2.6.2 Demand-side Policies ✅

Question 1

What is the distinction between monetary and fiscal policy?

Answer 1

Monetary policy - manipulated by gov using banks to control AD (QE and interest rates).

Fiscal policy - use of tax and gov spending to influence AD.

Question 2

What is the transmission mechanism? What countries is this specifically for? What policies does this relate to?

Answer 2

When a policy makes a ripple effect in the economy. Specifically for developed countries. Monetary

Question 3

What are interest rates and who controls them?

Answer 3

Reward of saving and cost of borrowing. Bank of England through the base rate (repo rate).

Question 4

What does interest rates overall control?

Answer 4

Inflation.
Low interest = econ growth (inflationary pressure).

Question 5

How does interest rates control inflation?

Answer 5

Transmission mechanism.

Question 6

What do high interest rates do to growth?

Answer 6

Lowers it.

Question 7

What happens when interest rates fall?

Answer 7

Economic growth and redistribution of income (savers/lenders —> borrowers/loaners).

Question 8

Problems with fiscal policy?

Answer 8

• exchange rate may effect trade too much (trade deficit).
• changes take up to 2 years.
• low interest may not be enough to stimulate demand. (Liquidity trap)
• depends on credit availability.

Question 9

What is the liquidity trap?

Answer 9

When interest has fallen low but there is a preference to hoard cash than take a dept with low interest.

Question 10

What is QE?

Answer 10

• central bank buys assets from the market to reduce the interest rate and increase money supply.
• it creates new bank reserves and increases its liquidity thus increasing investment and loans.
• when bank buys assets that increases their price but lowers their yield.

Question 11

What are the problems with QE?

Answer 11

• risky (hyper inflation).
• only increase demand for assets
• no guarantee wealth effect will increase MPC.

Question 12

What does lower yields mean?

Answer 12

Reduces cost of borrowing and increases spending.

Question 13

What does higher asset prices do?

Answer 13

Wealth affect.

Question 14

What is fiscal policy?

Answer 14

Gov spending on tax. (Expansionary or contractionary)

Question 15

What are two types of tax?

Answer 15

Income (cut in this will increase di).
Corporate (cut in this will increase firms profit thus investment).

Question 16

What is the difference between budget surplus and budget deficit?

Answer 16

Budget deficit is when they are spending more than received in revenue, budget surplus is receive it more than spent.

Question 17

What is the difference between direct and indirect tax?

Answer 17

Direct tax is money paid directly to gov, indirect is tax that is passed on to someone else.

Question 18

Problems with fiscal policy?

Answer 18

• gov spending impacts LRAS eg by cutting spending this will effect education.
• inequality impacts when controlling demand. Plus also incentives.
• political issues (increasing tax).

Question 19

What is the Bank of England role?

Answer 19

• monthly meetings to set bank rate + if QE is needed.
• monitor inflation (dictate if expansionary or contractionary monetary policy is needed).

Question 20

How does a rise in intrest rates cause a fall in ad?

Answer 20

• Increase cost of borrowing thus fall in consumption (saving more attractive) + investment (will need high returns) = reduces AD.
• Fall in demand of assets pushes prices down = causing negative wealth effect leading to a fall in consumption + lower investment due to lower prices.
• High intrest rates = reduces confidence in spending/borrowing/investment = reducing AD.
• Other loans on houses are more expensive thus lower di.
• value of pound will rise due to hot flows coming in the make money off high intrest. (Imports will be cheaper + exports more expensive) = decrease net trade thus AD.

Question 21

What are problems w using intrest rates to control demand?

Answer 21

• May cause trade deficit.
• Intrest rate changes take up to 2 years.
• Sometimes low intrest rates is not enough (liquidity).
• High intrest rates LT will impact investment thus LRAS.