Unit 5.1 Government Economic Policy
Macroeconomic Objectives:
Low & stable inflation: To keep ____________ under control.
Low employment: Unemployment is a waste of resources and means the economy is
under producing.
Economic growth: this increases the standard of ____________ as more goods and
services are produced
A balance in the balance of payments: A deficit means more money is leaving the
country than is coming in; a surplus means another country has a deficit. A balance may
be desirable.
Types of policy:
Demand side policies: attempts to influence aggregate ______________
Supply side policies: attempts to increase the quantity and _________ of the factors of
production specifically labour, capital and enterprise- this will increase an economy’s
ability to produce (affecting aggregate _____________).
Expansionary policies: increasing aggregate demand e.g. lower tax rates, higher
_______________ spending, lower interest rates.
Contractionary policies: decreasing aggregate demand e.g. higher tax rates, lower
government spending, higher interest rates.
Instruments of government policy:
Demand side policies:
1. Fiscal Policy:
Fiscal Policy is an instrument of DEMAND MANAGEMENT which seeks to
control the level of economic activity in an economy through the control of
TAXATION and GOVERNMENT EXPENDITURE.
Quite simply, if a government spends more, without increasing taxes, then aggregate
demand increases. For example, if the government spends more on defence then
government purchases will increase on military goods and more people will be employed
either directly or indirectly.
If the government reduces taxes (e.g. income tax, corporation tax) or increases transfer
payments (pensions, unemployment benefit etc) without reducing its own spending, then
aggregate demand will increase. Reduced taxes and increased spending increase people’s
________________________- they have more money in their pockets to spend.
Problems with fiscal policy?
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Time delays- any change in policy will take time to work through the economy,
by which time the policy change may no longer be needed.
Information problems- it is difficult to know the exact position of the economy
at any moment
Government intervention either overshoots or undershoots i.e. increases AD
too much or too little because of time lags and poor information; this can
destabilise the economy.
Some items of spending are very difficult to reduce due to political sensitivity
e.g. education and ___________ spending- to cut back on these would be
politically unwise.
2. Monetary Policy
Monetary Policy is a tool of MACROECONOMIC POLICY which involves the
regulation of the MONEY SUPPLY and/or INTEREST RATES in order to control
the level of expenditure in an economy.
Interest rates affect household spending and _____________ spending. If the Central
Bank raises interest rates, it increases the cost of borrowing money and thus consumer
durable spending will fall, investment spending will fall and saving becomes more
attractive.
Supply-side policies
Supply side policies can involve both fiscal and monetary policies. They include
‘interventionist’ policies such as government spending to improve infrastructure making
it cheaper to move goods and people around and spending on education and training of
the labour force.
There are also market based policies use to encourage competition and increase the
incentive to work. For example:
1.
2.
3.
4.
Reduction in income taxes:
Reduction in business (profits) tax:
Reductions in unemployment benefits:
Deregulation & privatization: