aluate the view that monetary policy is the most effective way of tackling deflation in developed countries such as the UK and Japan - Jun 2017

Question 1

Intro

Answer 1

• Monetary policy is an action that influences the money supply in an economy
• Deflation is a fall in the overall price level in an economy
• Developed countries have high economic growth and security with high living standards
• Deflation can spiral into a recession through the multiplier effect

Question 2

P1

Answer 2

• Expansionary monetary policy can stimulate demand and investment in the economy
• This can be achieved through reducing interest rates and quantitative easing
• Making spending more attractive and saving less attractive
• Boosts investment and consumer spending, accounting for 80% of AD
• Pushes AD outwards and LRAS, good in the long run creating jobs
• Unlikely to shift SRAS
• Negative nominal interest rates are dangerous and erode bank profitability
• No guarantee that interest rate cut will lead to more spending if consumer confidence is low

Question 3

P2

Answer 3

• Expansionary fiscal policy includes reducing tax rates and increasing government spending
• Spending can be targeted to regions and people to guarantee an increase in AD
• Tax cuts can be targeted to maximise the marginal propensity to consume and accelerator
• Increased budget deficit is a drawback, which is likely to be financed by an increase in surplus in the financial account
• Fiscal policy can put extra strain on government finances so might not be achievable
• Guaranteed to boost AD, but might conflict with other political policies
• Indirect tax cuts might not be as attractive as initially seen

Question 4

P3

Answer 4

• Expansionary monetary policy will lead to a depreciation in the exchange rate
• Saving money in UK banks is less attractive than other banks, increasing the supply of pounds onto the FOREX market
• Depreciation is exacerbated as people are less likely to demand pounds
• WPIDEC makes imports more expensive and exports cheaper
• Reduction in the balance of trade and hence net leakages from the circular flow of income
• AD will increase and inflation will result as people look to make purchases domestically and exports gain competitiveness
• Demand is inelastic for imports, so the effects would be rather limited and smaller than first imagined plus is a longer-term solution due to the time lag

Question 5

Conclusion

Answer 5

• Not many strategies can be used to combat deflation in developed countries
• Expansionary monetary policy has no guarantee to stimulate demand as consumers can opt to continue saving at a less attractive rate
• Stimulus should encourage investment and consumer spending, improving consumer confidence leading to a better recovery
• Negative nominal interest rates could be damaging to a large proportion of the UK who are savers and lead to the profitability of banks deteriorating
• Expansionary fiscal policy will guarantee some inflation with G being a component of AD
• Exchange rate manipulation could improve the balance of trade, but demand for imports is inelastic
• Sustainable policies are seen across many developed economies