Demand side policies

Question 1

Monetary vs fiscal policy

Answer 1

Monetary:
-Use of interest rates, changes in the money supply, and exchange rates to affect AD and therefore economic growth and inflation
-Conducted by BoE - independent from gov

Fiscal:
-Changing government spending and taxation to influence AD - stimulate economic growth and stabilise the economy
-Conducted by gov

Question 2

How monetary policy uses interest rates

Answer 2

-Monetary Policy Committe (MPC) - 9 members meet every 6 weeks

-Bank alters base rate

Reduction in base rate causes (transmission mechanisms)
-Consumption and investment to increase due to lower costs of borrowing
-Higher consumption leads to increase in asset prices - positive wealth effect
-Saving becomes less attractive - lower return
-Mortgage interest rates are lower - more disposable income
-Reduced incentives for investors to hold money in British banks - demand for the pound will fall - exports cheaper - imports more expensive - depreciation in currency - net trade increases

Question 3

Asset purchases to influence money supply - QE

Answer 3

-Stimulate economy when standard monetary policy is no longer effective - inflationary effects/ depreciation of currency - been used by European central bank

-Used when inflation is low and it is not possible to lower interest rates further

-CB creates money and buys assets in form of gov bonds from financial institutions
-Price of bonds increase, yield decreases
-Increases cash flowing in financial system
-Encourages more lending to firms and individuals - cost of borrowing lower
-Encourages spending, investment, thus growth
-Causes inflation - BoE can sell assets to reduce spending

Question 4

Limitations of monetary policy

Answer 4

-Banks might not pass base rate onto consumers
-Banks may be more risk averse - unwilling to lend - e.g. after 2008 financial crisis
-Consumer and firm confidence needs to be high

Question 5

Fiscal policy - gov spending and taxation

Answer 5

-Gov can influence size of circular flow by changing the budget
-Gov mostly spends on welfare benefits, pensions, health, education
-Income tax is the biggest source of revenue

Expansionary:
-Increase spending/reduce taxes
-increase in disposable income
-Increased consumer spending providing confidence is high
-AD shifts right
-AS expands
-High GDP can close negative output gap
-Can focus on specific sectors

Question 6

Limitations of fiscal policy

Answer 6

-Time lag, months to years
-If gov borrows from private sector, fewer funds available for private sector- leads to crowding out
-If interest rates are high fiscal policy might not be effective
-Debt needs to be paid off- difficult to borrow in future

Question 7

Gov budget deficit vs surplus

Answer 7

Budget: expenditure> tax receipts

Surplus: tax receipts> expenditure

Question 8

Direct vs indirect taxes + examples

Answer 8

Direct:
-Imposed on income
-Paid directly to gov from taxpayer
-e.g. income, corporation, NICs, inheritance

Indirect:
-Imposed on expenditure of goods and services
-Increase COP for producer
-Increase market price, demand contracts
-e.g. VAT

Question 9

MPC

Answer 9

-Target 2% inflation rate
-Maintain price stability
-9 members meet 8/year
-Determine monetary policy

Question 10

The Great Depression

Answer 10

-1929
-By 1933 RGDP fell by 30%
-Unemployment increased to 25%
-Lasted over a decade - economic declines hadn’t lasted more than 2 years atp

-Caused by wallstreet crash
-Loss in consumer and business confidence decreased consumption and investment
-Period of unstable boom
-banking system unstable

RESPONSES
UK:
-cut public sector wages/ benefits, and raised income tax to balance budget
-High interest rates to maintain the pound
-Eventually left the gold standard and cut interest rates

USA:
-Used public sector investment, work schemes for the unemployed, fiscal stimulus, to increase AD for recovery
-Some argue there was not enough spending for it to be effective - the war ended the depression
-Tried to increase money supply - unclear the effectiveness

Question 11

Global Financial Crisis of 2008

Answer 11

-Decline in world GDP

-Asset prices were high and rising
-Boom in economic demand
-Subprime mortgages issued
-House prices crashed in US in 2006
-Several homeowners defaulted on their mortgages
-Banks lost huge funds
-Required assistance from gov in form of bailouts

RESPONSES
UK:
-Nationalised banks
-Expanisonary monetary policy - record low interest rates - QE
-Cut VAT from 17.5% to 15%
-Huge increase in gov borrowing - FP

USA:
-Nationalised banks
-Expanisonary monetary policy - record low interest rates - QE
-More expansionary fiscal policy - recovered faster