9708 · 10.3
Effectiveness of policy options to meet all macroeconomic objectives flashcards
Revision flashcards for Cambridge 9708 Effectiveness of policy options to meet all macroeconomic objectives (syllabus 10.3). Flip, recall, then mark a real past-paper question.
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Fiscal policy strengths?
Direct effect on G; automatic stabilisers; multiplier amplifies impact — effective in deep recession with spare capacity.
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Fiscal policy weaknesses?
Time lags (recognition, implementation); crowding out; public debt; political constraints.
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Monetary policy strengths?
Quick to implement (rate decisions); independent central bank; flexible — no direct fiscal cost.
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Monetary policy weaknesses?
Long and variable lags; ineffective at zero lower bound (liquidity trap); uneven impact on asset prices.
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Supply-side policy role?
Shifts LRAS right — raises potential output and employment without demand-pull inflation; slow to take effect.
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Why use a policy mix?
Single instrument cannot achieve all objectives — coordinated fiscal, monetary, and supply-side tools address different gaps and time horizons.
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What is the primary conflict illustrated by the short-run Phillips Curve?
The inverse relationship or trade-off between the rate of inflation and the rate of unemployment. Policies to reduce unemployment tend to increase inflation, and vice versa.
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Define a 'policy mix' in macroeconomics.
The combination of fiscal, monetary, supply-side, and/or exchange rate policies used concurrently by a government to achieve its macroeconomic objectives, aiming to mitigate the conflicts that arise from using a single policy.
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How can supply-side policies theoretically achieve 'non-inflationary economic growth'?
By increasing the economy's productive capacity (shifting LRAS to the right), they allow national output to increase to meet rising aggregate demand without putting upward pressure on the general price level.
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Distinguish between expenditure-switching and expenditure-reducing policies.
Expenditure-reducing policies (e.g., higher taxes, lower government spending) cut overall demand to reduce import spending. Expenditure-switching policies (e.g., devaluation, tariffs) aim to make domestic goods relatively cheaper than imports, encouraging a switch in spending.
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What is 'stagflation' and why is it difficult to solve with a single policy?
Stagflation is a period of stagnant economic growth, high unemployment, and high inflation. A single demand-side policy cannot solve it: expansionary policy would worsen inflation, while contractionary policy would worsen unemployment. It typically requires a policy mix.
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What is the 'liquidity trap'?
A situation, typically when nominal interest rates are near zero, where monetary policy becomes ineffective because people and firms hoard cash rather than investing or spending, regardless of how much the central bank increases the money supply.
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How does 'crowding out' limit the effectiveness of expansionary fiscal policy?
Increased government borrowing to fund a deficit drives up interest rates, which in turn reduces (crowds out) private investment and interest-sensitive consumption, partially or fully offsetting the initial boost to aggregate demand.
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Differentiate between interventionist and market-based supply-side policies.
Interventionist policies involve government spending to boost supply (e.g., on education, infrastructure). Market-based policies aim to free up markets and provide incentives (e.g., tax cuts, deregulation, privatisation) to increase efficiency and supply.
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What is the 'J-curve effect'?
Following a currency devaluation/depreciation, the current account balance may worsen in the short term before it improves in the long term. This is because import prices rise and export prices fall immediately, but the quantity of imports and exports takes time to adjust.