Booklet 6 - managing the economy (policies)

• Fiscal policy 


  Government policy that determines the levels of government spending and taxation
• Fiscal policy is often used to increase AD in the economy
• Monetary policy 


  Gov policy that involves controlling the money supply in the economy, and how expensive it is to borrow that money
• Monetary policies involve manipulating interest rates, exchange rates and restrictions on the supply of money
• budget Deficit


  When gov spending is greater than revenue
• Budget surplus


  When gov spending is less than its revenue
• Supply side policy


  Gov policy that aims to increase aggregate supply in economy. E.g increasing productive capacity
• 6 main aims of macro economic policies:

  1. Trade deficit
  2. inflation (2%)
  3. economic growth
  4. employment (95%)
  5. redistribution of income
  6. government spending / stability
• A contractionary fiscal policy can involve

  • cuts in government expenditure in terms of GDP
  • increase in direct/ indirect taxes
  • attempt to reduce budget deficit
• 3 main areas of gov spending In uk are :

  1. transfer payments - e.g benefits / state pensions
  2. current gov spending - state provided goods and services
  3. capital spending - roads and schools
• Direct taxes are levied on income, wealth and profit.
• Direct taxes include :

  • income tax
  • inheritance tax
  • national insurance contributions
  • capital gains tax
  • corporation tax
• Indirect taxes are taxes on spending
• Indirect taxes include :

  • duty tax on fuel and alcohol
  • VAT
• Discretionary fiscal changes 


  Deliberate changes in direct and indirect taxation and gov spending. E.g increased capital spending on roads
• Automatic stabilisers


  Changes in tax revenues and government spending that come about automatically as economy moves through business cycle
• Tax revenues

  When the economy is expanding rapidly the amount of tax revenue increases which takes money out of the circular flow of spending and income
• Welfare spending


  A growing economy means gov don’t have to spend as much on welfare benefits such as income support or unemployment benefits
• fiscal policies to boost supply in economy:

  • Labour market incentives (lowering tax)
  • capital spending
  • entrepreneurship and investment
  • research and development/ innovation
  • Human capital
• What is the purpose of the Monetary policy committee (MPC)


  Responsible for setting interest rates to meet governments inflation target and maintain price stability in economy
• Transfer payments


  Payments made by the government to individuals with no goods or services provided in return (benefits)
• the multiplier effect


  injection into the economy results in larger than proportionate increase in income (GDP/National income)
• The multiplier is calculated as 1 / (1 - MPC), where MPC is the marginal propensity to consume.
• MPC stands for Marginal Propensity to Consume, which is the portion of additional income that consumers spend rather than save.
• the burden of an indirect tax can be shifted to the consumer, as it is typically included in the price of goods and services.
• Direct taxes, especially progressive taxes like income tax, can reduce income inequality by taxing higher incomes at a higher rate.
• Indirect taxes are regressive in nature, meaning they can disproportionately affect lower-income individuals since everyone pays the same tax rate on goods, regardless of income.
• A progressive tax system is one in which the tax rate increases as the taxable income increases, and it is typically associated with direct taxes like income tax.
• A proportional tax is a tax system where the tax rate is the same for all income levels, meaning everyone pays the same percentage of their income, regardless of how much they earn.
• Regressive taxes, such as consumption taxes, are difficult to evade, making them a more reliable source of revenue compared to income taxes, which can be more easily avoided or evaded.
• Monetary policy is the process by which a central bank, such as the Federal Reserve or Bank of England, controls the supply of money, interest rates, and inflation to achieve macroeconomic goals like price stability and economic growth.
• Expansionary monetary policy aims to increase the money supply and lower interest rates to stimulate economic growth, often used during periods of recession or high unemployment.
• Contractionary monetary policy aims to decrease the money supply and raise interest rates to curb inflation, typically used when the economy is overheating.
• Central banks adjust interest rates to influence borrowing and spending. Lower interest rates encourage borrowing and investment, while higher rates discourage it to reduce inflation.
• Money is any asset that is a medium of exchange for goods and services
• How does monetary policy affect inflation?


  By increasing or decreasing the money supply and adjusting interest rates, monetary policy helps control inflation. Raising interest rates reduces inflation, while lowering rates can stimulate spending and inflation.
• Interest rates represent the cost of borrowing money or the return on savings, typically expressed as a percentage of the principal amount per year
• Nominal interest rates are the stated rates on loans or investments, while real interest rates adjust for inflation to reflect the actual purchasing power of the money.
• What happens to the economy when interest rates are lowered?

  Lower interest rates reduce the cost of borrowing, encourage spending and investment, and can stimulate economic growth.
• What effect do rising interest rates have on inflation?


  Rising interest rates can help reduce inflation by discouraging borrowing and spending, which slows down economic activity.