue in a year

what is a budget fiscal surplus

when tax revenue is greater then government spending in a year

what are the types of fiscal policy

• discretionary fiscal policy

• automatic stabalisers

what is discretionary fiscal policy

discretionary fiscal policy is the term used when the government chooses to actively influence AD by changing its expenditure or taxes.

what is an automatic stabiliser

are changes in tax revenues and government spending that come about automatically as the economy moves through the business cycle

why should the government spend more (G)

• to provide a socially efficient level of public goods and overcome market failure - affordable access to healthcare, education, housing = improve human capital, productivity

• safety net for welfare benefits = redistribute wealth

• provide necessary infrastructure = transport, education ,healthcare facilities

• manage growth of AD

• promote equity in the allocation of scarce recources

why should the government tax more (T)

direct tax - levied on income and wealth and profit

indirect - taxes on spending

• changes in tax can have effects on AD and AS

• disposable income - post tax profit - cost of employing extra workers - real income of workers

• LRAS - work incentives to attract a skilled labour force

explain the Phillips curve and fiscal policy

the Phillips curve shows the relationship between unemployment and inflation between the economy

• there is an inverse relationship between wage inflation and unemployment.

• The curve suggested that the changes in unemployment have a direct and predictable effect on the level of price inflation.

there is trade off with the rate of unemployment and the level of inflation.

what is fiscal austerity

when the gov uses contractionary fiscal policy to decrease their budget deficit. Its primary aim is to slow down the rate of growth of national debt by bringing gov borrowing to lower levels.

WHAT IS monetry policy

the decisions made by the central bank i.e BOE regarding monetary variables such as money supply and interest rate in order to influence consumer and business spending in order to influence AD

what are the BOE main objectives

• CPI inflation 2% +- 1%

• BOE act of 1998 ensures monetry does not conridict government objectives for sustained growth and high employment

• aims to raise intrest rates before inflation accelerates

what is expansionary monetary policy

• decrease the base rate of intrest to increas AD and help the economy grow.

• it makes it cheaper to borrow money - encourage consumer spending

what is deflationary monetry policy

higher intrest rates on both loans and savings - to eliminate overheating in the economy.

explain quantitative easing

• BOE increases money supply and creates money electronically

• this money is used to buy long term assets : government bonds from financial instatutions

• Financial instatutions such as HSBC can use cash (liquid asset) to invest in new businesses, housing or lending

• this monetry stimulus helps the economy grow due to the increase in money supply, therefore there is more credit available for lending out to businesses and consumers = C + I increases