Chapter 31/32

Question 1

What are policy instruments and give 3 examples?

Answer 1

Tools gov implement their policies, e.g. interest rate, taxes, levels gov spending

Question 2

Define fiscal policy.

Answer 2

Decisions about gov spending, taxes, and levels of borrowing that affect aggregate demand.

Question 3

What are the main sources of gov revenue?

Answer 3

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.

Question 4

What is a fiscal deficit?

Answer 4

Amount by which gov spending exceeds gov revenue

Question 5

Do govs want to be in fiscal deficit or surplus?

Answer 5

Deficit because otherwise national debt builds up and money has to be borrowed. This may mean taxes will rise.

Question 6

Define fiscal surplus.

Answer 6

Amount by which gov revenue exceeds gov spending.

Question 7

Why do govs want fiscal surplus?

Answer 7

It means there is excess money which can be used to repay debts, reduce taxes, or improve public services.

Question 8

What is the main reason fiscal policies are used?

Answer 8

To control aggregate demand in an economy.

Question 9

What’s the difference between expansionary and contractionary fiscal policies?

Answer 9

Exp- fiscal measures used to increase agg demand
Cont- fiscal measures used to decrease agg demand

Question 10

What can fiscal policies affect?

Answer 10

Inflation. economic growth, unemployment, current account deficit, environment.

Question 11

How do fiscal policies affect inflation?

Answer 11

If inflation is too high because of rapidly increasing agg demand, it may be decreased by raising taxes/borrowing interest rates. (contractionary)

Question 12

How do fiscal policies affect economic growth?

Answer 12

If govs want to increase economic growth, they will try to increase agg demand by using expansionary fiscal policies.

Question 13

How do fiscal policies affect unemployment?

Answer 13

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.

Question 14

How do fiscal policies affect current account deficit?

Answer 14

If the deficit is too high because imports exceeds exports, the gov may try to decrease demand for imports by using contractionary policies.

Question 15

How do fiscal policies affect the environment?

Answer 15

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.

Question 16

Define monetary policy.

Answer 16

Central banks using money supply and interest rates to control aggregate demand in the economy.

Question 17

What are interest rates?

Answer 17

The money paid to lenders for borrowing money, as a percentage of money borrowed.

Question 18

What is a base rate?

Answer 18

Rate of interest set by central banks for ending to other banks, which affects all other rates in the economy.

Question 19

What is the role of central banks?

Answer 19

• implement the gov’s monetary policy and regulate the banking system.
• Act as a lender to central banks
• Control inflation + stabilize the currency
• Set interest rates

Question 20

What impact do interest rates changes have on macroeconomic objectives?

Answer 20

Inflation, unemployment, economic growth and the current balance.

Question 21

How do interest rates affect inflation?

Answer 21

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.

Question 22

How do interest rates affect unemployment?

Answer 22

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.

Question 23

How do interest rates affect economic growth?

Answer 23

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.

Question 24

How do interest rates affect the current balance?

Answer 24

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.

Question 25

What 3 things are important when discussing the impact of interest rates?

Answer 25

-Income elasticity of imports.
-The strength of link between IR% and exchange rates.
-Price elasticity of demand for imports/exports.

Question 26

How does the income elasticity of imports affect interest rate changes?

Answer 26

If demand for imports were income elastic, rising interest rates in foreign nations would reduce demand for them, improving the current balance.

Question 27

How does the strength of the link between interest rates and exchange rates affect the impact changes of interest rates?

Answer 27

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.

Question 28

How does the price elasticity of demand for imports/exports impact changes of interest rates?

Answer 28

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.

Question 29

How do interest rate changes impact consumers?

Answer 29

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.

Question 30

How do interest rate changes impact firms?

Answer 30

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.

Question 31

Define quantitative easing.

Answer 31

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.

Question 32

What negative impacts can quantitative easing have?

Answer 32

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.