Please enable JavaScript.
Coggle requires JavaScript to display documents.
Unit 5 - Government Macroeconomic Intervention - Coggle Diagram
Unit 5 - Government Macroeconomic Intervention
Government macroeconomic policy objectives
Low unemployment
High tax revenue
Low government spending on benefits
High output
Workers don't loose skills and work habits
Quality
Jobs may be unskilled, insecure and low-paid
Economic growth
Living standards improve
Unemployment decreases
Too high rate
Inflationary pressure may build up
Pressure on resources
Demand increases faster than supply
Entreprenuers become over optimistic
Price stability
Inflation target - 2%
Measure of inflation tends to overstate any rise in prices
Deflation may result from a lower target inflation
A low and stable rise in prices caused by increased demand encourages firms to increase their output
Makes the central bank more accountable
Can be a range, or can be a central target with a margin either side
If firms, workers and households have confidence in a bank's ability to meet its target they wont act in a way that will push prices up, for example demanding higher wages.
Fiscal policy
Budget
The annual budget is a statement of government's fiscal policy
Surplus - revenue exceeds expenditure
Automatic stabilisers - Changes in the spending and taxation that reduce fluctuations in aggregate demand but occur without changing government policy
Deficit - expenditure exceeds surplus
Cyclical deficit - caused by a decline in economic activity - will disappear when GDP rises
Structural deficit - Caused by an imbalance between government spending and taxation
Taxation
Indirect taxes
On the sale of goods and services
Paid by consumers but collected by firms supplying the products
If demand is price inelastic, more of the tax will be passed onto consumers
Specific indirect taxes are a set amount per unit
Sin taxes are aimed to discourage people from buying products bad for their health
Can be changed easily and are cheaper to collect
Direct taxes
Taxes on income and wealth
Income tax and Corporate tax
Discourage effort, innovation and saving
Encourages tax avoidance and evasion
Tax avoidance
Tax evasion
Government spending
Transfer payments
Non-exhaustive government spending
Unemployment benefits
State pensions
Interest payments on the national debt
Current spending
Exhaustive government spending
Goods and services used to provide state-financed serives
Capital spending
Infrastructure such as state schools and hospitals
Exhaustive government spending
Contractionary fiscal policy
Lower the growth of aggregate demand
Reduce spending
Result of changes in government policy or changes in economic activity
Deliberate changes are discretionary fiscal policy
Increases taxes
Impact
Reduce demand pull inflation
Workers may seek higher wages, resulting in cost push inflation
May disincentivise workers
Reduce economy's productive capacity
Expansionary fiscal policy
Increase aggregate demand
Increasing spending
May increase an existing budget defecit
Cutting tax
Impact
Increase countries output
Raise employment
Can solve cyclical unemployment
Depending factors
Are firms and households worried about the future?
Demand - pull inflation
National debt
Expressed as a percentage of GDP
Increases during economic downturns
Can be paid of with extra revenue earned from a budget surplus
Opportunity cost of interest payments
Makes loaners reluctant to lend
Monetary policy
Tools
Money supply
Exchange rate
Interest rates
Credit regulations
Contractionary
Reduce aggregate demand or the growth of it
Rise the interest rates
Decrease in money supply
Decrease in restrictions on bank lending
Price level
The policy is mostly used to reduce demand pull inflation and the focus is on the interest rate
If inflation rises, the central bank may counteract this by raising the rate of interest to reduce aggregate demand
Commercial banks may not rise interest with the central banks because they are commercial
Equilibrium national income
Where an economy has sparce capacity, expansionary monetary policy can raise national income
Increase emploment
Contractionary monetary policy may reduce national income, output and employment, unless it is when the economy is operating without sparce capacity, in which case it reduces inflation.
Expansionary
Increase aggregate demand
Increase in the money supply
Cut in the interest rate
Reduce restrictions on bank lending
Effectiveness
Difficult to control the money supply - commercial banks have incentive to lend and not restrict growth of their lending
It can take up to 18 months for interest rates to have their full impact.
A rise in interest rate harms borrowers but benefits savers
Supply side policy
Policy objectives
Increase aggregate supply by improving the workings of product and factor markets
Increase productive capacity
Shift LRAS curve to the right
Increase productivity
Policy tools
Promoting infrastructure development
Support for technological improvement
Education and training
Cutting corporate tax
Cutting income tax
Trade union reform
Privatisation and deregulation
Encouragement of immigration
Impact on the macroeconomy
National income and real output
Increase quality of resources
Increase quantity of resources
Price level
Demand pull inflation can decrease as supply can keep pace with higher aggregate demand
Cost push inflation can be corrected by reducing the costs of production
Employment
Workers skills and geographical and occupational mobility improve
Frictional and structural employment decrrease
Effectiveness
Most effective in the long run
Quality of labour and productive capacity can be directly increased
Can take a long time to have effect, so uneffective in the short run
Not effective if it is not high quality, or the skills it develops aren't needed in the longer temr
Infrastructure development can be expensive and take time to construct, by which time demand has changed
Benefits aren't evenly spread
Wont raise output if economy is initially operating with spare capacity