2.6.2 - demand side policies Flashcards
(46 cards)
What is the role of the Bank of England’s Monetary Policy Committee?
Their main aim is for inflation to remain at 2% (CPI). They make decisions about the base rate and quantitative easing. The MPC is made up of nine people, they meet on a monthly basis to set the base rate and QE.
What are the 3 ways the MPC can influence AD?
- interest rates
- the money supply
- the exchange rate
what is the main method used to control the money supply?
quantitative easing
How does quantitative easing work?
The Bank of England can create new money electronically, most of this money is used to buy government bonds and assets. Commercial banks receive cash, increasing liquidity, stimulating lending = increased consumption and investment. Buying lots of bonds pushes the price up, interest rates on loans are affected by the price of bonds. If prices go up, interest rates should go down - easier to borrow and spend money. The currency depreciates, increasing net exports. Positive wealth effect created. Quantitative easing increases consumption and investment, increasing AD and ensuring the country meets its inflation target.
What are government bonds?
A type of investment where you lend money to the government and in return it promises to pay back a certain sum of money in the future with interest
How can quantitative easing increase business investors?
Many investors buy bonds as a safe place to put their money. If the prices of those bonds increases, their safety becomes more expensive so investors are encouraged to buy shares or lend money to business again instead, supporting the economy
What is quantitative easing?
When the Bank of England buys assets in exchange for money to increase the money supply in times of low demand.
How does QE affect government borrowing?
It helped the government to borrow money to cover a budget deficit. The government pays less interest on bonds owned by the Bank of England than other investors, taking further pressure off public finances.
What are the impacts of QE?
- the bank buys assets so there is a rise in demand and asset prices rise, causing a positive wealth effect, so that people increase their consumption. Cost of borrowing will decrease as higher asset prices means lower yields, so it is cheaper for consumers and businesses to finance spending.
- the money supply will increase. private sector firms receive more money to spend on goods/services, increasing investment and consumption, leading to higher AD. It may push asset prices up further. Banks have more reserves, so they can increase lending to consumers and firms, increasing consumption and investment.
- commercial banks may lower interest rates are they receive money from BofE, and can offer low interest deals to consumers. Increased money supply means prices of money falls, encouraging borrowing, increasing investment and consumption, leading to a rise in AD.
How does QE impact pensions?
Bond prices are used to estimate how much it will cost to provide pensions in the future. Increased bond prices means cost of providing future pensions rises so firms were obliged to make bigger payments into their pensions, reducing possible investment money.
How is the exchange rate used as monetary policy (depreciation)?
The sale of pounds to depreciate the value of Sterling. Exports are cheaper and imports expensive, increasing net exports and AD. However, this increases cost of production as imported FOPs are more expensive.
what is the target CPI for the MPC?
CPI target at 2%, minus or plus 1%
What is expansionary/loose/inflationary monetary policy?
Reducing the base interest rate, increasing consumption. Reduced mps as opportunity cost of spending falls, expansion in borrowing (cheaper), increased demand for g/s, increased purchasing power via wealth effect, increased investment etc.
What is contractionary/deflationary/tight monetary policy?
Reducing the base interest rate to reduce inflation. Increased saving, reduced consumption due to fall in purchasing power, reduced investment, etc.
What is government expenditure used for?
- spending on g/s for current use eg. health, education
- capital expenditure = spending on infrastructure eg. roads, hospitals
- transfer payments = provides benefits in cash/payments to poor and vulnerable households
what is the role of the Treasury (fiscal policy)?
it allocates government spending and oversees collection of taxes.
what is fiscal policy?
Manipulation of g and t by the government to influence AD to stabilise the economy. Increased taxation will reduce disposable income, reducing consumption and AD, reducing inflationary pressure. Increased government spending increases AD, stimulating economic growth.
what is stabilisation policy?
the government has a responsibility to smooth out the peaks and troughs of the business cycle.
what are the two main types of fiscal policy?
discretionary stabilisers and automatic stabilisers
what are discretionary stabilisers?
the government actively adjusts fiscal policy in response to a boom or downturn.
how would the government use discretionary stabilisers when the economy is overheating?
the government may increase tax to temper aggregate demand. this would likely be amplified by the multiplier effect
What are the main impacts of discretionary fiscal policy?
-alters AD level
-effects LRAS - tax changes provide incentives, encourage investment and improve human capital
-influences distribution of income
-determines size of the state relative to the private sector
what are automatic stabilisers?
this reduces fluctuations of national income without deliberate action by the government. a natural fiscal response to a slowdown or recovery in economic activity. inherent cyclical adjustments in the level of tax revenue and government expenditure through the business cycle.
what is fiscal stance?
refers to whether the government is pursuing an expansionary (loose or inflationary) or contractionary (deflationary or tight) fiscal policy