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Questions and Answers
What are the main components of fiscal policy?
What are the main components of fiscal policy?
The main components of fiscal policy are government expenditure and taxation.
What is expansionary fiscal policy?
What is expansionary fiscal policy?
Expansionary fiscal policy is when the government decreases taxation or increases government expenditure to stimulate economic activity.
How does contractionary fiscal policy impact the economy?
How does contractionary fiscal policy impact the economy?
Contractionary fiscal policy impacts the economy by increasing taxation or decreasing government expenditure, leading to lower aggregate demand.
What is a budget deficit?
What is a budget deficit?
List two sources from which the government can fund a budget deficit.
List two sources from which the government can fund a budget deficit.
What effect does expansionary fiscal policy have on aggregate demand?
What effect does expansionary fiscal policy have on aggregate demand?
Why is printing money to fund a budget deficit generally avoided?
Why is printing money to fund a budget deficit generally avoided?
What is the formula for aggregate demand, and how does government spending affect it?
What is the formula for aggregate demand, and how does government spending affect it?
What is the primary function of open market operations in relation to government borrowing?
What is the primary function of open market operations in relation to government borrowing?
How do bonds function as a financial instrument for investors?
How do bonds function as a financial instrument for investors?
What is crowding out in the context of fiscal policy?
What is crowding out in the context of fiscal policy?
Name two goals of fiscal policy.
Name two goals of fiscal policy.
Identify one constraint on fiscal policy effectiveness.
Identify one constraint on fiscal policy effectiveness.
What is the Keynesian multiplier effect in economic terms?
What is the Keynesian multiplier effect in economic terms?
How can fiscal policy effectively target specific economic sectors?
How can fiscal policy effectively target specific economic sectors?
Why might some argue that private sector management of funds is preferable to government intervention?
Why might some argue that private sector management of funds is preferable to government intervention?
What effect does increased government expenditure have on the aggregate demand curve?
What effect does increased government expenditure have on the aggregate demand curve?
How does government borrowing to finance infrastructure projects impact interest rates?
How does government borrowing to finance infrastructure projects impact interest rates?
Under what economic conditions is crowding out likely to occur?
Under what economic conditions is crowding out likely to occur?
In what circumstances might crowding out be less of a concern for government fiscal policy?
In what circumstances might crowding out be less of a concern for government fiscal policy?
Why does the type of government spending matter in the context of crowding out?
Why does the type of government spending matter in the context of crowding out?
What happens to output and price levels when crowding out occurs?
What happens to output and price levels when crowding out occurs?
How can foreign financing influence the effects of government spending in less developed countries (LDCs)?
How can foreign financing influence the effects of government spending in less developed countries (LDCs)?
Flashcards
Open Market Operations
Open Market Operations
Government buying or selling bonds to influence money supply and interest rates.
Bond
Bond
A security where investors lend money; get interest and get the initial funds back after a period.
Crowding Out
Crowding Out
When government borrowing increases interest rates, making it harder for private sector to borrow and invest.
Fiscal Policy Goals
Fiscal Policy Goals
Low and stable inflation, low unemployment, stable economic growth, equitable income distribution, and external balance.
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Fiscal Policy Constraints
Fiscal Policy Constraints
Political pressures, time lags, need for sustainable debt, and crowding out.
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Automatic Stabilizers
Automatic Stabilizers
Government policies that automatically reduce the impact of economic shocks.
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Multiplier Effect
Multiplier Effect
Increase in national income caused by an initial change in spending.
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Keynesian Multiplier
Keynesian Multiplier
Ratio of change in national income to an initial change in injections into the circular flow (spending).
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Fiscal Policy
Fiscal Policy
Government policy that adjusts the economy by changing government spending, taxation, or both.
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Expansionary Fiscal Policy
Expansionary Fiscal Policy
Government policy to increase economic activity. Lower taxes or increase government spending, or both.
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Contractionary Fiscal Policy
Contractionary Fiscal Policy
Government policy to reduce economic activity. Increase taxes or decrease government spending, or both.
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Budget Deficit
Budget Deficit
Situation where government spending exceeds tax revenue.
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Funding a budget deficit
Funding a budget deficit
Methods to finance government spending exceeding tax revenue.
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Printing Money
Printing Money
Creating new money to fund a budget deficit. Often leads to inflation.
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Borrowing from overseas
Borrowing from overseas
Funding a budget deficit by taking loans from international sources.
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Aggregate Demand (AD)
Aggregate Demand (AD)
Total demand for goods and services in an economy. Affected by consumer spending and government expenditure.
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Government Expenditure (G)
Government Expenditure (G)
An increase in government spending, such as on infrastructure, shifting the aggregate demand curve to the right, raising prices and output.
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Interest Rate
Interest Rate
Cost of borrowing money, influencing private investment decisions.
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Private Investment (I)
Private Investment (I)
Spending by businesses on capital goods like machinery and equipment, impacting economic growth.
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Crowding Out in Recession
Crowding Out in Recession
Crowding out is less likely in a recession because the private sector isn't already investing, so the government's spending is filling an existing void.
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Macro Government Policies
- Government policies aim to manage the economy through demand-side and supply-side policies.
- Demand-side policies focus on altering aggregate demand (AD).
- Supply-side policies aim to increase the economy's capacity to produce.
Demand-Side Policies
- Fiscal policy involves altering government spending and taxation.
- Expansionary fiscal policy involves decreasing taxation or increasing government spending, or both.
- Deflationary/Contractionary fiscal policy involves increasing taxation or decreasing government spending, or both.
- Monetary policy involves changing the interest rate or the money supply
Fiscal Policy
- Fiscal policy is used to alter the economy by changing either government expenditure, taxation or both.
- Taxes include direct taxes and corporate taxes.
- Expansionary fiscal policy occurs when the government decreases taxation, increases government spending or both.
- Deflationary/contractionary fiscal policy occurs when the government increases taxation, decreases government spending or both.
Monetary Policy
- Monetary policy is where the government adjusts the economy by changing interest rate or the money supply.
- The interest rate affects the decisions of firms to invest.
- An increase in capital stock will increase the economy's ability to produce.
- Increasing the money supply decreases interest rates and vice versa.
Evaluating the Effectiveness of Fiscal Policy
- Constraints on fiscal policy include political pressure, time lags, and the sustainability of debt.
- Strengths of fiscal policy include targeting specific economic sectors and effectiveness in deep recessions.
- Automatic stabilizers help to moderate short-term fluctuations.
Evaluating the Effectiveness of Monetary Policy
- Constraints on monetary policy include limited scope, low consumer and business confidence.
- Strengths of monetary policy include short time lags, flexibility, and ease of reversibility
Keynesian Multiplier
- A multiplier is the ratio of change in the level of national income to an initial change in one or more injections into the circular flow model (I, G, C).
- It assumes the government is increasing expenditures or businesses are increasing investment.
- It also assumes looking at one instance, not a continuous flow.
- Finally it assumes AD rises.
Accelerator Effect
- Due to depreciation (loss of value over time), all capital equipment must be replaced over time. This requires investment.
- The accelerator effect is the relationship between induced investment and the rate of change of national income.
- It explains the level of investment in society
- Induced investment - the incentive to invest in new equipment to meet an increase in AD and increase capacity.
- Firms work at full employment, to increase output you need to invest constantly, firms want to maintain a fixed output ratio
Crowding Out
- Crowding out occurs when public sector spending replaces private sector spending.
- If the government borrows domestically to fund spending, this may drive up interest rates, reducing private sector investment.
- The price level falls and output falls back from Y1 and Y2.
Tools of Monetary Policy
- Open market operations (OMO) involve the buying and selling of government securities (a type of public sector debt).
- Minimum reserve requirements (MRR) are the minimum amount that commercial banks are required to keep as reserves in the central bank.
- Changing the central bank's minimum lending rate (MLR) affects the interest rates charged on credit transactions, bank loans, and mortgages. Quantitative easing (QE) injects money directly into the economy and increases the money supply.
Government Policies - Supply Side Policies
- Supply-side policies improve the quality and quantity of factors of production, and increase the economy's capacity to produce.
- They're designed to increase competition and efficiency.
- Examples include removing labour market rigidities, incentives, deregulation, trade liberalization, encouraging small business startups, and investing in research and development.
Macro Goal: Sustainable Level of Government (National) Debt
- Measurement of government debt as a percentage of GDP.
- Relationship between budget deficit & government debt.
- Costs of high government debt include: Debt servicing costs, credit ratings, and impacts on future taxation & government spending.
Real vs. Nominal Interest Rates
- Nominal interest rate is the actual rate agreed upon by a bank and a customer (e.g. 8%).
- Real interest rate reflects the impact of inflation on return to savers and debt to borrowers (e.g., real interest rate = nominal interest rate - inflation rate).
Economic Growth and the PPC
- Economic growth can be an increase in actual output (movement along curve).
- It can also be an increase in production possibilities (outward PPC shift).
- Factors that influence economic growth include increased investment and productivity.
Economic Growth and AD/LRAS
- AD increase leads to higher output and price level in the short run.
- LRAS increase leads to potential output increasing and a potential stable increase in income and output levels in the long run (non inflationary growth).
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Description
Test your knowledge on macroeconomic government policies, focusing on demand-side and supply-side strategies. This quiz covers crucial concepts such as fiscal policy, monetary policy, and their impacts on the economy. Challenge yourself with questions related to government spending and taxation.