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Flashcards in Macroeconomic Policies Deck (27)
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fiscal policy

government's manipulation of taxes and expenditures with the goal of increasing or decreasing the level of aggregate demand in an economy


automatic fiscal policy: economic growth

economies at full employment level of output with low unemployment and high income will experience automatic decrease in government expenditure (benefits, etc.)


automatic fiscal policy: recession

during recessions and periods of high unemployment government expenditure automatically increases (benefits, etc.)


graphs of automatic fiscal policy for growth and recession

  • ST = stabilised 
  • would normally move from AD1 to AD2 but doesn't because of fiscal policy


graph showing built in automatic stabilisers


closing a recessionary gap

tax cut and spending package


closing an inflationary gap

increase taxes or decrease government spending 


discretionary fiscal policy

change in taxes and spending undertaken by government with the explicit aim of either stimulating or contracting the overall level of demand in the economy to promote economic stability and full employment


advantages of fiscal policy

prevents a 'double dip' recession

  • if prices/wages are sticky downwards, once in deep recession do not naturally rise, worsening recession

quick fix for rampant inflation

  • contractionary policy quick and easy to implement, causes prices to fall

increases aggregate demand

  • reduces size of deflationary gap
  • reduces cyclical unemployment
  • pulls economies out of liquidity trap


disadvantages of fiscal policy

time lag

  • administrative time lag: time to plan and administer tax change
  • recognition time lag: time taken to recognise that policies need to change
  • impact time lag: time between implementation and outcome


  • deflationary fiscal policy can be unfavorable politically, may be avoided before re-election


  • inflationary fiscal policy very expensive because need to invest in huge amounts of capital

crowding out



demand-side policies

  • monetary policy
  • fiscal policy


supply-side policies: encourage competition


  • can bring sucess if government monopoly ineffective and competition encourages
  • ineffective if becomes market monopoly
  • ineffective if government natural monopoly
  • government monopoly may provide positive externalities which could be lost in privitisation 

anti-monopoly legislation

  • breaking up natural monopoly = bad



supply-side policies: labor market policies

labor markets

  • legislation against trade unions
  • education and training
  • income tax rates (decrease in tax incentive for people to work harder)
  • unemployment benefits (makes opportunity cost of not working too high)


  • reduction in health&safety laws reduces costs and increases output
  • unsafe working conditions = negative outcome
  • reduction in environmental laws reduces costs
  • increased environmental degradation and other negative externalities

incentive related policies

  • reduce MTR on high earners does nto have predictable outcome
  • may increase or decrease tax revenue based on cultural factors (how people respond to changes)


money market graph


money demand

desire to hold money as an asset and demand for money as a means to purchase goods and services


why is money supply curve perfectly inelastic?

  • central bank has authority to set the level of money supply
  • operates independently of interest rate


contractionary monetary policy

actions by central bank to decrease money supply and increase interest rates


expansionary monetary policy

actions by central bank to increase money supply and decrease interest rates


reserve asset ratio

percentage of liabilities kept to cover potential withdrawals


credit multiplier

  • as lent money circles through economy back to bank a specific percentage kept back and surplus lent out again
  • creates new money in circulation


how to implement expansionary monetary policy?

  • decrease RAR to increase MM
  • government buys back bonds to increase money in circulation in open market operations
  • central bank lending interest rates decreased


expansionary monetary policy graphs


how to implement contractionary monetary policy?

  • increase RAR to decrease MM
  • government sells bonds to decrease money in circulation in open market operations
  • central bank lending interest rates increased


advantages of monetary policy

  • no political constraints (central bank tends to be semi-autonomous from government)
  • no crowding out (encourages investment by lowering interest rates, not government borrowing)
  • easier to track money supply than government expenditure
  • can be put into effect quickly


disadvantages of monetary policy

  • time lag (takes a while before interest rates trickle down to general population)
  • does not help liquidity trap: income elasticity of demand for investment more inelastic during recession: businesses not responding to change in interest rates
  • contractionary MP ineffective against cost-push inflation: exacerbate recessionary pressure


supply side policies: labor market reforms

  • reduction of minimum wage reduces labor costs and makes workers more responsive to labor market which increases output
  • increases inequality
  • reducing transfer payments and union power leads to more flexible labor market but increased inequality



supply side policies: government intervention

investment in human capital

  • increase education and healthcare provision
  • increases long run economic growth

investment in technology

  • private sector research and development limited by profit motive
  • government able to do this R&D without requiring profit

investment in infrastructure

  • works best in areas where cost is too great for private sector but where therea are significant positive externalities 
  • large scale projects subject to political pressures - results in inappropriate 'prestige' projects at expense of useful projects