Economic Policy

• What is fiscal policy?

  When the government manipulate taxation and/or government spending to change aggregate demand. Aggregate demand is made up of consumption, investment, government spending and net exports
• How do you work out net exports?

  Exports - Imports
• what is an expansionary fiscal policy?

  Designed to raise aggregate demand and would involve tax cuts and/or increased government spending, this may happen in a recession
• What is a contractionary fiscal policy?

  designed to reduce aggregate demand and would involve tax increases and/or reduced government spending
• What was fiscal policy used for in 1970?

  Controlling the economy. Used to:

  • Influence the level of unemployment or inflation in times of severe boom (reducing ad) or recession (expand ad).
  • To 'smooth' out general upturns and downturns in the economy (business cycle) to prevent the emergence of problems such as inflation or external deficit.
• What happens when the government wishes to expand fiscal policy?

  Government spending rises but its income (tax revenue) falls. This may lead to borrowing
• How does the government borrow?

  Selling bonds to the public and/or financial institutions. These are usually for a fixed period and involve payment of interest. Some bonds are undated, meaning the initial sum is never repaid but interest is received indefinitely.

  • Bonds for 1 year + = gilts.
  • Short term bonds = treasury bills
• What does government borrowing cause?

  Rise to a budget deficit. The total quantity of debt outstanding is known as the national debt. this is the sum of all past budget deficits.
• What can happen in rapid economic growth?

  Occasionally, a budget surplus can result this reduces national debt.
• what is the UKs current budget deficit?

  2023-24 is £114 billion or about 5.8 % of GDP. Approx 3% is acceptable
• What can happen to a country with large debt?

  greater debt implies greater payment of interest, hence increasing national debt is costly. If debt grows more quickly than GDP then interest payments become very large. This means countries are unable to pay and may default
• How are fiscal policies effective?

  Automatically stabilises the economy to an extent in times of recession/boom.
• What happens when national income rises?

  People pay more taxation so that slows down the expansion and prevents overheating. Expenditure on unemployment benefits also falls
• What can happen in a recession?

  People pay less taxation and spending on unemployment benefit rises which will provide a boost to aggregate demand in recession
• what is discretionary fiscal policy?

  Government may choose to change tax rates and/or adjust government spending to meet other objectives like GDP targets or to lower unemployment
• For fiscal policy to be successful what do governments need to be able to?

  • predict effect of changes in government spending. If spending is financed by borrowing, then higher interest rates may reduce consumption & investment.
  • predict effect of tax changes. If taxes are cut where will people spend it or save it?
• How can timing be an issue for fiscal policies?

  Not effective instantaneously so that it can destabilise an economy. For example, in a recessions after tax cuts and increased gov spending, these may not take effect until the economy is already recovering so that will add inflationary pressure
• How does monetary policy work in the UK?

  Bank of England monetary policy committee meets once a month in order to set interest rates (currently 5.25%). They intervene in the money market to ensure this rate is maintained. As the issuer of money then the central bank has a degree of control over the money supply which enables them to influence interest rates.
• What is the UK governments current target?

  UK gov sets targets for policy. currently has a target of 2% for inflation. they allow the bank of england independence to decide what rate of interest will achieve this.
• why is the growth of money supply crucial?

  Its important to restrict the money supply to keep inflation stable. increases in gov borrowing can lead to increase money supply so its important that excessive gov spending is avoided
• monetary control techniques include:

  • setting minimum reserve assets ratios for banks. forcing banks to retain a % of assets in liquid form to reduce scope for credit creation.
  • reduce central bank lending to retail banks. retail banks can borrow cash short term from the central bank to cover any shortfalls by refusing to lend then banks must cut back on lending and credit creation
• How does the UK control interest rate?

  normally monetary policy is conducted via interest rate control. the central bank announces the rate of interest then conducts open market operations to ensure this rate is stable. when it loans to retail banks it will charge them this interest rate for loans.
• what does the effectiveness of changing interest rates depend on?

  elasticity of loan demand. when demand is inelastic then to be effective interest rate changes must be large. this can pose problems as higher interest rates will lead to reduced consumption, reduced investment, difficulties for homeowners and upward pressure on the currency leading to a decline in competitiveness internationally
• What are supply side policies?

  Economic policies that focus on increasing the production and supply of goods and services in order to stimulate economic growth.
• How can fiscal policies be used in relation to microeconomic & supply side policies?

  to provide investment tax breaks such as lower corporation tax can boost firms funds etc
• what are microeconomic policies?

  Government interventions to influence individual markets.
• how can monetary policies effect education and training?

  boost labour skills and improve quality of the workforce
• how can monetary policies effect privatisation?

  to reduce monopoly power and boost competition which can lead to innovation, improved product quality and lower prices
• what are investment zones?

  designed to boost local growth and investment attracting firms with tax breaks and offering extended training schemes. several zones were setup in 2023 with money designated for each (£160mill in total).
• what's trade union reform?

  designed to reduce strikes and to lower wages