10: Monetary and Fiscal Policy

Question 1

Fiscal Policy

Answer 1

the use of government spending and revenue instruments to influence the level of aggregate demand, and thus output, employment and economic growth.

Question 2

2 effects of fiscal policy

Answer 2

1. Multiplier Effect

2. Crowding out Effect

Question 3

Multiplier Effect

Answer 3

the impact on output from a certain amount of government spending has a bigger effect than the size of the government spending.

Question 4

Crowding Out Effect

Answer 4

where the extra government spending leads to a reduction in other components of aggregate demand.

Question 5

In recession Govs should…

Answer 5

increase spending (G) and cut taxes (T) moving the Government Budget into deficit;

Question 6

In boom, Govs should…

Answer 6

reduce spending (G) and raise taxes (T) moving the Government Budget into surplus;

Question 7

Expansionary Fiscal Policy

Answer 7

Suppose economy is in recession or growing too slowly. The government can respond by increasing G or lowering tax rates.

Question 8

Contractionary Fiscal Policy

Answer 8

Suppose the economy is booming or growing too fast. The government can respond by decreasing G or increasing tax rates.

Question 9

Monetary Policy

Answer 9

the manipulation of the amount of money in the economy or interest rates in order to affect the level of aggregate demand.

Question 10

Functions of RBA (3)

Answer 10

• The conduct of monetary policy;
• Maintenance of financial stability (Emergency lending to banks)
• Operate the non-cash payments system.

Question 11

How does RBA control inflation?

Answer 11

o If inflation is too high, the RBA increases the interest rate → slows down borrowing and spending → lower inflation and output.

o If inflation is too low, the RBA lowers the interest rate → higher borrowing and spending → higher inflation and output.

Question 12

Money Market

Answer 12

• The market in which agents who demand (or want) money meet agents who can supply (or lend) money.
• This market determines the interest rate – more specifically, the nominal interest rate (r).

Question 13

How is money supply measured?

Answer 13

• Currency: the notes and coins in the hands of the non-bank public (Cp).
• Current deposits: balances in bank accounts that depositors can access on demand by using cards (credit or debit) or writing a cheque (D).

Question 14

Liquidity Preference Model

Answer 14

Explains process and state of the Money Market