C38 Demand side policies Flashcards
What are demand-side policies
Monetary policy
Fiscal policy
These have a major effect on the AD
What are monetary policies?
Policies that involve making decisions about interest rates and the money supply
What are contractionary monetary policies?
Reducing AD by using high interest rates and restriction the money supply
What are expansionary monetary policies?
Increasing AD by reducing interest rates and putting less restriction on the money supply
What is the problem with demand-side policies?
They cannot achieve all economic objectives at once
There will always be a trade-off
What is the main objective of monetary policies?
Price stability
Low inflation rates
Economic Gorwoth
Decrease unemployment
Who are interest rates set by in the UK?
By the MPC (monetary policy committee)
What does the MPC do?
Set inflation targets of 2%
Must be within + or - 1% of this target or they must get in contact with the bank of England
Why are low inflation rates desired?
Represents a stable economy and reduces the uncertainty for future investment
What traits of the Bank of England allow for stability and credibility?
Independent (politics doesn’t play a role)
Accountable (must reach the target or have to consult with the chancellor)
What does the MPC do to avoid conflicts with other objectives?
Monitoring economic data
size of output gaps
exchange rates average earning changes
What effect will an increase in interest rates have?
–borrowing
–spending
–investment
–onfidence
–exports
+ saving
+ imports
What is the liquidity trap?
When people are pessimistic about the future state of the economy, they may still chose to not invest even with low interest rates
How does the market affect interest rates?
Bank rates changes will cause changes to all interest rates as banks ofter have to borrow money
What are bank rates?
Lowest the Bank of England will lend at
How do interest rates affect exchange rates?
High-interest rates
–> High demand to buy
–> increase in the value of the £
–> more imports, fewer exports
–> bad equilibrium for BOP
What is the time lag from BOE changes?
It takes years before the changes of the BOE to actually show effects
What are fiscal policies?
Policies involving government spending and taxation
What are expansionary fiscal policies?
Boost AD by increasing government spending and reducing taxation (causes budget deficit as GS> Revenue)
What are contractionary fiscal policies?
Reducing AD by reducing government spending or increasing taxes (causes budget surpluses as GS< Revenue)
What are automatic stabilisers?
Fiscal policy that automatically reacts to changes in the economic cycle
What are discretionary policies?
Deliberate changes to spending and taxation level
What is a structural budget position?
Long term fiscal stance during a part of the economic cycle
What is a cyclical budget position?
Shorts term fiscal stance effected by the economic cycle
What is current expenditure?
Repeated spending on things that are used quickly (wages)
What is capital expenditure?
Spending on long term assets
What is progressive taxation?
Individual’s taxes raise as income rises
What is regressive taxation?
Individuals taxes fall as income rises
What is proportional taxation?
Everyone pays the same % of tax of their income
What tax system is used in the UK?
Progressive taxation e.g VAT and Income tax
What affects government spending?
Population and its age
Government policies
Why are budget deficits bad?
Government in debt
Discouraged investment
This leads to increased taxation
Why are budget surpluses bad?
Suggests that taxes were too high
What is the golden rule?
The government can borrow for investment and infrastructure but not for current expenditure
What was it replaced by?
Office for budget responsibility, who help to manage government spending
Why does increasing interest rates reduce inflation?
Incentivises saving and reduces incentive to consume
