Demand-Side Policies Flashcards
who creates demand side policies in the UK
Bank of England
what is monetary policy
the use of interest rates and the money supply to manipulate the level of aggregate demand in the economy
what are the key functions of the central banks (e.g Bank of England) (5 roles)
- Implement monetary policy
- manage national debt
- regulate the banking industry
- issue currency
- provide funds to banks suffering from short term liquidity problems (bail the banks out)
list some things that must be taken into account when setting interest rates
- unemployment
- uk exports
- gov spending plans
- wage rate rises
- consumer and business confidence
- cost of raw materials
- house prices
what is tightening the monetary policy
increasing in interest rates
=borrowing more expensive = less consumption, investment and exports = AD shifts left = lower price level
what is loosening the monetary policy
reducing interest rates
=easier borrowing = more consumption, investment and net exports = AD shifts to right = higher price level
what would the MPC consider doing if forecasted inflation is above the 2% target
tightening the monetary policy
what would the MPC consider doing if forecasted inflation is below the 2% target
loosening the monetary policy
what is the impact of increased interest rates on borrowers
- Mortgage interest rates rise
- households with mortgages have less money to spend
- consumption decreases
- aggregate demand decreases
- price level falls and inflation falls
- demand for housing falls
- house prices fall - homeowners feel less wealthy
- consumption decreases
- aggregate demand decreases
- price level falls and inflation falls
what is the impact of decreased interest rates on borrowers
- Mortgage interest rates fall
- households with mortgages have more money to spend
- consumption increases
- aggregate demand increases
- price level rises and inflation rises
- demand for housing rises
- house prices rise - homeowners feel more wealthy
- consumption increases
- aggregate demand increases
- price level rises and inflation rises
what is the impact of increased interest rates on savers
- saving becomes more attractive
- more income is saved and less spent
- consumption decreases
- aggregate demand decreases
- price level falls and inflation falls
what is the impact of decreased interest rates on savers
- saving becomes less attractive
- more income is spent and less saved
- consumption increases
- aggregate demand increases
- price level rises and inflation rises
what is the impact of increased interest rates on firms
- borrowing costs for investment increases
- firms cut back on plans for expansion
- investment decreases
- aggregate demand decreases
- price level falls and inflation falls
what is the impact of decreased interest rates on firms
- borrowing costs for investment decreases
- firms increase plans for expansion
- investment increases
- aggregate demand increases
- price level rises and inflation rises
what is the impact of increased interest rates on the exchange rate
- uk becomes a more attractive place to save
- hot money flows into the uk
- demand for the £ increases
- value of the £ increases and uk exports become more expensive
- net exports falls
- aggregate demand decreases
- price level falls and inflation falls
what is the impact of decreased interest rates on the exchange rate
- uk becomes a less attractive place to save
- hot money flows out of the uk
- demand for the £ falls
- value of the £ decreases and uk exports become less expensive
- net exports increases
- aggregate demand increases
- price level rises and inflation rises
what is quantitative easing
a form of expansionary monetary policy.
the central bank purchases assets like government bonds from the market to increase the money supply and encourage lending and investment, which should boost economic activity
how does quantitative easing work with relation to money supply
- the central bank electronically creates new money
- this money is used to buy government bonds
- the money supply increases
- as a result there is a decrease in the cost of borrowing for banks and government
- the government increases spending in the economy
- the banks use the created money to lend to businesses and consumers
- this leads to higher investment and consumption = a boost in AD
what are some positive effects of quantitative easing
- it depreciates a countries exchange rate making exports more competitive helping to increase AD
- in 2009 it helped increase economic output by around 1.5%/2%
what are some negative effects of quantitative easing
- can cause higher inflation if the amount needed is overestimated
- imports become more expensive leading to cost push inflation
- can lead to currency wars
- dependent on whether the banks will lend the funds
what is FISCAL policy
the use of taxes and government spending to manipulate the level of aggregate demand in the economy and is controlled by the government
what is the Chancellor of the Exchequer
the person in charge of the government’s FISCAL policy.
key roles for FISCAL policy
correcting market failures
- carbon taxes per tonne of CO2
- sugar drinks levy (2018)
- subsidies to help people afford social housing
changing the final distribution of wealth and incomes
- progressive direct taxes
stabilising and stimulating aggregate demand
- changes in income tax, NIC’s and VAT
- changes in state welfare / public sector pay policies
improving the economy’s supply-side potential (LRAS)
- increased state spending in education and public health
- funding for infrastructure spending inc energy and infrastructure
responding to external shocks
- like the Furlough Scheme and Job retention scheme during Covid
Direct taxes
levied on income, wealth and profit
the burden cannot be passed on
e.g income tax, national insurance, capital gains
Indirect taxes
levied on expenditure
the burden can be passed on
e.g VAT, excise duties on fuel, cigarettes
progressive taxes
the proportion of income paid in tax increases as income rises
regressive taxes
the proportion of income paid in tax decreases as income rises
e.g flat rate taxes on cigarettes take a greater share of a poorer person’s income than a richer person’s
proportional taxes
the proportion of income paid in tax remains constant as income changes
what are the reasons for tax
- revenue generation: to fund gov programmes like education
- redistribution of income and wealth
- economic stabilisation: stimulate spending and control inflation
- regulation and incentives: encourage innovation
- public goods: to supply goods that otherwise would be underproduced
What does the ‘Wealth of the Nations’ state about taxation and who wrote it (FCCE)
Adam Smith
Fairness - benefit pay principle, based on ability to play
Certainty and Convenience - know what your tax burden is, its easy to pay
Efficiency - hard to avoid and with limited unintended effects
what is the uk’s tax burden
(tax as a percentage of GDP)
38%
what are the uk’s income tax brackets
£12570 free
£12571-£50270 20%
£50271-£125140 40%
over £125140 45%
what are the uk’s corporate tax bracket
small profit rates 19%
main rate 25%
what is interest
the reward for saving and the cost of borrowing
what are index numbers
they show the percentage change in price/quantity from the base year
what is crowding out
when the government borrows there is a limited amount of loanable funds
this means that any funds invested in government bonds leaves less available for investment in the uk private sector
evaluation of crowding out
-government could borrow from abroad or sell shares to overseas governments leaving more money for uk investment in the private sector
-private sector could attract FDI
what is discretionary fiscal policy
when a government chooses to increase or decrease taxes and government spending
what is it called when governments choose to increase or decrease taxes and government spending
discretionary fiscal policy
what are automatic stabilisers
when taxes and government spending automatically increase or decrease
what is it called when taxes and government spending automatically increase or decrease
automatic stabilisers
what do deflationary and contractions policies aim to do and what are the different policies
decrease AD
monetary and fiscal policy
what is expansionary policy and what are the policies
aimed to increase AD
monetary and fiscal policy
How does quantitative easing work in relation to government bonds
- BofE electronically creates more money
- This money is used to buy government and corporate bonds
- Demand for government bonds increases so the marker value rises
- This creates a positive wealth effect and can increase consumption
- The yield will fall making it cheaper for the government to borrow so government spending may rise
- Because yield is effectively the long term interest rate, interest rates may fall
- Hot money flows out of the UK
- The £ depreciates and net exports will improve
What are the different ways Quantitative easing can effect the components of AD
Consumption rises - increased liquidity and lower interest rates
- positive wealth effect from higher market value on bonds
Investment rises - increased liquidity and lower interest rates
- financial institutions may invest their money from selling the bonds into UK firms
Government Spending rises - higher demand for gov bonds lowers the yield so they can borrow more cheaply
Net Exports rises - because yield is effectively long term rate of interest, interest rates may fall so hot money flows out of the UK so the £ depreciates.
