2.6.2 Demand side policies Flashcards
What is Monetary policy
an attempt to influence the level of economic activity through interest rates and the money supply, controlled by the central bank/ monetary policy committee
What is the base rate
set by the MPC
the rate at which the BofE will lend to the financial system
influences the structure of all other interest rates
Why does MPC control the monetary policy
to remove political pragmatism and short termism from interest rate decisions
What is the gov set inflation target
2%
What is a symmetrical target
a requirement places on central bank to respond if inflation is too low or high (1-3%)
What is the letter
If below 1% or above 3% the governor of BofE must write a letter of explanation to the chancellor
What information does the MPC consider when setting interest rates
may be a time lag so can’t use current rates
- GDP growth
-Output gaps (inflationary and deflationary)
-Unemployment, equity, house prices, credit, confidence, forecasts for inflation, foreign exchange markets
Explain The Monetary Transmission Mechanism
Base rate- market rates/asset prices/expectations and confidence - domestic demand- total demand -inflationary pressures - inflation
Base rate- exchange rate- net external demand- total demand- inflationary pressure- inflation
Base rate- exchange rate- import prices- inflation
What are interest rates
the cost of borrowing and the return on saving
What are exchange rates
the price of one currency in terms of another
What is FOREX
the global financial market for trading currencies
What is the difference between currency appreciation and depreciation
A- an increase in the value of one currency against another
D- decrease in value
What is speculation
selecting investments with high risk in order to profit from anticipated price movements
What does a rise in interest rates cause (terms of currency)
savers have greater return so attracts hot money to UK banks, increased demand for £, so appreciation of £, means speculators buy
What does a fall in interest rates cause (in terms of currency
outflows of hot money, selling of the £, causes depreciation
What does the impact of interest rates depend on
size in change in interest rates,
interest rates in other countries,
if financial markets trust banks,
speculation and how market views change
What is the impact of appreciation on AD
makes exports more expensive and cheaper
exports decrease and imports increase
reduces AD
eases inflationary pressures
Impact of depreciation on AD
exports cheap so increase
imports expensive so decrease
increases AD
increases inflationary pressures
What impacts the effect of a change in currency
-other factors that impacts imports and exports
- Uk doesn’t make some imported goods
-some exports are made from imported parts
What is the impact of a change in interest rates on the objectives
Inflation- increased IR is deflationary and decreased IR is inflationary
Economic growth- IR impacts AD which impacts growth
Balance of payments- interest rates impacts exchange rates which causes appreciation and depreciation
What is quantitative easing
when the central bank buys gov bonds to pump money directly into the financial system- is last resort
What is a liquidity trap
when interest rates are near zero so people hoard cash instead of investing so liquidity is trapped in the banking system, QE is used in attempt to encourage lending in liquidity trap
What is the process of QE
-injection of electronic money to purchase bonds
-prices of assets rise so yields decrease
-banks and investors invest in higher yields like bonds and shares
-lower yields push down borrowing costs
-encourages spending and investment
-the rising price of assets creates a wealth effect which will increase C and I
-the increased supply of money causes depreciation causing rise in net trade
What are the aims of QE
-bank lending to start flow increasing C & I
-confidence rises as lending and spending rise
- AD rises meaning no recession
-inflation target is met
What are the limitations of QE
-in uk bond yields are already low
-in recession low yields may not encourage risk taking
-fiscal policy may be needed
What are the potential issues of QE
-Inflation caused by increased money supply
-Depreciation causes by fears of inflation causing selling of currency
-Rising inequality caused by policy benefitting high income earners,banks and bond holders
What is the process of quantitative tightening/tapering
-BofE sell bonds or bonds mature and BofE gradually remove money from circulation
-increased supply of bonds reduces bond prices, yields increase
-interest rates increase
-reduces C and I
-banks buy bonds so cash reserves fall and so does money supply
-high interest rates also caused appreciation and rise of imports so decreased net trade
Why is the timing of quantitative tightening important
too soon- economy suffers recession and deflation
too late- causes inflation problems so must gradually release to avoid flooding the market
What is the budget
the annual financial statement of the economy
What is fiscal policy
the use of gov expenditure and borrowing and taxation to influence the economy, effects levels of AD, output, employment and inflation, influencers business cycle and AS
What is fiscal policies effect on AD
G is part of AD but also has effects via the multiplier,
Tax impacts disposable incomes and therefore AD
What is fiscal policies effect on AS
gov spending increases productivity effecting LRAS,
tax cuts increase incentives to work
What are the benefits of taxation
-raises revenue to finance gov spending
-helps manage AD to meet objectives
-redistributes income and wealth
-corrects market failure (negative externalities)
What is direct taxation
on income, wealth, profit
e.g income tax, national insurance contributions, capital gains tax, corporation tax
What is the Laffer curve
Displays the concept of ‘taxable income elasticity’- taxable income will change in response to the rate of taxation
- as taxes increase from low levels so would tax revenue, but there is a point where people would regard it as not worth hard work which would lead to falling income and tax revenue
-Arthur Laffer believed rates are too high and we should decrease rates to incentivise work (right wing)
What is indirect taxation
tax on consumer spending on g/s
e.g vat, excise duty, road tax, tv licence
What is the difference between progressive, neutral and regressive tax
P- the % of tax rises as income rises
N- % tax is constant
R- % tax falls as income rises
What are the impacts of VAT tax compared to income tax
VAT- rates don’t directly effect incentives to work, leads to inflation, increase regressivley
Income- change incentives to work, increase disposable income, may not impact in a desired way
What are the types of government spending
Transfer payments- not part of G in AD, welfare payments e.g job seekers allowance
Capital spending- improves countries infrastructure (new assets)
Current spending- day to day on public services e.g healthcare and education
What are the two types of keynesian demand management
Automatic stabilisers- gov spending and taxation varies automatically over the economic cycle
Discretionary fiscal policy- alteration of gov spending and taxes deliberately for economic objectives
What is expansionary fiscal policy (and other names for it)
Inflationary/ Loosening fiscal policy/deficit spending
-increases gov spending, reduces taxation, increases a budget deficit, aims to increase AD via the multiplier, counters a recession
What is contractionary fiscal policy (and other names for it)
Deflationary/ Tightening fiscal policy
-decreases gov spending, increases taxation, increases budget surplus, aimed to decrease AD to reduce inflationary pressures, used in a boom
