2.6.2 Demand side policies

Question 1

What is Monetary policy

Answer 1

an attempt to influence the level of economic activity through interest rates and the money supply, controlled by the central bank/ monetary policy committee

Question 2

What is the base rate

Answer 2

set by the MPC
the rate at which the BofE will lend to the financial system
influences the structure of all other interest rates

Question 3

Why does MPC control the monetary policy

Answer 3

to remove political pragmatism and short termism from interest rate decisions

Question 4

What is the gov set inflation target

Answer 4

2%

Question 5

What is a symmetrical target

Answer 5

a requirement places on central bank to respond if inflation is too low or high (1-3%)

Question 6

What is the letter

Answer 6

If below 1% or above 3% the governor of BofE must write a letter of explanation to the chancellor

Question 7

What information does the MPC consider when setting interest rates

Answer 7

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

Question 8

Explain The Monetary Transmission Mechanism

Answer 8

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

Question 9

What are interest rates

Answer 9

the cost of borrowing and the return on saving

Question 10

What are exchange rates

Answer 10

the price of one currency in terms of another

Question 11

What is FOREX

Answer 11

the global financial market for trading currencies

Question 12

What is the difference between currency appreciation and depreciation

Answer 12

A- an increase in the value of one currency against another
D- decrease in value

Question 13

What is speculation

Answer 13

selecting investments with high risk in order to profit from anticipated price movements

Question 14

What does a rise in interest rates cause (terms of currency)

Answer 14

savers have greater return so attracts hot money to UK banks, increased demand for £, so appreciation of £, means speculators buy

Question 15

What does a fall in interest rates cause (in terms of currency

Answer 15

outflows of hot money, selling of the £, causes depreciation

Question 16

What does the impact of interest rates depend on

Answer 16

size in change in interest rates,
interest rates in other countries,
if financial markets trust banks,
speculation and how market views change

Question 17

What is the impact of appreciation on AD

Answer 17

makes exports more expensive and cheaper
exports decrease and imports increase
reduces AD
eases inflationary pressures

Question 18

Impact of depreciation on AD

Answer 18

exports cheap so increase
imports expensive so decrease
increases AD
increases inflationary pressures

Question 19

What impacts the effect of a change in currency

Answer 19

-other factors that impacts imports and exports
- Uk doesn’t make some imported goods
-some exports are made from imported parts

Question 20

What is the impact of a change in interest rates on the objectives

Answer 20

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

Question 21

What is quantitative easing

Answer 21

when the central bank buys gov bonds to pump money directly into the financial system- is last resort

Question 22

What is a liquidity trap

Answer 22

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

Question 23

What is the process of QE

Answer 23

-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

Question 24

What are the aims of QE

Answer 24

-bank lending to start flow increasing C & I
-confidence rises as lending and spending rise
- AD rises meaning no recession
-inflation target is met

Question 25

What are the limitations of QE

Answer 25

-in uk bond yields are already low
-in recession low yields may not encourage risk taking
-fiscal policy may be needed

Question 26

What are the potential issues of QE

Answer 26

-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

Question 27

What is the process of quantitative tightening/tapering

Answer 27

-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

Question 28

Why is the timing of quantitative tightening important

Answer 28

too soon- economy suffers recession and deflation
too late- causes inflation problems so must gradually release to avoid flooding the market

Question 29

What is the budget

Answer 29

the annual financial statement of the economy

Question 30

What is fiscal policy

Answer 30

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

Question 31

What is fiscal policies effect on AD

Answer 31

G is part of AD but also has effects via the multiplier,
Tax impacts disposable incomes and therefore AD

Question 32

What is fiscal policies effect on AS

Answer 32

gov spending increases productivity effecting LRAS,
tax cuts increase incentives to work

Question 33

What are the benefits of taxation

Answer 33

-raises revenue to finance gov spending
-helps manage AD to meet objectives
-redistributes income and wealth
-corrects market failure (negative externalities)

Question 34

What is direct taxation

Answer 34

on income, wealth, profit
e.g income tax, national insurance contributions, capital gains tax, corporation tax

Question 35

What is the Laffer curve

Answer 35

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)

Question 36

What is indirect taxation

Answer 36

tax on consumer spending on g/s
e.g vat, excise duty, road tax, tv licence

Question 37

What is the difference between progressive, neutral and regressive tax

Answer 37

P- the % of tax rises as income rises
N- % tax is constant
R- % tax falls as income rises

Question 38

What are the impacts of VAT tax compared to income tax

Answer 38

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

Question 39

What are the types of government spending

Answer 39

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

Question 40

What are the two types of keynesian demand management

Answer 40

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

Question 41

What is expansionary fiscal policy (and other names for it)

Answer 41

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

Question 42

What is contractionary fiscal policy (and other names for it)

Answer 42

Deflationary/ Tightening fiscal policy
-decreases gov spending, increases taxation, increases budget surplus, aimed to decrease AD to reduce inflationary pressures, used in a boom