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Macroeconomic policy
What is a policy? A policy is a course of action designed to achieve a stated objective
List the main macro policies. Government can use fiscal monetary or supply side policies
Why does government need macroeconomic policies? Macro policies allow the government
to influence the demand or supply side of the economy to meet macroeconomic objectives.
Distinguish between policy instruments, policy measures, and policy tools. These terms
have identical meaning and refer to methods used by government to influence economic activity
Budgets
What is the budget? An annual report setting out government tax plans
Define net government spending. The difference between public expenditure and tax receipts
Define a budget surplus. The amount by which government income exceeds government
spending over a time period eg one year
Define a budget deficit. The amount by which government spending exceeds government
income over a time period eg one year
Identify the key elements of a budget deficit. There are two main causes of a budget deficit
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Cyclical deficit: caused by the downturn and recession stages of the economic cycle when
tax receipts fall and spending on unemployment related benefits rise
Structural deficit: caused by a fundamental imbalance between government spending
and receipts. Structural deficits occur at potential GDP because government receipts are
too low to sustain public spending
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How can the government tackle a cyclical deficit? Cyclical deficits disappear during the
recovery and boom stages. Economic growth raises tax revenues and cuts benefit payments
How can governments tackle structural deficits? Action must be taken to reduce government
spending and increase receipts eg by raising taxes.
Explain the budget position? The budget position is the relationship between government
spending and tax revenues. There are three potential positions:
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Balanced budget: government revenue equals government expenditure ie G=T
Budget surplus: government revenue is greater than government expenditure ie G>T
Budget deficit government revenue is less than government expenditure ie G<T
How are budget deficits financed? If the government spends more than its tax receipts then
the budget is in deficit. The deficit is funded by borrowing and added to the national debt.
What is the national debt? The national debt is total amount owed by the government.
How does national debt arise? The state builds up debt over time by running a budget deficit.
What determines the size of the national debt? National debt is the sum of previous budget
deficits. The larger previous deficits, the larger the current national debt.
What is the cost of the national debt? The national debt incurs interest charges. The
opportunity cost of interest payments is forgone spending on infrastructure or public services
When is the national debt the problem? If the national debt becomes too large a proportion
of GDP, then the burden of interest payments has a severe impact on the level of public services.
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Macroeconomic policy |
Fiscal policy
What is fiscal policy? Fiscal policy is the use of government expenditure, benefit payments, tax
levels and rates to influence the level and makeup of aggregate demand
List the main types of fiscal policy instruments. The two main instruments of fiscal policy
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Government spending (G): on public services, infrastructure and benefits. The
government can adjust the amount, timing and composition of government spending
Taxes (T): government can adjust the types of tax, rates of tax, coverage of tax ie who
pays, and what is taxed eg children’s clothing is exempt from VAT
How does fiscal policy affect the economy? Fiscal policy affects the:
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Aggregate demand: eg increasing government spending (G) and cutting taxes increases
aggregate demand and moves the economy to a new level of GDP
Aggregate supply: eg tax cuts raise incentives to join the labour force or work overtime
What is a government’s fiscal stance? Fiscal stance refers to the intended impact of public
spending and taxation plans on the level of future economic activity and can be:
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Neutral: fiscal policy aims to have no impact on the future levels of AD
Reflationary expansionary or loose: fiscal policy aims to increase the future level of AD
Deflationary contractionary or tight: fiscal policy aims to lower the future level of AD
Does the government have full control over the level of its spending and tax revenues?
No. Tax receipts and job-related benefits depend on the level of GDP.
Explain automatic stabilisers. These are automatic fiscal changes brought about by the
economic cycle. They impact quickly without any policy changes and smooth the economic cycle
How do automatic stabilisers work in a recession? Automatic stabilisers trigger changes in
AD that counter the economic cycle. In a slump public spending on unemployment related
benefits automatically rise, stimulating AD. Automatic stabilisers are countercyclical
Define discretionary fiscal policy. Deliberate changes in government spending and taxation
Explain counter cyclical policies. Countercyclical policies aim to move demand in the opposite
direction to the economic cycle eg increases in public spending in slumps
List the strengths of fiscal policy. Fiscal policy has a multiplier effect and can be targeted at
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specific products eg taxes on demerit goods or subsidies for merit goods;
particular regions eg tax breaks for firms locating areas of high unemployment;
given sections of the population eg benefits for vulnerable groups in society
Identify fiscal policy implementation issues. Fiscal policy is made less effective if
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there are long implementation time lags eg time taken to secure planning permission and
build a new school or road
Uncertain multiplier. The multiplier value is uncertain. The multiplier effect has time lags
Tax changes affect incentives Increasing income and corporation tax rates diminishes the
incentive to work, and so reduce aggregate supply. Fiscal policy affects supply side policy.
Fiscal policy is inflexible. Budgets occur annually. Monthly budgets to adjust tax rates would
confuse households and firms – uncertainty reduces investment
Crowding out. government borrowing reduces the funds available for private sector
investment leading to higher interest rates
Contractionary fiscal policy involves politically unpopular spending cuts and tax increases. In
practice it can be hard to cut spending on education and health
| Macroeconomic policy
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