2.6.2: Demand-Side Policies Flashcards
What is monetary policy?
Where governments control AD levels by altering monetary variables (e.g. amount of money in the economy).
What is fiscal policy?
The use of taxes & government expenditure to manipulate AD levels.
What are the monetary policy instruments?
-Interest rates.
-Quantitative easing.
What are interest rates?
The cost of borrowing/reward for saving (expressed as a percentage).
The Monetary Policy Committee (MPC) tries to ________ the base rate to cause a ________ in AD.
Reduce, rise.
What are the mechanisms of interest rates?
-Rise in C: Saving is less attractive (due to a lower rate of return).
-Rise in C & I: Lower costs of borrowing.
-Rise in (X-M): Lower interest rates de-incentivise investors to hold their money in British banks. The value of the pound will be weaker, but net trade will rise.
What are the limitations of interest rates?
-Changes take up to 2 years to have an effect.
-Lack of confidence will reduce the borrowing/lending rate no matter how low interest rates are.
What is quantitative easing?
Where a central bank (e.g. the Bank of England) buys assets in exchange for money to increase money supply for banks.
When is quantitative easing used?
When inflation is low & it isn’t possible to lower interest rates.
What is meant by buying assets in quantitative easing?
Increasing the size of banks’ accounts (reserves), which encourages banks to lend more money.
How does quantitative easing cause a positive wealth effect?
- Banks purchase assets through electronic money.
- Prices of assets rise, while interest adjust downwards.
- This encourages banks to rebalance their portfolios by increasing investment in other assets with a higher interest rate.
- Lower interest rates reduce borrowing costs for business (stimulus for borrowing/spending).
- Owners experience an increase in their wealth, confidence & spending.
- This positive effects of this may then spread out to the real economy.
What are the limitations of quantitative easing?
-Risky, and can cause inflation/hyperinflation. The flood of cash in the market may encourage reckless financial behavior and increase prices.
-QE can create asset bubbles, which are unsustainable increases in the prices of certain assets, such as stocks or housing, that can burst and cause financial instability.
-Causes a greater wealth inequality, as the owners of assets benefit from price rises.
What is government spending?
The expenditure of governments.
What does a rise in government spending result in?
A rise in AD.
The government can ________ the ________ of the circular flow of income.
Influence, size.
What are the limitations of government spending?
-Cutting government spending to reduce AD also reduces the quality of AS, due to a cut in investment costs.
-If the economy is close to full capacity, then higher government spending may cause inflationary pressures and little increase in real GDP.
What is a fiscal/budget deficit?
When the government spends more than they receive.
What is a fiscal/budget surplus?
When the government spends less than they receive.
What is taxation?
A financial contribution made to the government.
What can tax revenue be used for?
Government expenditure.
What are the limitations of taxation?
-Causes opposition.
-Reduces economic growth, as it reduces the incentives for work, investment, & entrepreneurship.
What is direct taxation?
Taxes payed directly by the taxpayer.
What is indirect taxation?
When the economic agent charged with the tax passes the tax onto someone else (e.g. firms can pass on the burden of indirect tax to the consumer).
What is an example of direct tax?
Income tax.
