Government Policies to Meet

Macroeconomic Objectives

© Ian Tay 2013

 Macroeconomic Objectives
(Remember, if the question asks about “Economic
Effects / Consequences” – think about these issues)

• Economic growth
• Price stability – in effect, the control of inflation
• Full employment
• Current Account of the Balance of payments
equilibrium
• A movement toward equality in the distribution of
income
• Protection of the environment
• Sustainable Budget Deficit/Debt
 Demand Side Policies
• Fiscal Policy : Changing Government Spending
and Taxes
• Monetary Policy: Changing Money Supply –
interest rates and/or quantitative easing
 Fiscal Policy Definition

• Fiscal policy involves the use of government

spending, taxation and borrowing to
influence both the pattern of economic
activity to achieve the macoreconomic
objectives
• Also known as the budgetary stance of the
central government of a country.
 Government Revenue
• Direct taxation is levied on income, wealth and
profit.
– income tax,
– national insurance contributions
– capital gains tax
– corporation tax.
• Indirect taxes are taxes on spending
– excise duties on fuel, cigarettes and alcohol
– Value Added Tax (VAT) on many different goods and
services
 Direct vs Indirect Taxation
Direct Taxation Indirect Taxation
Pros: Pros:
- Progressivity  Equal Distribution of - Gives Consumers Choices
Income - Relatively Less Disincentive
- More Certain Government Revenue - Less Chances of Avoidance
- Greater Demand Management
- Perception of More Government
Accountability
Cons: Cons:
- Brain Drain - Regressivity  Unequal Distribution of
- Fiscal Drag - Less Incentive to Work Income
- Fall in FDI - Uncertain Government Revenue
- Laffer Curve Analysis (Tax Avoidance / Tax - Poorer Demand Management
Evasion) - Inflationary Impact (Increase Cost of
Production)
- Perception of Less Government
Accountability
- Increase in Price of Exports
 Laffer Curve
At a tax level of 0% and 100% no
revenue is attained. This is
because at 0% the government
wouldn’t collect any money and at
a 100% there would be absolutely
no incentive to work as an
individual wouldn’t gain anything
out of it.
http://learneconomicsonline.com/laffercurve.php
• Illustrating the effects of the level of taxation and the revenue
gained from this taxation.
• Point T*, at which an optimal amount of revenue would be
collected.
• Raising the tax rate above T* would be counterproductive and
would result in earning less tax revenue. The same applies for
decreasing the tax rate.
• Although T* appears to be at a rate of 50% this isn’t necessarily
true and could be elsewhere.
• High tax rates could prohibit growth if individuals don’t have an
incentive to work hard or to innovate and create products, for
firms it could mean not investing in the economy and expanding
operations. At high tax rates people may also try to evade
paying, this can be done through loopholes or illegally.
• Low taxes might encourage growth, investment and spending
thus increasing GDP but the government would have a smaller
percentage of this. However, in absolute terms, they might
receive more money than if the tax rate is higher. Therefore
lower tax rates may generate more tax revenue than lower tax
rates.
 Government Spending
• Transfer Payments (welfare payments)
• Jobseekers’ Allowance,
• Child Benefit,
• State Pension,
• Housing Benefit,
• Current Government Spending:
– state-provided goods & services that are recurrent
• Salaries paid to people working with the government
• N.b. The NHS claims a sizeable proportion of total current spending – over
1 million people employed by the NHS
• Capital Spending:
– infrastructural spending
• new motorways and roads,
• hospitals, schools
• prisons.
 Budget Outcome and Budget Stances
Possible Description Budget Stance
Budget
Outcome
Balanced Expected T = Neutral
Budget Expected G
Budget Expected T > Contractionar
Surplus Expected G y

Budget deficit Expected T < Expansionary

Expected G
 Non-discretionary Fiscal Policy
(Automatic Stabilizers)
• Those aspects of budget which come into play to
offset changes in income and expenditure
associated with business cycle.
~ Automatic changes in tax receipts
~ Unemployment benefits and social welfare
 Discretionary Fiscal Policy
• Those aspects of budget over which the
government exercise control.
• Automatic stabilizers cannot eliminate 100% of
the impact to changes in the business cycle.
• Consequently, the government deliberately
changes taxation levels (revenue) or its
expenditure to achieve the goals of
macroeconomic management (e.g. economic
growth).
 Fiscal Policy
Transmission Mechanism
 Budget Impacts
• Budget surplus impact
~ Under a budget surplus, aggregate demand
falls.
~ Because of the Multiplier, the fall in economic
activity is greater than the change(s) in revenue
and/or expenditure.
 Budget Impacts
• Budget deficit impact
~ Under a budget deficit, aggregate demand
rises.
~ Because of the Multiplier, the rise in
economic activity is greater than the change(s)
in revenue and/or expenditure.
 Expansionary fiscal policy

Recession or
contraction

Increase government Increase job opportunities

spending
Incomes increase

AD increases
Decrease tax
Price level rises
Expansionary fiscal policy

Economic growth

Expansion
 Contractionary fiscal policy

Boom or
expansion

Decrease government Decrease job opportunities

spending
Incomes decrease
AD decreases
Increase tax Price level falls
Contractionary fiscal policy

Economic growth
slow down

Contraction
 Evaluation on the
Effectiveness of Expansionary Fiscal Policy

• Other factors might offset the impact of Expansionary

Fiscal Policy
– e.g Although G is increasing, I decreases by more. Therefore AD
will continue to fall.
– e.g. Although Income Tax decreases leading to an increase in
Disposable Income, as confidence is still low, C will remain the
same or continue to decrease.
• Time lags – time required to approve and implement fiscal
legislation can weaken the effectiveness of discretionary
fiscal policy as a tool for macroeconomic stabilization.
• Uncertainty about the changes in economic variables such
as GDP growth, multiplier, etc.
• Crowding out occurs when increased
government spending reduces private sector
spending.
- Assume that the government adopts an
expansionary fiscal policy with the result that
the level of government borrowing increases.
- The increased borrowing is likely to drive up
the rate of interest. This in turn reduces
private-sector borrowing and hence reduces
consumption and investment. Private-sector
expenditure is ‘crowded out’.
• Opportunity cost. Public sector debt involves
interest payment (2009/10: £28bn just on
interest payments)
• A redistribution of income.
• Possible inflationary impact.
• Excessive budget deficit : Government will
find it difficult to borrow
 Tight Fiscal Policy to Stimulate Growth i.e
Expansionary Fiscal Contraction
• To reduce national debt
• To regain investor confidence in the economy – ensure a
good credit rating
• To avoid a debt crisis
• Christine Lagarde – “I shudder to think what would happen if UK did not
reduce its deficit in 2010”
• To reduce the debt servicing ratio (less opportunity cost)
• The budget deficit that is being experienced now is not just
cyclical but also structural
• Less inflation
• Less crowding out
 Evaluation
• Sacrificing Current Growth
• UK’s credit rating is fine – investors are still confident in
the UK
• Tight Fiscal Policy actually increased government
expenditure (due to increase benefit payments)
• Reducing debt has to be seen as a long term issue –
sacrificing the current generation for the benefit of the
future generation
• Increasing Taxes to Reduce Budget Deficit/Debt might
worsen Budget Deficit/Debt (Laffer Curve Analysis)
 Effectiveness of Contractionary Fiscal Policy
to Reduce Inflation
• Increase Tax eg. Income Tax  Less Disposable Income
 Less Consumption  Less AD  Lower Price Level
• Increase Tax eg. Corporation Tax  Less Profits after
Tax  Less Investment  Less AD  Lower Price
Level
• Increase Tax eg. VAT  Less Real Income  Less
Consumption  Less AD  Lower Price Level
– However, VAT increase  Cost of Production Increases 
SRAS decrease (Keynesian LRAS moves upwards)  Higher
Price Level
 Difference between Fiscal Deficit and
National Debt
• Fiscal Deficit is when Government Spending is
more than Government Revenue
• National Debt is the accumulated amount of
money that a government has borrowed and
has to be paid back. (Debt Service is the
interest payable on the debt)
 Distinction between structural and cyclical
deficits
• Cyclical Deficit is one based on a cyclical occurrence due to the
economic cycle (Boom and Bust).
– Cyclical Deficit is high during a Bust
– Cyclical Deficit is low during a Boom
• The structural deficit is basically the current budget deficit,
adjusted to exclude the cyclical nature of the economy.
– Structural deficit is the bit of the deficit that remains even when the
economy is booming / at its peak.
– Structural Deficit is the underlying deficit that is not directly affected by
economic performance.

• https://www.youtube.com/watch?v=I1GXqP1mugE
 Problems with High Debts
• The downgrading of the country's credit rating may mean that
investors are less willing to buy gilts (government bonds /
securities), meaning the government becomes less able to finance
its debt, or has to pay higher rates of interest on its debt . This
could also reduce investments in the economy due to worries of a
default (not able to pay back their loans).
• May lead to the crowding out of private sector consumption and
investment
• Rising costs of debt service means a rising opportunity cost
– The money has been spent on current rather than capital expenditure,
meaning that no future rise in productive capacity / real GDP / tax revenue
can be expected to help pay off the debt
– Inequitable to future generations
• Further austerity measures are 'politically difficult' to take
 Evaluation
• If growth is high, then not a problem.
• Debt sustainable (Western Eurozone such as Germany or France have high debts but
did not face any issues with it while the PIIGS did face issues)
• Debt forgiveness / relief under the HIPC (Highly Indebted Poor Countries) initiative
• Some measures have already been taken to reduce the deficit, for example cutting
subsidies and introducing a new corporate tax, which may reduce debt in the future
• The high rate of inflation is likely to erode the real value of the debt (if debt is issued
in domestic currency)
• The liberalisation of international capital markets reduces the chances of crowding
out occurring to any significant extent
• Credit Rating merely opinions? https://www.youtube.com/watch?v=Bumfpo4FW0I
• Depends on where the debt is coming from – domestic debts are usually more easily
managed.
 Causes Effects
Ageing Population Higher Pension
Payments
High Healthcare
Spending Low Credit Rating

Pandemic
Higher Non-
Discretionary G Crowding Out Effect
High Debts
Recession Higher
Discretionary
Government
Spending
Tax Evasion / High Debt Servicing
Desire to Tax Avoidance
Develop the “Benefit Tourism”
Economy
Politically Difficult to Fix
Impact of Migration (EU)
Reasons for increased fiscal deficits
• Global recession
– leading to rising unemployment – falling income tax and VAT receipt; increased expenditure on
unemployment benefits
– Falling consumer spending; falling profits; business failure and lower revenue from corporate
taxes)
– Fiscal stimulus to prevent recession turning into depressions (depression = prolonged
recession)
– Financial crisis resulting in need for bank bailouts (and certain other large industries)
• Decrease in employment/rising inactivity rates: e.g. more people in higher education
• Increased expenditure on public services e.g. improving infrastructure, NHS.
• Rising cost of state pensions and benefits – ageing population
• Rise in risk premium on some countries’ debt – higher interest rate payments as
confidence on countries fell.
• Increased migration – EU citizens can claim benefits from the UK government.
• Deindustrialisation – structural unemployment  increased benefits spending
 Monetary Policy

Monetary Policy involves interest

rates (cost of credit / rewards from
savings) or Quantitative Easing (QE)
 Role of Central Banks
• • as banker to the government (in the UK, the national debt is managed by the Debt Management
Office www.dmo.gov.uk )
• • as banker to the bank, as a lender of last resort. When a financially troubled bank gets into short-
term difficulties and is unable to raise enough cash, the central bank will lend to them to provide the
liquidity needed. The reason for this is to preserve the stability of the banking and financial system so
that a run on a panic-ridden bank is prevented and individuals’ deposits are protected. See parts 5
and 6 of the Bank of England animations, which also cover the role of regulation
• • as part of regulation of the banking industry – see parts 5 and 6 of the Bank of England animations,
with part 6 particularly targeted at regulation (note that not all central banks may be financial
regulators – this varies from country to country)
• • implementation of monetary policy – see parts 2, 3 and 7 of the Bank of England’s animations. Parts
2 and 3 provide excellent revision of monetary policy, while part 7 gives an overview of: o monetary
policy – Monetary Policy Committee (MPC)
• o macroprudential policy – Financial Policy Committee (FPC)
• o microprudential policy – Prudential Regulation Authority (PRA).

• The PRA supervises the largest banks and the FPC monitors risk to the entire financial system.
 Monetary Policy Committee
• Sets interest rates
– To enable inflation target to be met.
• Made up of nine members
– the Governor,
– the two Deputy Governors,
– the Bank's Chief Economist,
– the Executive Director for Markets
– four external members appointed directly by the
Chancellor.
• Meets every month
Monetary Policy
Interest Rates
 Negative Interest Rates
Commercial
Higher
Banks who
Commercial Amounts of
Negative Save with the Commercial
Banks will Capital to Cost of
Interest Rates Central Bank Banks Will Increase Increase in
Save Less with Lend Out Borrowing
(Central Bank will now be Have To Cut Borrowing Investments
the Central (Increase in Decreases
e.g MPC BoE) charged to Interest Rates
Bank the Supply of
save in the
Money)
Central Bank

However….
• There is no longer room for any more expansionary monetary policy in the
future. Eg. Sweden Riksbank already cut interest rates to negative in the past 5
years, now there is a crisis, they can’t cut interest rates anymore
• Savers Are Losing Money
• Hyperinflation?
• Weaken Exchange Rates (if not all countries doing it)

https://www.youtube.com/watch?v=hkpB0Xt_qQk
 Evaluation
• Changes in Official Rates might not affect Market
Rates
• Time Lag (18-24 months)
• Problem of Predicting the Future to make current
decisions
• Other Factors Change
• Liquidity Trap
• Requires international cooperation and
coordination as well
Monetary Policy
Changing the money supply: Quantitative Easing

https://www.youtube.com/watch?v=
J9wRq6C2fgo

http://news.bbc.co.uk/1/hi/busines
s/7924506.stm
Quantitative Easing
 Evaluation
1. Cash hoarding – Sitting on the Cash, not lending it out
2. De-leveraging – Using the extra money to pay back debts, not
to make new loans
3. Credit availability remains low
4. Opportunity cost
5. Future inflation
6. Bank of England should buy newly issued bonds directly from
the government rather than existing bonds held by the
commercial banking system.
7. Alternatives: Credit easing, projects such as Project Merlin
(pledge by banks to increase lending to small businesses)…..
 Pandemic Emergency Purchase Programme
(PEPP)
• Conducted by the European Central Bank (ECB)
• Temporary (Short Term) Asset Pruchase Programme
• Expansionary Monetary Policy
• But it's Non-Standard (as opposed to the
standard/traditional interest rates and QE)
• Buying Government Bonds / Corporate Bonds / Security
• Difference with QE: ECB is buying some bonds directly
from the governments issuing them
• Intention/Purpose: To Keep Cost of Borrowing Low for
Eurozone Countries
 Evaluation of PEPP
• Certain Southern European countries will not
learn from the crisis – leads to complacency –
they won’t attempt to make any structural
changes to reduce their structural deficit, they
will continue spending lots of money.
• Moral Hazard – Southern European countries
will take too much risk because they know
that the ECB will always help them out.
 Supply-side Policies
KAA
Privatisation
Deregulation
Labour Market Reforms
Education and Training
Increase Labour Market Flexibility
Increase National Minimum Wage
Decrease Unemployment Benefits
Encouragement of Enterprise
Reduce Barriers to Entry
Subsidies to Businesses
Credit to SMEs
Tax Reforms
Reduce Income Tax
Reduce Corporation Tax
Reduce Capital Gains Tax
Research and Development
Subsidise R&D
Tax Incentives for R&D
Government creation of R&D Firms
Infrastructure Development
EVAL
Private Monopolies not efficient as well
There are other barriers to entry
Trained in wrong field
Low Job Security
Inflation is High, Real NMW lower
Long Term Unemployment / Allocative Inefficiency
Wastage from too much competition
Opportunity Cost
Complacency
Lower incentive to work hard (as satisfied already)
Disproportionately benefit large firms
Bubbles
Subsidies might be used inefficiently
Time Lag
No actual outcome
No need for such good infrastructure
4.5.4

MACROECONOMIC POLICIES FROM

A GLOBAL PERSPECTIVE
 Class Notes w/b 25/5/20
Discussion From: https://www.ft.com/content/66164bbc-40c7-4d91-a318-a0b4dbe4193e
 measures to reduce fiscal deficits and national debts
KAA
• Increase taxes
– 2010 (UK): Increase VAT from 15% to 17.5%
– 2011 (UK): Increase VAT from 17.5% to 20%
• Reduce Government spending
– Reduce size of the bureaucracy (current spending
decrease)
• Government departments budgets lashes
– Eg. Police, teachers, office workers
– Reduce welfare benefits (transfer spending
decrease)
• E.g unemployment benefits, disability benefits, single
parent benefits, pensions, child allowance,
– PFI projects instead of direct spending (capital
spending decrease)
CONCLUSION: Implement policies to increase economic growth (could be used as an
• Debt Forgiveness / Restructuring
evaluation of the above measures) eg. decreasing income taxes, decreasing corporation taxes,
increase government spending
EVAL
• Laffer Curve
– Increasing taxes would lead to decrease in tax revenue
because of increased tax evasion and tax avoidance (or simply
a decrease in economic activity)
– Tax Avoidance: increase in usage of transfer pricing strategies,
Hiring accountants to “cook the books”
– Tax Evasion: Black/Grey market activities, cash payments,
Creating shell accounts, offshore accounts, tax havens
(Bermuda, Cayman Islands)
• Reduce size of bureaucracy  increase unemployment
 increase unemployment benefits claim
government spending increases  fiscal deficit increase
• Reduce welfare benefits  increase inequality, long
term unemployment (creation of a poverty trap)  less
people working  less income tax
• PFI projects might be more expensive in total. Fiscal
deficits will increase eventually. Long term debt will
increase.
• Difficult to agree on debt forgiveness and restructuing
Effects of government policies to reduce fiscal deficits and national
debts (austerity)

NEGATIVE EFFECTS
POSITIVE EFFECTS
• Laffer Curve
– Increasing taxes would lead to decrease in tax revenue because of • Increase investor confidence (less possibility of a
increased tax evasion and tax avoidance (or simply a decrease in debt crisis / default on debts)  Increase I 
economic activity)
Increase AD  Increase Y
– Tax Avoidance: increase in usage of transfer pricing strategies, Hiring
accountants to “cook the books” – Regain country’s AAA credit rating
– Tax Evasion: Black/Grey market activities, cash payments, Creating • Low interest rates when borrowing  less
shell accounts, offshore accounts, tax havens (Bermuda, Cayman
Islands)
opportunity cost ---> any extra revenue gained
• Reduce size of bureaucracy  increase unemployment  can be spent on development projects
increase unemployment benefits claim government • Less crowding out (Private investors have more
spending increases  fiscal deficit increase opportunity to borrow money due to cheaper
• Increase inequality especially if welfare spending is cut. and more available credit since the demand from
• Long term unemployment (creation of a poverty trap) government is lower)  Private investments
• PFI projects might be more expensive in total. Fiscal deficits will increase
increase eventually. Long term debt will increase.
• Deflation (AD decrease, P decrease)
• Reduce inflation
• Economic contraction (G decrease, AD decrease)
Conclusion: Countries like the UK did not have to reduce fiscal deficits / national
• Less crowding in
debts. Investor confidence was still high. No need to sacrifice current standards
of living
 Impact of changes in interest rates and the supply of money

EVAL • Cash hoarding – Sitting on the Cash, not lending it out

• Changes in Official Rates might not affect Market • De-leveraging – Using the extra money to pay back debts,
Rates not to make new loans
• Time Lag • Credit availability remains low
• Problem of Predicting the Future to make current • Opportunity cost
decisions • Future inflation
• Other Factors Change • Bank of England should buy newly issued bonds directly
• Liquidity Trap from the government rather than existing bonds held by
• Requires international cooperation and the commercial banking system.
coordination as well • Alternatives: Credit easing, projects such as Project
Merlin (pledge by banks to increase lending to small
businesses)…..
measures to increase international competitiveness
KAA
• Supply Side Policies
– Subsidies to Domestic Firms to increase productivity
(R&D subsidies)
– Corporation Tax Cuts to encourage reinvestments (esp
in R&D) to increase productivity
– Privatisation (to make firms more productively efficient
due to profit-max motive) and Deregulation (to
encourage more competition)
– Increase labour market flexibility (to encourage
competition and increased productivity)
• Exchange Rate Policies
– Devaluation of the domestic currency
• Control of Inflation and Macroeconomic Stability
(to ensure that cost of production remains low)
• Fiscal Policy – Decrease Taxes, Increase Subsidies
• Monetary Policy – Low Interest Rates to stimulate
investments?
• Protectionist Policies (to develop infant industries
so that they can compete in the long run)
EVAL
• Supply Side Policies
– Training takes a long time
– Cost a lot to the government – Opportunity Cost
– Corporation Tax cuts will increase profits that are not
reinvested
– Subsidies might be misused
– Private monopoly not efficient as well
– Deregulation but there are still other barriers to entry
• Marshal-Lerner Condition (elasticities), J-Curve
• Other factors affecting Cost of Production and
Price besides Inflation
• Relative Inflation more important than just
inflation itself
• Expansionary Fiscal Policy --> Crowding Out /
Debt Crisis
• Expansionary Monetary Policy  Increase
Inflation
• Protectionist Policy  Complacency
 Maybe for Paper 3 (Business & Government
Measures)
Measures used by businesses could include:
• Research and development resulting in improved designs or new products
• Investment in new technology
• Investment in capital equipment
• Pricing strategies (e.g. limit pricing)
• Improved reliability of products
• Better customer service

Measures used by governments could include:

Range of supply side policies including…
• Privatisation
• Education and training
• Investment tax relief
• Improvements in infrastructure
• Cutting unemployment benefits
• Removal of regulations e.g. health and safety,
environmental, employment protection
• Encourage immigration.

If appropriate examples are given, candidates could also discuss:

Devaluation of currency;
Increase in trade barriers
Subsidies
 Measures to control global companies'
(transnationals') operations
KAA
• the regulation of transfer pricing
– Tax on Turnover?
– Capital gains tax?
– Reduce Corporation Tax?
• Reduce tax avoidance / tax evasion
• Regulations
• Preventing mergers and takeovers
• Financial Transaction Tax / Tobin Tax
/ Robin Hood Tax
EVAL
• Tax on Turnover could disproportionately
disadvantage smaller firms
• limits to government ability to control
global companies
• TNC/MNC’s “footloose” (no loyalty to any
countries)
• MNC/TNCs provide lots of employment
(monopsony power)
• Firms will always find ways to avoid /
evade taxes
 Use and impact of macroeconomic policies to
respond to external shocks to the global
economy
• External Shocks: Rise in Commodity Prices, Recession in Other Countries, War, Natural
Disasters, Global Financial Crisis, Asset Bubble Bursting
• Eg. Policies to Respond to the 2008 Global Financial Crisis

KAA EVAL
Expansionary Monetary Policy: Decrease Interest Rates Liquidity Trap
(0.5%) and QE

Expansionary Fiscal Policy (Fiscal Stimulus): Decrease Austerity measures more effective? Restores Confidence
Taxes (VAT Emergency Rate 15%) and Increase
Government Spending (Bailout RBS/Lloyds)

Protectionist Policies: Tariffs, Quotas, Public Retaliation (Trade Wars)

Procurement, Administrative/Technical Barriers,
Subsidies, Dumping,
Exchange Rate Policies: Devalue Currency Floating Exchange Rate will automatically stabilise the
economy

Supply-side Policies: Privatisation, Deregulation, Labour Time Lag

Market Reforms, Tax Reforms, Encouragement of
Enterprise, Research and Development
Problems facing policymakers when
applying policies:

KAA EVAL
• Data is easily attainable today /
• inaccurate more reliable / forecasts quite
accurate
information • At least, some could be offset by
• risks and domestic growth
uncertainties
• inability to control
external shocks
 Effects of High Inflation (above 2% CPI)
KAA
• Decrease in Real Income  Purchasing Power
Decrease  Standards of Living Decreases.
• Low income earners now need to spend more
on necessities – can’t afford other goods
• Shoe-Leather Cost / Menu Costs
• Cost of Production Goes Up  Firms Try to Cut
Cost  Fire workers  Unemployment Increase
• Decrease international competitiveness  Price
of exports increases  quantity of exports
decreases Value of Exports Decreases  Net
Exports Decreases  Current Account Deficit
Increases
• Political and psychological costs
• Fixed income earners affected the most (e.g.
those on fixed pensions / those depending on
income from a fixed interest rate)
• Lenders and savers also lose out if inflation rate
is higher than interest rates
• Wage-price spiral
EVAL
• Variable income earners (inflation adjusted
income earners) not affected that badly.
• Shoe-Leather Cost / Menu Costs not that
significant today due to the advancements of
technology i.e. internet / credit & debit cards
• Certain non-essential jobs more vulnerable to
being laid off.
PED X might be inelastic.
•
• Relative inflation figures more important.
• Government debt’s real value decreases.
• Borrowers benefit
• Short-term effect (maybe it can decrease as
government is taking the right steps /
inflationary pressures were temporary such as
rise in indirect tax, rise in oil prices)
 Effects of Deflation (Def: persistent
decrease in price level in an economy)
KAA
• Firms will be less confident with the economy as
their expected profits will be lower Produce /
Invest less AD Decrease  Growth Decreases
• Firms invest less  Demand less workers 
Unemployment increases (this can be shown
through and output gap in the AD/AS diagram)
• If prices expected to go down consume less
now/increase savings  AD decreases /
standards of living decreases
• Job security also decreases  less life
satisfaction  standards of living decreases
• Only spend on necessities  less choices 
lower standards of living
EVAL
• If Deflation is caused by decrease in cost of
production, that is actually good for the
economy (more investments, less
unemployment)
• Real incomes increases (choices increases,
standards of living increases)
• International competitiveness increases
It is really bad if it creates a deflationary
•
cycle/spiral but if its just a short term issue, not
a big problem.
 Effects of low inflation (1-2%)
KAA
• Maintain International competitiveness  price
of exports will not be too expensive
• Investor confidence is high  continue investing
“animal spirits”  AD increase  Y increases
Employment opportunities remain high
• Value of savings only maintained if interest rates
• Consumer confidence is high due to job security
and wealth effect
• Value of savings maintained
• Less likelihood of a bubble
EVAL
• Other factors affecting competitiveness
• Philips curve analysis – low inflation is negatively
correlated with unemployment.
• Could lead to deflation (analyse further with the
problems associated with deflation)
•
higher than inflation rates
measures to reduce poverty and inequality

KAA
• Progressive Taxation (Tax higher
income more than lower income)
– Income Tax
– Inheritance Tax
– Financial Transaction Tax (EU) / Tobin
Tax / Robin Hood Tax
– Corporation Tax
Free Education / Training / Healthcare
•
• Increase ease of doing business, break
up monopolies, increase contestability
• Nationalisation (more allocative
efficiency)
• Fight corruption – uphold rule of law
and ensure a system based on
meritocracy is upheld
Conclusion: most Significant is Meritocracy?
• More generous welfare benefits
EVAL
• Opportunity Cost – Government
Failure
• Training – Lack of Information on
which area to train workers in
• Less Incentive to Work (since
there is more welfare benefits)
• Less Incentive to Innovate (Less
Profits)
• Tax Avoidance / Evasion
• Less Investments as taxes are
too high
• Less efficiency (nationalisation)
• Less Trickle Down