2.6.2- Demand Side policies

Question 1

What is the difference between monetary and fiscal policy

Answer 1

• Monetary policy is where the central bank or regulatory authority attempts to control the
  level of AD by altering base interest rates or the money supply
• Fiscal policy is use of borrowing, government spending and taxation to manipulate the
  level of aggregate demand and improve macroeconomic performance

Question 2

State two monetary policy instruments

Answer 2

1) interest rates
2) Asset purchases to increase the money supply (quantitative easing)

Question 3

Define Quantitative easing

Answer 3

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

Question 4

Define money supply

Answer 4

The entire quantity of a country’s commercial bills, coins, loans and credit.

Question 5

Define monetary policy commitee

Answer 5

Bank of England committee of nine people (including the Governor) that meets every month to review the economy and set monetary policy interest rates for the UK.

Question 6

Define monetary policy

Answer 6

Central bank policies govern the supply of money and the interest rate in an economy in order to influence output, employment and prices. In the UK the policy is administered by the Bank of England.

Question 7

Define interest rate

Answer 7

the cost or price of borrowing, or the gain from lending

Question 8

Define interest rate

Answer 8

the cost or price of borrowing, or the gain from lending

Question 9

Overall what is the main effect of a rise in interest rate

Answer 9

fall in AD

Question 10

What does the role of the bank of england include

Answer 10

role and operation of bank of england’s monetary policy committe

Question 11

Who control monetary policy

Answer 11

• s controlled by the Bank of England rather than the gov
• The Monetary Policy Committee (MPC) makes the most important decisions, including the Bank of England base rate and the actions over quantitative easing.

Question 12

What is the aim of the monetary policy committee - what if this aim is not met

Answer 12

• Their main aim is keep inflation at 2%
• if it goes below 1% or above 3% the governor of the Bank of England has to write a letter to the Chancellor of the
  Exchequer explaining why this is happened and what the Bank of England is doing to bring it back to the target.
• They use CPI in order to see whether this target has been
  met

Question 13

Describe actions of the MPC since 2009

Answer 13

• Since 2009, the MPC has kept the bank rate at 0.5% and policy has become focussed on boosting economic growth and employment.
• It was reduced to 0.25% following the Brexit vote but rose again in November 2017 due to the inflation that the
  weak pound brought about.
• They plan to raise the interest rate once the negative
  output gap has been eliminated and the economy is growing strongly

Question 14

What is the MPC made up of

Answer 14

The Committee is made up of nine people: five are from of the Bank of England, including the Governor of the Bank of England, and the other four are independent outside experts, mainly economists.

Question 15

What is the general way MPC tackles inflation

Answer 15

• rate of inflation rises indicates excess demand in the economy so they raise the base rates to reduce AD
• rate of inflation falls towards zero so MPC would cut interest rates to boost AD and nudge inflation back up to its target level

Question 16

Define monetary policy committee

Answer 16

Bank of England committee of nine people (including the Governor) that meets every month to review the economy and set monetary policy interest rates for the UK.

Question 17

Define corporation tax

Answer 17

A tax on the profits made by companies, in the UK the main rate of corporation tax is 19% and is expected to fall to 18% by 2020.

Question 18

Define expansionary monetary policy

Answer 18

A relaxation of monetary policy means an attempt to use an expansionary monetary policy to boost aggregate demand, output and jobs – includes lower interest rates

Question 19

Define inflation target

Answer 19

The Bank of England has a CPI inflation target, which is currently 2 per cent

Question 20

Define quantitative easing

Answer 20

The introduction of new money into the national supply by a central bank. In the UK the Bank of England creates new money to buy financial assets from financial institutions. Total planned QE in January 2017 totalled £445 billion.

Question 21

When is QE used

Answer 21

when mpc needs to adopt loose monetary policy to stimulate AD at a time when interest rates are already low or negative

Question 22

What does QE do and what are its intended effects

Answer 22

Increase the money supply which will enable individuals and firms to spend more

Question 23

REFER TO PMT NOTES ON 2.6 FRO EXPLANATION OF QUE

Question 24

Basic explanation of QE

Answer 24

1) central banl digitally creates money and adds it to the balance sheet
2) central bank purchases financial asses from banks and other financial institutions
3) Financial instituions have more money increased demand for bonds and other financial assets cause their vaues to rise. The wealth of owners of these assets therefore increases
4) it is hoped financial institutions spend the money or lend it to the other people to spend

Question 25

Define liquidity

Answer 25

Liquidity is a company’s ability to convert assets to cash or acquire cash—through a loan or money in the bank—to pay its short-term obligations or liabilities

Question 26

Define liquidity trap

Answer 26

where even low interest rates cannot
stimulate AD.

Question 27

What is a danger of QE

Answer 27

Financial institutions may initially use this new money to increase its reserves and then start increasing ledning when the inflation rate is already rising so demand pull inflaton is now harder to control

Question 28

How was QE first introduced in 2009

Answer 28

• AD WAS LOW AFTER 2008 RECESSION AND NEEDED STIMULATION BUT INTEREST RATES WERE ALREADY AT A LOW RATE OF 0.5%

1) the Bank of England bought assets (e.g. government Treasury bills) from firms such as insurance companies and commercial banks.
2) However, QE was slow to work at first because the banks were still reluctant to lend money after the credit crunch. Instead they used it just to increase their reserves of money.
3) Eventually these banks did begin to lend money to other firms and individuals - who used the money to, for example, invest in new machinery, start new businesses or buy houses.
4)All of this spending boosted aggregate demand and led to an increase in the rate of inflation (see below).