Government policy instruments

2.6.2 Demand-side policies: unit content Students should be able to: Define demand-side policies Distinguish between monetary and fiscal policy Explain monetary policy instruments (interest rates, asset purchases to increase the money supply (quantitative easing)) Explain fiscal policy instruments (ET) Distinguish between government budget (fiscal) deficit and surplus Distinguish between direct and indirect taxation Use AD/AS diagrams to illustrate demand-side policies Describe the role of the Bank of England (role and operation of MPC) Assess demand-side policies in the Great Depression and the Global Financial Crisis of 2008 (different interpretation and policy response in the US and UK) Evaluate the strengths and weaknesses of demand-side policies

Macroeconomic policy objectives and instruments What is the difference between a policy objective and a policy instrument? There are two main policy instruments: 1. Demand-side policy (monetary and fiscal policy) 2. Supply-side policy

Demand-side policies Demand side policies aim to increase a________ d________. If the economy is in a recession or a period of below trend GDP, so that there is spare capacity, (n_______ output gap) then demand side policies can increase the rate of economic growth. However, if the economy is already close to full capacity (trend rate of GDP) a further increase in AD will mainly cause ___________.

Policy instruments – monetary policy (demand-side) Monetary policy is the most common tool for influencing economic activity. Who runs this? What does it refer to? What is the MPC’s main objective? How often do they meet? What do they set? What target are they aiming for?

Interest rates What is the current rate and when was it set?

The Bank of England’s Monetary Policy Committee The MPC is made up of _____ experts (5 senior Bank of England staff and 4 are external members appointed by the Chancellor). Each has a vote to decide what interest rate to set. Its main job is to maintain prices as measured by CPI It takes about two years for a change in interest rates to have its full effect on inflation. So the MPC sets interest rates based on its forecast for inflation two to three years ahead.

What factors do the MPC consider? GDP g_____ and spare capacity; surveys about where the economy is within an economic cycle Bank lending and consumer c_______ figures Equity markets (share prices) and house p______ Consumer c________ and business c_________ Labour market data e.g. average e_________ Trends in global foreign exchange markets International data

What problems do the MPC face?

Policy instruments – monetary policy To boost AD, the MPC can ____ interest rates. What will be the impact on the cost of borrowing, investment and consumer spending? What ill be the impact on saving and spending? What will be the impact on mortgage interest payments? Why does this matter?

Evaluation of changing interest rates

Quantitative easing (students should have a basic knowledge) Bank of England “prints” money Uses this to buy bonds from banks or pension funds So what is the impact on the circular flow? What is the impact for firms and individuals? Any drawbacks?

The transmission mechanisms of monetary policy

What is a budget deficit? A budget deficit occurs when? If the government is running a budget deficit, how does it pay for it? This can be through the Bank of England selling Treasury Bills and long-term government bonds. Who buys the government debt?

Why does a budget deficit matter?

What is the impact on aggregate demand of a government trying to reduce a budget deficit?

Budget deficit - recap When the government is running a budget deficit, it means that in a given year, total government expenditure exceeds total tax revenue. Note that this is NOT the same as a current balance deficit In the short run an increase in the government’s budget deficit will increase aggregate demand and hence ______ unemployment. The increase in aggregate demand is likely to lead to:

Fiscal policy Fiscal policy refers to changes to ___________ and __________________ This is run by the ________________ For example the government might decide to reduce its budget surplus. A contractionary fiscal policy is used when inflation is accelerating. The government will aim for a surplus to reduce aggregate demand. So they will ___________ expenditure and/or _______________ taxes.

Direct versus indirect tax Direct tax refers to the tax levied on a person’s _______________; paid directly to the government E.g. Indirect tax is levied on a person who consumers the goods and services and is paid indirectly to the government. The burden of tax may fall on the consumer or the firm or a combination (depends on ______ of demand and supply). E.g.

Label the following as direct or indirect tax: Can be used to reduce negative externalities Helps in reducing inflation Increases inflation May lead to black market Progressive tax Regressive tax (makes income distribution more unequal) T ax evasion is not possible because it is included in the price of the goods and services. Tax evasion is possible.

Evaluate the strengths and weaknesses of demand-side policies Draw a table or mind map summarizing the strengths and weaknesses of demand-side policies

2.6.3 Supply-side policies: unit content Students should be able to: Define supply-side policies Distinguish between market-based and interventionist methods Aims of market-based and interventionist policies (to increase incentives, to promote competition, to reform the labour market, to improve skills and quality of the labour force, to improve infrastructure) Use AD/AS diagrams to illustrate supply-side policies Evaluate the strengths and weaknesses of supply- side policies

Policy instruments – what are supply side policies? A supply-side policy is a government scheme to promote m_______ forces, cut c________ and to raise the full employment level of output. They are designed to increase aggregate supply by improving e___________ (through improved productivity and increasing competition). They improve the supply side of the economy i.e. they increase the amount of 'supply' that is capable of being produced over the long term. They improve the p___________ p___________ of the economy

Market-based versus interventionist supply side policies Market-based policies focus on the power of the ________ market, or allowing the forces of supply and demand to eliminate equilibria imbalances. The role of the government in market-based policies is __________ since it tends to interfere with the market mechanism. Interventionist policies focus on the need for the government to intervene in markets to achieve a goal.

Market-based supply side policies Market-based supply-side policies include: Deregulating and/or p___________ the public sector (although not much left!) E____________ free trade R____________ income and/or corporation tax rates ______________ the national minimum wage ______________ trade union power (although this has been done!) Reforming the benefits system to ______________ workers to take available jobs

Interventionist supply side policies Interventionist supply-side policies include: increased government spending on e_________ and t___________ increased government spending on h____________ increased government spending on i_____________ stricter government competition policy policies to reduce the geographical immobility of labour, such as i______________ information on job vacancies and s_______________ worker relocation

Show the impact of supply side policies on the two versions of LRAS diagrams

What are the two diagrams used to illustrate supply side policies?

List measures that are used to increase the productivity of factors of production

Advantage of supply side policies (why classical economists like them!)

Disadvantage of supply side policies (why Keynesian economists don’t like them!)

Missing words: aims of market-based and interventionist policies To: improve s----- and q of the labour f---- improve i increase i promote c reform the l----- market