C04 (03) Government Management Of The Economy

Front 1

In order to
manage the economy
in some
rational and effective manner,

a government has
three requirements:

Back 1

1. A set of objectives

2. A set of policy instruments

3. Some economic theory

Front 2

The main

objectives
of the

government are:

(4 main objectives)

Back 2

full employment

the avoidance of inflation

economic growth

external balance

Front 3

Policy instruments
fall into
three

broad categories:

Back 3

1. Monetary policy

2. Fiscal policy

3. Supply side policy

Front 4

Economic theory

is necessary in

Back 4

the formulation of
economic policy

in order to

inform policy makers of

how economies work.

Front 5

Keynesian economists

The main beliefs

of this school of thought are:

4

Back 5

The economy is

not necessarily a
self-correcting mechanism
and can reach equilibrium at
any level of unemployment.

Money is a vital link

between markets, and

because money can be stored,

the level of

demand may be insufficient

to ensure full employment.

Inflation may be caused by a combination of

demand pull and

cost push pressures.

The govt must take the responsibility for managing the economy

and adopt an

interventionist approach

to economic policy.

Front 6

Monetarist/

new classical economists

believe:

5

Back 6

the market should be

broadly left to market forces.

Real and monetary forces

are separate,
so supply and demand determines the level of

prices in the economy.

Inflation is always the result of
excessive growth in the

money supply

causing excessive AD.

Full employment

is best achieved by
supply side policy. (Cont...)

Govts should, on the whole, adopt a
non-interventionist

approach to
economic policy.

Front 7

Monetary policy

is concerned with

Back 7

managing the
monetary environment

in order to
influence the decisions of
economic agents

(consumers, investors and businesses)

by affecting either
the availability of credit
or the price of credit.

Front 8

The

main feature

of
monetary policy

is ...

since ...

Back 8

the policy of
changing interest rates

since they are
the price of credit.

Front 9

The

central rate of interest
is usually

Back 9

the rate at which
the central bank

lends to the

money market

based on
the

treasury bill rates.

Front 10

The real interest rate
puts interest rates
in the context of inflation:

When the
nominal rate of interest (APR)
is higher than
the rate of inflation,

Back 10

there is a
positive real rate,

implying that
borrowers are losing

in real terms

but savers are gaining.

Front 11

When the rate of

inflation exceeds
the nominal rate of interest (APR),

Back 11

there is a
negative real rate of interest,

implying that
borrowers are gaining
and savers are losing.

Front 12

Five consequences
that are

the main effects of

an increase in
interest rates

include:

Back 12

fall in spending

fall in investment

fall in asset values

rise in the exchange rate

attraction of foreign funds

into the country

Front 13

The

primary objective
of a

monetary policy
is to

Back 13

limit inflation

and thereby

maintain the
value of money.

Front 14

A
loose or expansionary

monetary policy

of low interest rates

will ...

AD curve...

Output, employment, inflation ...

Back 14

increase spending
on both
consumer goods
and investment goods.

The AD curve will
shift to the right.

Output and employment
will both rise.
As will the rate of inflation.

Front 15

A
tight or contractionary
monetary policy
of high interest rates
will

Back 15

decrease spending
on both
consumer goods
and investment goods.

The AD curve will
shift to the left.

Output and employment
will both fall.
As will the rate of inflation.

Front 16

A central bank

faces
four main problems

in applying

monetary policy:

Back 16

1. Lack of sufficient, up-to-date information on the economy,

particularly money supply

2. Banks' aversion to

close supervision

3. Over-vigorous control
which may

stifle the initiative of the banks
and hinder their

profit-maximising ethos

4. Conflicting objectives

Front 17

A government's

fiscal policy

is concerned with

Back 17

the balance between

its tax receipts

and its expenditure

and the effects that
changes in the balance
might have on the economy.

Front 18

The

primary function of

taxation is

Back 18

to enable the government to

finance public expenditure, on

goods and services:
defence, law and order,
education, health services.

transfer payments:
state pensions,
unemployment benefit,
social welfare payments.

Front 19

Taxation
can be put to
several uses
as follows:

(4 uses)

Back 19

To change markets

(e.g., taxing harmful goods

to reduce consumption)

To influence the level of

aggregate monetary demand

To finance the provision of
public and merit goods

(defence and education)

To change the distribution of
income and wealth

(changing the balance between

direct and indirect taxes)

Front 20

The
canons of taxation
are as follows:

6

Back 20

Certainty

Convenience

Equity

Economy

Efficiency

Flexibility

Front 21

Efficiency
and
flexibility

(canons)

of a tax are

Back 21

principles
that have been added

since Adam Smith's day.

Front 22

The normal

distinction
in taxation
is between

two types of tax:

1.

Back 22

Direct taxes

are levied on

income and capital,

and

the incidence of the tax

and the burden of the tax

fall on the same person.

Front 23

The normal

distinction
in taxation
is between

two types of tax:

2.

Back 23

Indirect taxes

are levied on

expenditure,

and the

incidence and burden

may fall on

different persons.

Front 24

The distinction in taxation
in terms of
the nature of
the tax burden:

3 types

Back 24

Progressive taxes

Regressive taxes

Proportional taxes

Front 25

Progressive taxes

Back 25

are ones where

the proportion of income

paid in tax
rises
as income rises.

Most income taxes are progressive.

Front 26

Regressive taxes

Back 26

are ones where

the proportion of income

paid in tax

falls
as income rises.

Most indirect taxes are

regressive.

Front 27

Proportional taxes

Back 27

are ones where

the proportion of income

paid in tax
stays the same
as income rises.

Front 28

The difference between

central government

income and expenditure

is termed

Back 28

the

budget deficit

or

budget surplus

Front 29

The balance between

the income and spending of
the whole of the public sector

is nowadays more significant
and is termed

Back 29

public sector borrowing.

The current term for
government borrowing
in the UK is
public sector net borrowing
(PSNB).

Front 30

The
government budget
may be in
deficit where

Back 30

the flow of
government expenditure
exceeds
the flow of its
taxation income.

Front 31

The
government budget
may be in
surplus where

Back 31

the flow of
government expenditure
is less than
the flow of its
taxation income.

Front 32

In recession,

tax yields fall

as

Back 32

income and output
contracts

and

public expenditure on
social security

rises
as

unemployment increases.

Front 33

The government
may run a
budget deficit
for two reasons:

Back 33

1. To deal with unemployment

2. To finance public expenditure

Front 34

A distinction
can be made
between
two elements
in deficits:

1.

Back 34

Cyclical element

where the deficit
is a result of
the downswing phase
of the trade cycle

and will decrease
or even turn into a surplus
in the upswing phase.

Front 35

A distinction
can be made
between
two elements
in deficits:

2.

Back 35

Structural element

where the deficit

is the result of
a permanent imbalance
between
expenditure and taxation

and will not be affected by
the trade cycle.

Front 36

The ways in which
the governments deal with
the problem of
financing budget deficits
are:

2

Back 36

Borrowing from
non-bank private sectors

Issuing various types of
liability

Front 37

The golden rule for
government finances
states that:

1.

Back 37

over the whole trade cycle,

government

current expenditure on
goods,

services and
transfer payments

should not exceed its
taxation income.

Front 38

The golden rule for
government finances
states that:

2.

Back 38

only
government
investment expenditure
may be financed by
government borrowing.

Front 39

The golden rule for
government finances
states that:

3.

Back 39

the overall

burden of
public debt
should not

go above

sustainable levels.

Front 40

If a government
runs a
budget deficit,

> it can

finance the deficit
by ______________

> It will have to

Back 40

> borrowing.

> it will have to
correct the deficit
if its borrowing is
constrained in the long term.

Front 41

The objective of

a supply side policy

is

Back 41

to shift the

aggregate supply curve

to the right,

which would have the effect of

raising national income

and lowering unemployment

at the same time as

reducing inflationary pressures

in the economy.

Front 42

Graph of

Aggregate Demand and Supply model

(Shift in supply curve)

Back 42

Front 43

Supply side policy

consists of

a wide range of

measures,

the most important of which are:

5

Back 43

shifting taxation

away from direct

to indirect taxation

reducing social security payments

emphasising

vocational education and training

reducing the power of trade unions and employee organisations

deregulating and privatising

Front 44

Significant consequences of

supply side policies

are:

4

Back 44

making the taxation system

much more regressive

a more unequal distribution of income

a greater degree of

uncertainty for workers

with less employment protection

a fall in the relative

(and sometimes absolute)

standard of living

of many who are

dependent on

social security payments

Front 45

The typical

prices and incomes policy

involved:

Back 45

a limit on the

annual increase in

wages and salaries.

some controls on prices,

especially those

directly controlled by

the government.