(2.6) Macroeconomic Objectives and Policies

• Governments intervene in the economy in an attempt to improve its economic performance
• Key macroeconomic objectives


  • Economic growth
  • Low unemployment
  • Low and stable inflation
  • Balance of payment equilibrium on the current account
• Economic growth


  In the UK, the long run trend of economic growth is about 2.5%
• Governments aim to have sustainable economic growth for the long run
• In emerging and developing economies, governments might aim to increase economic development before economic growth, which will improve living standards, increase life expectancy and improve literacy rates
• Low unemployment


  Governments aim to have as near to full employment as possible, accounting for frictional unemployment by aiming for an unemployment rate of around 3%. The labour force should also be employed in productive work
• Low and stable inflation


  In the UK, the government target is 2%, measured by CPI. This aims to provide price stability for firms and consumers and will help them make decisions for the long run. If the inflation rate falls 1% outside the target, the Governor of the Bank of England has to write a letter to the Chancellor of the Exchequer to explain why this has happened and what the Bank intends to do about it
• Balance of payment equilibrium on the current account


  This is important to allow the country to sustainably finance the current account, which is important for long term growth
• Other macroeconomic objectives


  • Balance government budget
  • Protection of the environment
  • Greater income equality
• Balance government budget


  This ensures the government keeps control of state borrowing, so the national debt does not escalate. This allows governments to borrow cheaply in the future should they need to and makes repayments easier
• Protection of the environment


  This aims to provide long run environmental stability. It ensures resources used are not exploited, such as oil and natural gas, and that they are used sustainably, so future generations can access them too. Moreover, it means there is not excessive pollution
• Greater income equality


  This minimises the gap between the rich and poor. It is generally associated with a fairer society
• To achieve their macroeconomic objectives, governments are able to manage demand through monetary or fiscal policy
• In times of recession, they often increase AD to increase employment and economic growth whilst in a boom, they will decrease AD to decrease inflationary pressures
• They may also use supply side policies, which aim to bring about long-term growth
• Expansionary policy


  Aimed at increasing AD to bring about growth
• Deflationary policy


  Attempts to decrease AD to control inflation
• Monetary policy


  Where the central bank or regulatory authority attempts to control the level of AD by altering base interest rates or the amount of money in the economy
• Fiscal policy


  Use of borrowing, government spending and taxation to manipulate the level of aggregate demand and improve macroeconomic performance
• Repo rate


  The rate the Bank of England will charge for short-term loans to other banks or financial institutions
• A rise in interest rates


  Causes a fall in AD through four key mechanisms
• Mechanisms by which a rise in interest rates causes a fall in AD


  • Increased cost of borrowing for firms and consumers, leading to a fall in investment and consumption
  • Savings become more attractive, leading to a fall in demand for assets and a negative wealth effect
  • Fall in consumer and business confidence, leading to a fall in consumption and investment
  • Increased incentive for foreigners to hold money in British banks, causing the pound to rise and net trade to fall
• Problems with using interest rates to manage demand

  • Exchange rate may be affected so much that exports fall significantly and imports rise significantly, causing a balance of trade deficit
  • Changes in interest rates take up to 2 years to have their full effect and small changes may not affect people's decisions
  • Interest rates are so low that they cannot be decreased any further to stimulate demand
  • Not all interest rates are affected by the Bank of England base rate
  • Lack of confidence in the economy may mean that, no matter how low interest rates are, consumers and businesses do not want to borrow or banks do not want to lend to them
  • High interest rates over a long period of time will discourage investment and decrease LRAS
• Quantitative easing


  When the Bank of England buys assets in exchange for money in order to increase money supply and get money moving around the economy during times of very low demand
• Quantitative easing


  Increases consumption and investment, which increases AD and ensures the country meets its inflation target
• Effects of quantitative easing

  • Rise in asset prices causing a positive wealth effect and lower cost of borrowing
  • Increase in money supply, allowing banks to increase lending and households/businesses to increase consumption and investment
  • Commercial banks may lower their interest rates as they receive more money from the Bank of England
• Problems with using quantitative easing


  • It is very risky and, if not controlled properly, could cause high inflation and even hyperinflation
  • It would only lead to increased demand for second hand goods which pushes up prices but does not increase aggregate demand
  • No guarantee that higher asset prices lead into higher consumption through the wealth effect, especially if confidence remains low
  • It had a large effect on the housing market by stimulating demand and leading to rapid price rises, helping to worsen the issues of geographical mobility. It also led to rising share prices which increases inequality
  • Banks and economies are too dependent on quantitative easing, particularly within the Eurozone
• Monetary Policy Committee (MPC)


  Makes the most important decisions on monetary policy, including the Bank of England base rate and actions over quantitative easing
• The MPC's main aim is to keep inflation at 2% and if it goes below 1% or above 3% the governor of the Bank of England has to write a letter to the Chancellor of the Exchequer explaining why this is happened and what the Bank of England is doing to bring it back to the target</b>
• Since 2009, the MPC has kept the bank rate at 0.5% and policy has become focussed on boosting economic growth and employment. It was reduced to 0.25% following the Brexit vote but rose again in November 2017 due to the inflation that the weak pound had caused
• The Monetary Policy Committee (MPC) makes the most important decisions, including the Bank of England base rate and the actions over quantitative easing
• Main aim of the MPC

  Keep inflation at 2% and if it goes below 1% or above 3% the governor of the Bank of England has to write a letter to the Chancellor of the Exchequer explaining why this is happened and what the Bank of England is doing to bring it back to the target
• Since 2009, the MPC has kept the bank rate at 0.5% and policy has become focussed on boosting economic growth and employment
• The bank rate was reduced to 0.25% following the Brexit vote but rose again in November 2017 due to the inflation that the weak pound brought about
• The MPC plans to raise the interest rate once the negative output gap has been eliminated and the economy is growing strongly
• Composition of the MPC

  • 5 from the Bank of England, including the Governor
  • 4 independent outside experts, mainly economists
• A rise in income tax


  Causes a fall in disposable income, leading to a reduction in consumption and thus decrease AD
• A rise in corporation tax


  Decreases a firm's post-tax profits, leading to a reduction in investment and thus decrease AD
• A rise in government spending


  Increases AD since it is one component
• Budget deficit


  When the government spends more money than they receive