Chapter 31/32 Flashcards
Fiscal policy/monetary policy
What are policy instruments and give 3 examples?
Tools gov implement their policies, e.g. interest rate, taxes, levels gov spending
Define fiscal policy.
Decisions about gov spending, taxes, and levels of borrowing that affect aggregate demand.
What are the main sources of gov revenue?
Direct taxes: Imposed on firms+ individuals, such as income tax, social insurance tax, capital gains tax (selling assets)
Indirect taxes: VAT, business rates
Environmental taxes: taxes designed to protect the environment.
What is a fiscal deficit?
Amount by which gov spending exceeds gov revenue
Do govs want to be in fiscal deficit or surplus?
Surplus because otherwise national debt builds up and money has to be borrowed. This may mean taxes will rise.
Define fiscal surplus.
Amount by which gov revenue exceeds gov spending.
Why do govs want fiscal surplus?
It means there is excess money which can be used to repay debts, reduce taxes, or improve public services.
What is the main reason fiscal policies are used?
To control aggregate demand in an economy.
What’s the difference between expansionary and contractionary fiscal policies?
Exp- fiscal measures used to increase agg demand
Cont- fiscal measures used to decrease agg demand
What can fiscal policies affect?
Inflation. economic growth, unemployment, current account deficit, environment.
How do fiscal policies affect inflation?
If inflation is too high because of rapidly increasing agg demand, it may be decreased by raising taxes/borrowing interest rates. (contractionary)
How do fiscal policies affect economic growth?
If govs want to increase economic growth, they will try to increase agg demand by using expansionary fiscal policies.
How do fiscal policies affect unemployment?
To reduce unemployment, govs want to grow the economy so there are more job opportunities. Firms need to produce more, so the gov may spend more on construction etc.
How do fiscal policies affect current account deficit?
If the deficit is too high because imports exceeds exports, the gov may try to decrease demand for imports by using contractionary policies.
How do fiscal policies affect the environment?
If economic growth is too fast, it may damage the environment, so contractionary fiscal policies like landfill tax and climate change levies may be used.
Define monetary policy.
Central banks using money supply and interest rates to control aggregate demand in the economy.
What are interest rates?
The money paid to lenders for borrowing money, as a percentage of money borrowed.
What is a base rate?
Rate of interest set by central banks for lending to other banks, which affects all other rates in the economy.
What is the role of central banks?
- implement the gov’s monetary policy and regulate the banking system.
- Act as a lender to other banks
- Control inflation + stabilize the currency
- Set interest rates
What impact do interest rates changes have on macroeconomic objectives?
Inflation, unemployment, economic growth and the current balance.
How do interest rates affect inflation?
If inflation is too high, interest rates are raised, so money supply in the economy falls. People will be reluctant to borrow and will have less disposable income to spend. This means aggregate demand is lower and so prices will fall.
How do interest rates affect unemployment?
If interest rates are high, businesses will not be able to afford to borrow and their growth is prevented. Also, consumer will have less money to spend so profits fall and firms can’t afford to hire workers, unemployment rises.
How do interest rates affect economic growth?
If interest rates are high, businesses will not be able to afford higher output and consumers can’t afford to spend their disposable income, economic activity is inhibited.
How do interest rates affect the current balance?
A gov can decrease deficit by tightening monetary policy (inc IR%) this means agg demand in economy will fall and spending on imports falls as well, helping the deficit. However, this may inc price of exports and cheapen imports which is bad.
What 3 things are important when discussing the impact of interest rates?
-Income elasticity of imports.
-The strength of link between IR% and exchange rates.
-Price elasticity of demand for imports/exports.
How does the income elasticity of imports affect interest rate changes?
If demand for imports were income elastic, rising interest rates in foreign nations would reduce demand for them, improving the current balance.
How does the strength of the link between interest rates and exchange rates affect the impact changes of interest rates?
If the link is strong, high interest rates mean exchange rate is higher. Exports will become expensive and imports cheaper, this worsens the current balance.
How does the price elasticity of demand for imports/exports impact changes of interest rates?
If they’re both price elastic goods, interest rates rising will cause exchange rates to rise, meaning imports become cheaper and exports become expensive, worsening the current account.
How do interest rate changes impact consumers?
When IR% fall, payments on loans fall. People will borrow more because it cheaper, and so there will be more disposable income. This increases aggregate demand. Also, mortgage payments fall.
How do interest rate changes impact firms?
When IR% fall, payments on loans fall so profit margins rise. This increases business confidence and investments. When IR% fall, the exchange rate falls as well, making exports cheaper and imports expensive, helping the current balance.
Define quantitative easing.
Buying of financial assets such as gov bonds from commercial banks which means the flow of money from central to commercial banks to increase aggregate demand because then more loans are guaranteed.
What negative impacts can quantitative easing have?
It can be inflationary because money from the gov doesn’t exist and increases the cash balance of commercial banks without actually giving them cash.
