2.6 Macroeconomic Objectives & Policies Flashcards
What is monetary policy?
The use of interest rates and money supply to boost AD (and achieve macro objectives e.g growth, inflation)
What are interest rates?
The cost of borrowing money, expressed as a percentage of the amount borrowed
What is contractionary monetary policy?
Involves raising interest rates (and reducing the money supply) in order to reduce the inflation rate
What is expansionary monetary policy?
Involves cutting interest rates or increasing the money supply to boost economic activity
How do high interest rates affect AD?
Higher interest rates increase the cost of borrowing and reduce the value of assets leading to a decrease in AD
What is quantitative easing?
When the central bank buys financial assets e.g government bonds in exchange for money in order to increase borrowing and lending in the economy
How does quantitative easing increase AD?
The commercial bank now holds fewer bonds/loans and more money which it can lend to customers e.g households, firms wanting to invest. This leads to higher investment and consumption
What is the purpose of negative interest rates?
- Increase bank lending: banks more likely to lend than to hold on to money, incentive for consumers/firms to spend and invest, stimulating economic growth
- Combat deflation: incentivises spending + investment over saving or hoarding cash
What are 2 risks of negative interest rates?
- Lowers bank profitability: erodes interest rate income of banks
- Can cause banks to take excessive risks in search of higher returns
What are negative interest rates?
When central bank lowers the nominal interest rate below zero so interest is paid to borrowers rather than to lenders
Name 2 advantages of monetary policy
- Targeting interest rate controls inflation
- Easy to implement
Name 3 disadvantages of monetary policy
- Effects have a time lag
- Ability to reduce inflation depends on type (effective on demand-pull)
- Risk of hyperinflation
How does quantitative easing affect interest rates?
Lowers interest rates in order to encourage borrowing
How does quantitative easing affect exchange rates?
When interest rates fall, investors switch money from Uk assets to others. There is a fall in demand for the pound but a rise in supply. Therefore price falls against other currencies
What is fiscal policy?
The use of government spending, taxation and borrowing to boost AD (and meet its macroeconomic objectives)
What is expansionary fiscal policy?
Involves an increase in government spending and lowering taxes to boost AD
What is contractionary fiscal policy?
Involves a decrease in government spending and raising taxes to lower AD
What is a drawback of expansionary fiscal policy?
Leads to a worsening of government budget deficit, and may mean government have to borrow more to finance this
What is the difference between a budget deficit and budget surplus?
Budget deficit - when expenditure exceeds tax receipts in a financial year
Budget surplus - when tax receipts/income exceed expenditure
What are 3 limitations of fiscal policy?
- Governments may have imperfect information about the economy, leading to inefficient spending
- Time lag: could take months or years to have an effect
- If government spends too much, could be difficulties paying back and borrowing in the future
What are 2 sources of government revenue?
- Direct taxation: taxation on income, wealth and profit e.g income tax
- Indirect taxation: taxation on spending by consumers on goods and services e.g VAT
What is government debt?
The total amount of money the British government owes to the private sector and other purchasers of UK gilts e.g Bank of England
What are automatic stabilisers?
Automatic fiscal changes in the economy as it moves through different stages of the business cycle without direct intervention from government e.g increase in welfare benefits when unemployment rises
What is discretionary fiscal policy?
Intentional government changes in tax rates and government spending to achieve macroeconomic objectives