68-qa-aqaecon2

68-qa-aqaecon2 - Macroeconomic policy What is a policy? A...

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Unformatted text preview: Macroeconomic policy What is a policy? A policy is a course of action designed to achieve a stated objective List the main macro policies. Government can use fiscal monetary or supply side policies Why does government need macroeconomic policies? Macro policies allow the government to influence the demand or supply side of the economy to meet macroeconomic objectives. Distinguish between policy instruments, policy measures, and policy tools. These terms have identical meaning and refer to methods used by government to influence economic activity Budgets What is the budget? An annual report setting out government tax plans Define net government spending. The difference between public expenditure and tax receipts Define a budget surplus. The amount by which government income exceeds government spending over a time period eg one year Define a budget deficit. The amount by which government spending exceeds government income over a time period eg one year Identify the key elements of a budget deficit. There are two main causes of a budget deficit Cyclical deficit: caused by the downturn and recession stages of the economic cycle when tax receipts fall and spending on unemployment related benefits rise Structural deficit: caused by a fundamental imbalance between government spending and receipts. Structural deficits occur at potential GDP because government receipts are too low to sustain public spending How can the government tackle a cyclical deficit? Cyclical deficits disappear during the recovery and boom stages. Economic growth raises tax revenues and cuts benefit payments How can governments tackle structural deficits? Action must be taken to reduce government spending and increase receipts eg by raising taxes. Explain the budget position? The budget position is the relationship between government spending and tax revenues. There are three potential positions: Balanced budget: government revenue equals government expenditure ie G=T Budget surplus: government revenue is greater than government expenditure ie G>T Budget deficit government revenue is less than government expenditure ie G<T How are budget deficits financed? If the government spends more than its tax receipts then the budget is in deficit. The deficit is funded by borrowing and added to the national debt. What is the national debt? The national debt is total amount owed by the government. How does national debt arise? The state builds up debt over time by running a budget deficit. What determines the size of the national debt? National debt is the sum of previous budget deficits. The larger previous deficits, the larger the current national debt. What is the cost of the national debt? The national debt incurs interest charges. The opportunity cost of interest payments is forgone spending on infrastructure or public services When is the national debt the problem? If the national debt becomes too large a proportion of GDP, then the burden of interest payments has a severe impact on the level of public services. 30 Macroeconomic policy | Fiscal policy What is fiscal policy? Fiscal policy is the use of government expenditure, benefit payments, tax levels and rates to influence the level and makeup of aggregate demand List the main types of fiscal policy instruments. The two main instruments of fiscal policy Government spending (G): on public services, infrastructure and benefits. The government can adjust the amount, timing and composition of government spending Taxes (T): government can adjust the types of tax, rates of tax, coverage of tax ie who pays, and what is taxed eg children’s clothing is exempt from VAT How does fiscal policy affect the economy? Fiscal policy affects the: Aggregate demand: eg increasing government spending (G) and cutting taxes increases aggregate demand and moves the economy to a new level of GDP Aggregate supply: eg tax cuts raise incentives to join the labour force or work overtime What is a government’s fiscal stance? Fiscal stance refers to the intended impact of public spending and taxation plans on the level of future economic activity and can be: Neutral: fiscal policy aims to have no impact on the future levels of AD Reflationary expansionary or loose: fiscal policy aims to increase the future level of AD Deflationary contractionary or tight: fiscal policy aims to lower the future level of AD Does the government have full control over the level of its spending and tax revenues? No. Tax receipts and job-related benefits depend on the level of GDP. Explain automatic stabilisers. These are automatic fiscal changes brought about by the economic cycle. They impact quickly without any policy changes and smooth the economic cycle How do automatic stabilisers work in a recession? Automatic stabilisers trigger changes in AD that counter the economic cycle. In a slump public spending on unemployment related benefits automatically rise, stimulating AD. Automatic stabilisers are countercyclical Define discretionary fiscal policy. Deliberate changes in government spending and taxation Explain counter cyclical policies. Countercyclical policies aim to move demand in the opposite direction to the economic cycle eg increases in public spending in slumps List the strengths of fiscal policy. Fiscal policy has a multiplier effect and can be targeted at specific products eg taxes on demerit goods or subsidies for merit goods; particular regions eg tax breaks for firms locating areas of high unemployment; given sections of the population eg benefits for vulnerable groups in society Identify fiscal policy implementation issues. Fiscal policy is made less effective if there are long implementation time lags eg time taken to secure planning permission and build a new school or road Uncertain multiplier. The multiplier value is uncertain. The multiplier effect has time lags Tax changes affect incentives Increasing income and corporation tax rates diminishes the incentive to work, and so reduce aggregate supply. Fiscal policy affects supply side policy. Fiscal policy is inflexible. Budgets occur annually. Monthly budgets to adjust tax rates would confuse households and firms – uncertainty reduces investment Crowding out. government borrowing reduces the funds available for private sector investment leading to higher interest rates Contractionary fiscal policy involves politically unpopular spending cuts and tax increases. In practice it can be hard to cut spending on education and health | Macroeconomic policy 31 ...
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This note was uploaded on 02/08/2012 for the course ECO 51844 taught by Professor Sabet during the Spring '11 term at FIU.

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