Flashcards · H060 · Topic 6

The application of policy instruments flashcards

20 cards on Topic 6, subtopics 6.1 to 6.4. Pick a subtopic or study them all.

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Average vs marginal tax rate: Average: tax over total income. Marginal: the rate on the extra income. In a progressive system, the marginal rate exceeds the average rate.
Progressive vs regressive tax: how to test: Look at the average rate, not the amount paid. Progressive: the average rate rises with income. Regressive: it falls. Proportional: it stays the same.
Direct vs indirect tax: Direct: on income, profit and wealth. Indirect: on spending. The legal payer of an indirect tax is the seller, but the burden may fall on the buyer.
Budget position vs fiscal stance: Position is the balance (surplus, deficit or balanced). Stance is the direction policy pushes demand: expansionary, contractionary or neutral.
Budget deficit vs national debt: Deficit: spending exceeds revenue in a year (a flow). Debt: the stock of outstanding government borrowing on one date. A deficit adds to the debt.
Automatic stabilisers vs discretionary policy: Automatic stabilisers: parts of the budget that offset output swings with no new decision (tax receipts fall and benefits rise in a downturn). Discretionary: a deliberate change in spending or taxes.

Monetary policy instruments: The policy interest rate (which commercial rates follow), the money supply, quantitative easing and the exchange rate, used to influence AD.
What happens to AD when the policy rate is cut?: Borrowing is cheaper and saving less rewarding, so C and I rise; mortgage payments fall; the currency may depreciate, raising net exports. AD shifts right after a time lag.
Quantitative easing (QE): The central bank creates electronic money to buy assets, usually government bonds, from financial institutions, lowering long-term interest rates.
Inflation rate targeting: A published numerical inflation target that guides policy; in the UK the Bank of England's Monetary Policy Committee sets Bank Rate to meet the government's CPI target.
Real interest rate: Approximately the nominal rate minus inflation. Exactly (1 + nominal) ÷ (1 + inflation) − 1. Nominal 5% with expected inflation 3%: 1.05 ÷ 1.03 − 1 = 1.9%.

Supply-side policy: Measures that raise the quality or quantity of factors of production, or make markets work better, so potential output grows (LRAS shifts right).
Market-based vs interventionist supply-side policies: Market-based: deregulation, tax cuts, privatisation, labour market flexibility. Interventionist: state-funded education and training, infrastructure, subsidies for R&D.
Tax 30% and benefits lost at 45% of net pay. Effective marginal rate on an extra 100?: Net after tax = 70. Benefit lost = 0.45 × 70 = 31.5. Kept = 38.5, so the effective marginal rate is 61.5%.
Strengths and limits of supply-side policies: Strengths: can raise growth while lowering inflation and unemployment. Limits: long time lags, uncertain effects, cost to the budget, and some (such as benefit cuts) can widen inequality.

Policy conflict (trade-off): Pursuing one objective moves another away from its target. Conflicts are weaker when the economy has spare capacity.
Conflict: low unemployment vs low inflation: Raising AD cuts cyclical unemployment, but near capacity it bids up wages and prices: demand-pull inflation.
Conflict: economic growth vs the current account: Rising incomes raise imports. With an MPM of 0.2, a rise in income of 50 raises imports by 10, worsening the current account.
Conflict: growth vs the environment: More output uses more resources and raises emissions and other external costs, unless growth is decoupled from environmental harm.
Policy mix: Using several instruments together (fiscal, monetary, supply-side) so that one can offset the side effects of another.