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Topic 2 - Macro > 2.6.2 Demand-side Policies > Flashcards

2.6.2 Demand-side Policies Flashcards

1
Q

What are the three types of policies

Which are demand-side and which are supply-side

A

Demand-side: Fiscal and Monetary Policy

Supply Side policies

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2
Q

What is Fiscal Policy

A

Policies that include Gov Spending, Taxation and/or borrowing to affect AD

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3
Q

What is monetary policy

A

Policies relating to interest rates, money supply and/or the exchange rate

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4
Q

What is supply-side policy

A

Policies that increase the productive potential of an economy, usually in relation to increase in quantity/quality of an economy’s factors or production

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5
Q

What is expansionary fiscal policy used for

A
  1. To boost economic growth
  2. Reduce (cyclic) unemployement
  3. Increased demand-pull inflation
  4. Redistribution of income
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6
Q

What is contractionary fiscal policy used for

A
  1. Reduce inflation - demand pull
  2. Reduce budget deficit/national debt
  3. Redistribution of income
  4. Reduce current account deficit
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7
Q

Gives examples of how expansionary fiscal policy works

A
  1. Reduction in income tax (in particular on lower income)
  2. Reduction of Corporation Tax
  3. Increase in Gov spending (reducing regressive taxes may have a bigger effect because lower income households have a higher MPC)
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8
Q

How would you show expansionary fiscal policy on a Keynesian AD/AS diagram

A

Expansion in AD outwards

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9
Q

What can expansionary fiscal policy also have an effect on

A

LRAS

lower taxes could move more economically active into employment = increased productivity

lower cooperation tax = higher investment, increasing the economy stock in capital

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10
Q

What are automatic stabilisers

A

Fiscal Policy tools to influence GDP and counter fluctuations in the economic cycles

It used:

1) Progressive Income tax
2) Welfare benefits

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11
Q

How do automatic stabilisers work in a boom

To cushion demand

A
  1. Increased income, pushes workers into higher tax bands, increasing average rate of tax, slowing down the rate of consumption
  2. Unemployment will be lower = less Gov spending on welfare benefits
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12
Q

How do Automatic stabilisers work in a recession

Support output

A
  1. Income falls, pushes workers into lower tax bands, decreasing the average rate of tax return, preventing a drop in consumption
  2. Increased welfare spending
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13
Q

What is discretionary fiscal policy

A

Deflationary policy onto of automatic stabilisers

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14
Q

What are the two biggest sources of Government revenue

A

Income tax

VAT

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15
Q

What is direct tax

A

is levied on income, wealth and profits

It includes income tax, inheritance tax, national insurance capital gains, and cooperation tax

This burden of tax cannot be passed on

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16
Q

What is indirect tax

A

examples: exercise duties on fuels, cigarettes, and alcohol and VAT

Producers may be able to pass on all tax depending on elasticity

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17
Q

UK income tax is progressive or regressive?

What is the tax-free allowance on income?

What are the rates on tax

A

prgressive

££12,570

20%, 40%, 45%

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18
Q

What is the standard rate of VAT

Which products have a reduced rate

Which products are VAT free

A

20% since 2011

domestic fuel + power, children’s cars seats, have a 5% rate

Food, house construction, books have a 0% VAT

19
Q

What is monetary policy

A

Changes in interest rates, money supply and the exchange rates by central banks in order to influence AD

20
Q

What is the use of expansionary monetary policy

A
  1. Increase demand-pull inflation
  2. Economic growth
  3. Reduced unemployment
21
Q

What is the use of contractionary Monetary policy

A
  1. Reduced inflation
  2. Prevent excessive house price growth and credit in the economy
  3. Reduced excess debt + promote saving
  4. Reduce current account deficit = less income spent on imports
22
Q

What is the transmission mechanisms

A

various channels affecting variables in AD

23
Q

Describe the expansionary monetary policy transmission mechanism

A
  1. Decreased credit card interest rates = increased consumer spending
  2. Decreased saving rates = increased consumption
  3. Decreased Mortgage rates = increased consumption
  4. Decreased rates of business loans = increased investment
  5. Weaker exchange rate = increasing exports
24
Q

Describe a graph for expansionary monetary policy

A

Expansion on AD

25
Q

What can expansionary monetary policy also have an effect on

(besides AD)

A

LRAS

Increased Investment through lowered interest rates

Leads through increased long-run economic growth by increasing Net stock in capital

26
Q

Evaluate expansionary monetary policy

A
  1. Demand pull inflation
  2. Current account deficit
  3. Interest rates have a lower band before they have no effect (liquidity trap)
  4. Negative impact on savers
  5. Time lag (18-24 months)
27
Q

What does the effectiveness of monetary policy depend on

A

Depends on size of output gap (spare capacity)

Consumer + Business confidence

Banks are willing to lend or change in base vs interest rates

Size of rate cut

28
Q

What is Quantitative easing (QE)

A

Involves the introduction of new money into the national supply by a central bank

The new electronic money is used to buy assets (mainly bonds) from financial institutions such as insurance, pensions and commercial banks

29
Q

Where has QE been used

A

UK

USA

EU

30
Q

Describe the transmission mechanism of QE

A
  1. New electronic money is created by the central banks
  2. This is used to buy assets e.g. bonds from financial institutions
  3. This increases price of bonds
  4. Causes interest rates to fall
  5. Increases liquidity in financial sector
  6. Incentives to lend more
  7. Causes a positive wealth effect, from rise in asset prices
31
Q

What is the overall purpose of QE

A

to increase AD

32
Q

What is the wealth effect

A

lower yield (interest) rates leads to higher share + bond prices

Leading to people feeling wealthier and therefore spending more

33
Q

What is the borrowing cost effect

A

QE lowers interest rates on long term debt = Gov bonds and mortgages

34
Q

What is the lending effect

A

QE increases the liquidity of banks, increases income and spending in the economy

35
Q

What is the currency effect

A

lower interest rates have a side effect of causing the exchange rates to weaken = more competitive exports

36
Q

Why would you use QE

A

In normal circumstance, you would just reduce interest rates

However liquidity trap means that interest rates are too low, they have no effect

37
Q

A QE of £120Bn cut interest rates by

A

1%

38
Q

Problems with QE

A

QE is not meant to be permanent

What happens if the reverse of QE happens

39
Q

What policies were used after the 2008 Financial Crisis

A

Demand side

40
Q

What were the key origins of the 2008 recession

A
  1. Sub-prime lending - leading to high risk home buyers
  2. Financial Innovations - e.g credit default swaps
  3. Asset Price bubbles - excessive asset growth in house pricing
  4. Regulator capture - failure of credit rating industries
41
Q

What was the central Government response to the 2008 crisis

A
  1. Lower interest rates (expansionary monetary policy)
  2. QE
  3. Bank bailouts
  4. Financial Stimulus
42
Q

Arguments in favour (expansionary) policies

A
  1. Prevent depression - strong fiscal + monetary stimulus to increase demand
  2. Create jobs - labor-intensive infrastructure having a positive multiplier effect
  3. Avoid price deflation = price + wages falling
  4. Support confidence - investment + consumption
43
Q

Weakness/limits to the 2008 stimulus

A
  1. Keynesian liquidity trap
  2. Moral Hazard - bailing banks may allow them to become risker
  3. Savers - adverse effect of savers e.g. pensioners
  4. Rising property prices - wealth effect from QE and lower interest rates

Topic 2 - Macro (23 decks)

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