Government Economic Service (GES) Assessment Centre Macroeconomics and the UK Economy Flashcards

24 sample cards from the Macroeconomics and the UK Economy deck

Sampled from the end of the deck, so these are different cards from the ones shown on the syllabus page.

1. What factors determine the supply of labour, and how do skills and human capital affect it?

   Labour supply depends on the size and age structure of the population, participation/activity rates, migration, real wages, income tax and benefits, and the wage-leisure trade-off. Human capital—education, training and skills—raises productivity and effective labour supply, reduces structural unemployment, and shifts LRAS right; UK skills gaps are a noted constraint.

2. What is the Monetary Policy Committee (MPC), its composition, and its primary mandate?

   The MPC is the Bank of England's nine-member committee (the Governor, three Deputy Governors, the Chief Economist, and four external members) that sets monetary policy. Its primary objective is price stability—a symmetric CPI inflation target of 2%—and, subject to that, to support the government's objectives for growth and employment.

3. What is the UK inflation target, why is it symmetric, and what happens if it is missed?

   The target is 2% CPI inflation, set by the Chancellor. It is symmetric, so inflation too far below 2% is treated as seriously as too far above. If inflation deviates by more than 1 percentage point in either direction (above 3% or below 1%), the Governor must write an open letter to the Chancellor explaining why and the action being taken.

4. Describe the monetary policy transmission mechanism from Bank Rate to inflation.

   A change in Bank Rate feeds through several channels: (1) market interest rates on loans/savings; (2) asset prices and wealth; (3) expectations and confidence; and (4) the exchange rate. These affect consumption, investment and net exports, changing aggregate demand and the output gap, which then influences inflation. The process works with long and variable lags (roughly up to two years).

5. Through which channels does a rise in Bank Rate reduce aggregate demand?

   Higher Bank Rate raises borrowing costs (cutting consumer credit and investment), increases the reward for saving, raises mortgage repayments (reducing disposable income), lowers asset prices and wealth, and tends to appreciate the exchange rate (cutting net exports). Together these reduce $C$, $I$ and $(X-M)$, lowering AD and inflationary pressure.

6. What is quantitative easing (QE) and how is it intended to work?

   QE is an unconventional policy where the central bank creates new electronic reserves to buy financial assets, chiefly government bonds (gilts), from the private sector. This raises bond prices and lowers yields, increases the money supply and bank reserves, boosts asset prices and lending, and lowers long-term interest rates to stimulate AD—used when Bank Rate is near the zero lower bound.

7. What is the zero lower bound, and name unconventional policy tools used alongside QE.

   The zero lower bound is the point where nominal interest rates approach zero and cannot easily be cut further, limiting conventional policy. Tools beyond QE include forward guidance (signalling the future rate path to shape expectations), funding-for-lending/term-funding schemes to cheapen bank lending, negative interest rates, and quantitative tightening (QT)—the reversal of QE by selling assets or not reinvesting maturing ones.

8. What is central bank independence and why is it considered desirable?

   Operational independence means the central bank sets the policy instrument (interest rates) free of day-to-day political control while the government sets the inflation target (goal independence remains with government). It is valued because it removes the temptation to inflate for short-term political/electoral gain, anchoring expectations and enhancing the credibility and effectiveness of anti-inflation policy. The Bank of England gained this in 1997.

9. What is the time-inconsistency problem and how does credibility help solve it?

   Time inconsistency (Kydland-Prescott): a policymaker has an incentive to renege on a previously announced low-inflation policy to gain a short-run output/employment boost, but rational agents anticipate this, so inflation ends up higher with no output gain. A credible, independent, rules-bound central bank commits to the target, anchoring expectations and delivering lower inflation at lower cost.

10. Distinguish the budget deficit from the national debt, and define a cyclical versus structural deficit.

    The budget (fiscal) deficit is the annual shortfall when government spending exceeds tax revenue; the national debt is the cumulative stock of past borrowing. A cyclical deficit results from the economic cycle (low tax, high benefits in downturns) and self-corrects in recovery; a structural deficit remains even at full employment and requires policy action to remove.

11. Distinguish progressive, proportional and regressive taxes, and direct from indirect taxes.

    Progressive: average tax rate rises with income (e.g. UK income tax). Proportional: a constant average rate (flat tax). Regressive: average rate falls as income rises (e.g. VAT as a share of income). Direct taxes are levied on income/wealth and paid directly (income tax, corporation tax); indirect taxes are levied on spending and collected via intermediaries (VAT, excise duties).

12. What are fiscal rules, and what is the role of the Office for Budget Responsibility (OBR)?

    Fiscal rules are self-imposed constraints on borrowing or debt (e.g. balancing the current budget over a horizon, or debt falling as a share of GDP). The OBR, established in 2010, is the UK's independent fiscal watchdog: it produces official economic and fiscal forecasts, judges whether the government has a better-than-even chance of meeting its fiscal rules, scrutinises costings and assesses long-run sustainability.

13. What is the rationale for fiscal rules, and what is the debt-to-GDP ratio used to assess?

    Fiscal rules aim to ensure sound public finances, maintain market confidence, prevent excessive borrowing for political reasons, and keep debt sustainable. The debt-to-GDP ratio, $\frac{\text{National debt}}{\text{GDP}} \times 100$, scales debt to the economy's ability to service it; sustainability depends on the relationship between the interest rate $r$ and growth rate $g$ on the debt.

14. What are automatic stabilisers and how do they smooth the business cycle?

    Automatic stabilisers are features of the tax-and-benefit system that moderate the cycle without active government decisions. In a downturn, tax receipts fall (progressive taxes) and welfare spending rises automatically, supporting demand; in a boom, taxes rise and benefit spending falls, dampening demand. They reduce the amplitude of fluctuations and act with no implementation lag.

15. Distinguish discretionary fiscal policy from automatic stabilisers, and name a drawback of discretionary policy.

    Discretionary fiscal policy involves deliberate, active changes to spending or taxation (e.g. a stimulus package) to manage demand. Automatic stabilisers operate without new decisions. A key drawback of discretionary policy is time lags—recognition, decision and implementation lags—which can make it ill-timed and even destabilising, plus political bias toward spending.

16. Define the fiscal multiplier and give the simple closed-economy multiplier formula.

    The fiscal multiplier measures how much an initial change in injection changes total real output. In a simple model, $k = \frac{1}{1 - MPC} = \frac{1}{MPS}$. With taxes and imports, $k = \frac{1}{MPS + MRT + MPM}$, i.e. $\frac{1}{1 - MPC_{d}}$ where leakages are saving, tax and imports. A higher marginal propensity to withdraw gives a smaller multiplier.

17. What is crowding out, and how does it limit the effect of fiscal expansion?

    Crowding out occurs when increased government borrowing/spending raises demand for loanable funds and interest rates, reducing (crowding out) private-sector investment and consumption, offsetting the stimulus. Resource crowding out can also occur at full employment. The effect is weakest in a deep recession with spare capacity and low interest rates, where the multiplier is larger.

18. What are the main components of the balance of payments?

    The balance of payments records all transactions between a country and the rest of the world. Its main parts are: the current account (trade in goods and services, primary income, and secondary income/transfers); the capital account (small—e.g. capital transfers); and the financial account (investment flows: FDI, portfolio, reserves). In principle the accounts sum to zero.

19. What does the current account comprise, and what does a current account deficit imply?

    The current account = balance of trade in goods + balance of trade in services + net primary income (investment income/wages from abroad) + net secondary income (transfers). A current account deficit means a country spends more abroad than it earns, implying it is a net borrower from / seller of assets to the rest of the world, financed by a financial account surplus.

20. Compare a fixed exchange rate regime with a freely floating regime.

    Under a fixed regime the central bank pegs the currency and uses reserves/interest rates to maintain it, giving certainty for trade but losing monetary independence and risking speculative attacks. Under a free float the rate is set by supply and demand, automatically adjusting to imbalances and freeing monetary policy, but introducing volatility and uncertainty. A managed (dirty) float lies between, with occasional intervention.

21. What factors determine a floating exchange rate, and distinguish appreciation from devaluation?

    A floating rate is set by currency supply and demand, driven by relative interest rates (hot money flows), relative inflation (PPP), trade flows, FDI/portfolio flows, speculation and confidence. Appreciation/depreciation are market-driven rises/falls under a float; revaluation/devaluation are deliberate official changes to a fixed peg.

22. State the theory of comparative advantage and how it differs from absolute advantage.

    Absolute advantage: a country can produce a good using fewer resources than another. Comparative advantage (Ricardo): a country should specialise in and export the good in which it has the lower opportunity cost, even if it lacks absolute advantage. Mutually beneficial trade is possible whenever opportunity-cost ratios differ, raising total world output.

23. What is the J-curve effect following a currency depreciation?

    The J-curve describes how a currency depreciation initially worsens the current account before improving it. In the short run, demand for exports and imports is price-inelastic, so the higher cost of imports dominates and the trade balance deteriorates; over time, as quantities adjust (the Marshall-Lerner condition $|PED_{X}| + |PED_{M}| > 1$ holds), the balance improves, tracing a 'J' shape.

24. What is a global (external) economic shock, and why is international policy coordination valued?

    A global shock is a large unexpected event transmitted across economies—e.g. an oil/energy price spike, a financial crisis, a pandemic or a synchronised demand collapse—that is supply-side (raising costs, shifting SRAS) or demand-side. Policy coordination (via the G7, G20, IMF) is valued because uncoordinated national responses can create negative spillovers (e.g. competitive devaluations, protectionism); coordinated action internalises spillovers and stabilises the global economy more effectively.

What this deck covers

Macroeconomics and the UK Economy flashcards FAQ