The Main Instruments Of Government Macroeconomic Policy

1. The Main Instruments Of Government Macroeconomic Policy

2. Content Fiscal Policy Government expenditure Taxation Influence on AD / AS Monetary Policy Interest rates Money supply Exchange rates Supply side policies .

3. What is fiscal policy Fiscal policy looks at how government spend their money and how they control their taxes. There are 2 types of fiscal policy: Contractionary fiscal policy: Where the government reduce spending and / or when they make taxes higher, they try to increase its PSBR( public sector borrowing requirement) to fund the tax drops they also do this to reduce its surplus on its budget for the fiscal year. Expansionary fiscal policy: Where the government cut taxes or increase government spending. They will increase the amount the government borrows to fund the expenditure.

4. Government Expenditure Government expenditure covers all spending by the public sector The government spends money on many things including: Education Defence Welfare benefits Healthcare Infrastructure Police

5. Government Borrowing As well as gaining revenue through taxation the government can also finance their spending through borrowing The public sector net cash requirement (PSNCR) measures the annual borrowing requirement of the government in an economy

6. Direct & indirect taxes Direct taxes are taxes of income and expenditure e.g. income tax, corporation tax (levied on company profits). Indirect taxes are taxes such as VAT (value added tax), changes in this type of tax has a rapid effect on the level of economic activity. E.g. an increase in VAT will cut consumption

7. Fiscal Policy and AD Taxation influences the AD curve because: An increase in taxation will decrease the level of consumption in the economy An increase in taxation will increase the level of government spending in the economy A decrease in taxation will increase the level of consumption in the economy A decrease in taxation can decrease the level of government expenditure in the economy The impact of a change in government expenditure depends on the size of the multiplier

8. Fiscal Policy and AD Governments can utilise fiscal policy to control the level of AD in the economy There can be problems with this due to: Time lags The size of the multiplier Fiscal crowding out Peoples reaction to cuts / rises in taxation

9. Fiscal Policy and AS Fiscal policy can be used to increase the productive capacity of the economy This is because government expenditure can be used to: Increase the skill levels of workers Provide economic incentives to firms Increase factor mobility

10. Monetary Policy Monetary policy is the use of interest rates, money supply and exchange rates to influence economic growth and inflation Interest rates � are the cost of borrowing money Exchange rates � the value of one currency in terms of another Money supply � the amount of money in circulation in an economy

11. Interest Rates The Bank of England are responsible for setting interest rates in the UK The Bank sets the rate after analysing macroeconomic trends and risks associated with inflation Since 1997 the UK government has used interest rates to control the level of inflation in the economy (at a level of 1.5-3.5% - target = 2.5%) If the Bank believes the level of AD is rising too quickly potentially causing cost push inflation they will decide to raise interest rates

12. Interest Rates and The Economy Changes to interest rates influence many things in the economy: Housing prices and housing market � if interest rates rise the cost of mortgages increases therefore reducing demand for housing in theory (this has not occurred recently in the UK) Disposable income of house owners � if interest rates rise the real disposable income of home owners falls as they have larger mortgage payments (variable rate only)

13. Interest Rates and The Economy Credit demand � if interest rates rise the amount of credit sales should decrease as it becomes more expensive Investment � if interest rates rise they lead to a decrease in the level of investment Exchange rates � An increase in interest rates may lead to an appreciation of UK currency making exports less attractive

14. Interest rates and Inflation Interest rates are used to control inflation as when interest rates are increased consumption decreases as peoples real incomes are eroded by mortgage payments and credit payments and the opportunity cost of spending has increased By controlling interest rates the government aims to keep inflation at a low level

15. Interest and Exchange Rates Changes in the UK�s interest rates will lead to changes in the exchange value of the pound. If interest rates rise the value of the pound will rise so the pound will now buy more US dollars, Japanese Yen, Euros etc. If interest rates fall the value of the pound will fall so the pound will now buy less US dollars, Japanese Yen, Euros etc

16. Exchange rates A fall in the exchange rate reduces the price of exports and increases the price of imports Domestic demand will be stimulated and more people will buy exports as they are cheaper This will create a deficit on the current account of the balance of payments As consumption will increase it will increase AD which will increase the level of output in the economy and more it towards full employment

17. Supply Side Policies Supply side policies are policies that improve the supply-side of the economy increasing its efficiency and thereby resulting in economic growth Supply side policies can act in the product and labour markets

18. Supply side policies Trade union reforms Increased expenditure on training and education Changes in taxation Changes to welfare system Privatisation Deregulation Free trade Incentives for small businesses

19. Supply side policies Supply side policies cause economic growth as they cause the LRAS to shift outwards increasing the potential output of the economy If the economy is operating near full potential increases in aggregate demand can cause cost push inflation, by the LRAS curve shifting outwards this inflationary pressure is reduced

20. Supply side policies As supply side policies can cause the LRAS to shift outwards they can lead to a fall in unemployment levels Many supply side policies concentrate on the labour market and increase skills for workers which help reduce structural unemployment in the economy

21. Supply Side Policies As the LRAS shifts outwards businesses will have lower average costs as productivity has increased Lower costs mean that businesses are able to compete more internationally therefore making the balance of payments more healthy

22. Summary Fiscal Policy is the use of government expenditure and taxation to influence the level of inflation / economic growth Government expenditure covers all things the public sector spends money on Taxation earns revenue for the government either directly through income taxes or indirectly through VAT Monetary Policy is the control of the economy through interest rates, money supply and exchange rates The bank of England set the rate of interest in the UK The government uses interest rates to control the rate of inflation around its target of 2.5% Supply side policies aim to increase productivity in the economy therefore stimulating economic growth