limits of government policies (sam)

Limits of Government Policies:

Limits of Government Policies

Main Objectives:

Main Objectives Low and Stable Inflation Low Unemployment High Economic Growth Equilibrium on the balance of payment

Fiscal Policy:

Fiscal Policy Definition: Fiscal policy involves the Government changing the levels of Taxation and Government Spending in order to influence Aggregate Demand (AD) and therefore the level of economic activity (economic growth).

Limitations of Fiscal Policies:

Limitations of Fiscal Policies Disincentives of Tax Cuts. Increasing Taxes to reduce AD may cause disincentives to work, if this occurs there will be a fall in productivity and AS could fall . Time Lags. If the govt plans to increase spending this can take along time to filter into the economy and it may be too late . Spending plans are only set once a year. There is also a delay in implementing any changes to spending patterns .

Limitations of Fiscal Policies:

Limitations of Fiscal Policies Budget Deficit Expansionary fiscal policy (cutting taxes and increasing G) will cause an increase in the budget deficit which has many adverse effects.Higher budget deficit will require higher taxes in the future and may cause crowding out (see below Equity- F.P been used to redistribute income and wealth . Leads to sever market distortions. Higher income earners avoided tax by not wokring , moving abroad, etc.

Monetary Policy:

Monetary Policy Definition: Monetary policy involves changes in the base rate of interest to influence the growth of aggregate demand, the money supply and price inflation. Monetary policy works by changing the rate of growth of demand for money.

Limitations of Monetary Policies:

Limitations of Monetary Policies Liquidity Trap - When a cut in interest rates fail to stimulate economic activity. e.g. because of low confidence . Difficult to control many objectives with one tool - interest rates. For example, a rise in oil prices causes cost push inflation and lower growth. The Bank could increase interest rates to reduce inflation, but, it would cause economic growth to fall as well . Changing interest rates has an effect on the exchange rate Interest rates may affect some parts of the economy more than others . e.g. higher interest rates increase the disposable income of people with savings. But, could cause homeowners to be unable to afford their mortgages .

Supply Side Policies:

Supply Side Policies Definition: The branch of economics that considers how to improve the productive capacity of the economy. It tends to be associated with Monetarist, free market economics. These economists tend to emphasise the benefits of making markets, such as labour markets more flexible. However, some supply side policies can involve government intervention to overcome market failure

Limitations:

Limitations If unemployment is caused by demand deficiency and a fall in AD then supply side policies may not be effective. When the economy is an a recession the economy needs higher levels of AD supply side policies would not be able to solve the immediate problem Supply side policies such as education and training are successful in increasing the UK’s competitiveness we could see an increase in exports and this would help the balance of payments current account. However, they would take time to have effect and would not stop a rapid increase in imports, which has been a feature of the UK economy.

Limitations:

Limitations If supply side policies increase productivity and competitiveness it can help reduce the rate of inflation. For example, in the 1970s the UK experienced high inflation, partly caused by powerful trades unions. Reducing the power of trades unions, in the 1908s, helped keep wage inflation low. However, supply side policies may be insufficient for keeping demand pull inflation low, this will require effective Monetary and fiscal policy.