Demand side policies

Question 1

How many targets does the MPC have and what are they?

Answer 1

NOTE- MPC has single target of low inflation- BUT if under control- might allow other areas to benefit from ⬇️ interest rates

Question 2

What is unique about interests rates and exchange rates?

Answer 2

NOTE- interest rates & exchange rates change in same direction

Question 3

What are the 2 types of demand side polcies?

Answer 3

1) Monetary policy

2) Fiscal policy

Question 4

What is monetary policy?

Answer 4

Monetary policy- decision making using monetary instruments e.g. interest rate to influence AD

Question 5

What is the CPI inflation target and who is it set by?

Answer 5

CPI inflation target set by Chancellor of the Exchequer (now 2%)

Question 6

What happens if inflation changes from its target?

Answer 6

If falls outside 1-3% range then open letter sent by Governor of 🏦 of 🏴󠁧󠁢󠁥󠁮󠁧󠁿 to Chancellor to explain why

Question 7

What demand side tools are used by MPC?

Answer 7

2 main tools used by MPC- Bank/base 🏦 rate of interest & Quantitative easing (since 2009)

Question 8

Why was QE introduced?

Answer 8

interest rates alone ✖️ enough to take economy out of recession so QE needed (limit to how interest rates can go- negative interest rates ✖️ viable)

Question 9

How does an increase in interest rates introduced by the MPC affect consumers?

Answer 9

⬆️ interest rates-> ⬆️ cost of borrowing-> ⬇️ borrowing to finance consumer spending & ⬆️ saving (savers ✖️ spend due to ⬆️ interest rate gained on savings)-> ⬇️ AD-> ⬇️ in 🏠 prices as mortgages ⬇️ affordable-> ➖ 👎 wealth effects (ppl ⬇️ likely to spend BUT if 🏘 ⬆️ in value- owner could request mortgage equity release based on ⬆️ wealth) as 🏠 prices fallen ⬇️
- Mortgage payments ⬆️, hire purchases (loans on consumer durables e.g. 🚙 etc-> ⬆️ in repayments)- consumers delay major expenditures etc

Question 10

How does an increase in interest rates introduced by the MPC affect firms/producers?

Answer 10

⬆️ interest rates-> ⬇️ investment from firms due to ⬆️ cost of borrowing-> ⬇️ in current AD & ⬇️ long term output prospects (investment in capital e.g. could-> ⬆️ output in future)

⬆️ production costs due to ⬆️ interest rates-> ⬇️ exports & ⬆️ imports

Question 11

What is hot money and how does it work?

Answer 11

‘hot 🔥 money 💵’ attracted to ⬆️ interest rate- ppl rather put 💵 in a country’s 🏦 with ⬆️ interest rates as ⬆️ return on money than keeping in own country- NOTE exchange rate relatively ⬇️ at this point … reasonable amount of foreign currency exchanges to place in foreign 🏦- eventually after earning ⬆️ interest on money- take money back after exchange ⬆️- get more of own 💴 back as foreign currency has ⬆️ in value)

NOTE- ‘🔥💵’ ✖️-> ⬆️ in inflows & … ✖️ improve balance of payments as 💵 taken back soon after (✖️ spent in same country)

Question 12

What do demand side policies effect?

Answer 12

REMEMBER- DEMAND SIDE POLICIES SO EFFECT DEMAND ONLY BUT may-> change in price/or output depending on shape of AS curve

Question 13

How are interest rates set and how often?

Answer 13

🏦 rate set each month by MPC (aim to meet 2% inflation target)

Question 14

What are monetary ‘transmissions mechanisms’?

Answer 14

Monetary ‘transmissions mechanisms’- chain of reactions set off in economy causing AD to shift

Question 15

What is QE?

Answer 15

Quantitative easing- purchase of gilts (bonds) & other illiquid assets to make credit easier to access (increase liquidity/money supply)

Question 16

How does QE lead to increased demand and spending in the economy?

Answer 16

1) Financial assets purchased (funded by central 🏦 reserves which are paid for by selling treasury bills (90 day loans- very liquid- effectively cash)- … buying assets (bonds, gilts etc) injects money into economy & increases 💵 supply-> ⬆️ asset prices (in the short term- more money chasing same amount of goods/assets … value of these assets rise- in the long term-> inflation as value increase eventually eroded due to inflation)-> ⬆️ spending in short term as ➕ wealth effects experienced … ⬆️ consumption and … ⬆️ AD

2) Spending ⬆️ because asset holders have portfolios (assets) higher ⬆️ in value due to eventual ⬆️ in demand for those assets (note interest rate ⬇️ at the same time to ⬆️ demand- cheaper loans & mortgages makes assets ⬆️ attractive hence ⬆️ in their value) & 💵 easily & immediately available-> holders feeling ⬆️ wealthy as assets now ⬆️ liquid (easily transferable into 💵)-> ⬆️ spending/consumption (AD) in short term as ➕ wealth effects experienced
ALSO ⬆️ likely that consumers request mortgage equity release based on ⬆️ value of their property … can use 💵 to finance spending

3) Consumers & businesses take on ⬆️ debt (loans) due to lower yields (interest rates) on financial assets

Question 17

What are problems with QE?

Answer 17

1. Nature of banking 🏦 sector:
   - 🏦 still may be ⬇️ willing to lend despite ⬆️ 🏦 asset holdings & liquid assets due to QE- 🏦 concerned about their financial heath & … ⬇️ willing to lend
2. Inflation:
   - ⬆️ money supply-> long term inflation (‘too much 💵 chasing too few 🚘’) … 🚘/🧹 ⬆️ in price & 💴 value ⬇️

Question 18

What is the process of exiting QE?

Answer 18

• MPC tightens monetary policy (slows down growth) & QE assets resold in money markets (✖️ new assets bought)- bonds being resold has same affect as ⬆️ interest rates
• Credit ⬇️ easily available (lending made ⬆️ difficult)
• 💵✖️ longer pumped into economy as sharp growth taken economy out of recession- monetary policy now eased to maintain steady inflation at target 🎯

Question 19

What is fiscal policy?

Answer 19

Fiscal policy- government’s management of its spending & taxation to influence AD

Question 20

What is another way of saying expansionary fiscal policy?

Answer 20

Budget/Fiscal Deficit OR Loose Fiscal policy

Question 21

What is another way of saying contractionary fiscal policy?

Answer 21

Budget/Fiscal Surplus OR Tight Fiscal policy

Question 22

What is expansionary fiscal policy?

Answer 22

Budget/Fiscal Deficit (Expansionary (loose) Fiscal policy)- ⬇️ tax & ⬆️ government spending-> ⬆️ AD

Question 23

What is contractionary fiscal policy?

Answer 23

Budget/Fiscal Surplus (Contractionary (tight) Fiscal policy)- ⬆️ tax & ⬇️ government spending-> ⬇️ AD

Question 24

How does expansionary fiscal policy work and give an example of it

Answer 24

Aims to pump spending power into economy- multiplier magnifies effect
- Example- investment in 🏥-> ⬆️ jobs (doctors, nurses etc)-> their incomes spent in economy-> new incomes also spent

Question 25

How does contractionary fiscal policy work and give an example of it

Answer 25

Takes spending power out of economy- negative 👎 multiplier effects
- Examples- during boom 💥/fast growth- government ⬇️ growth- avoid inflation

Question 26

What is direct taxation and what are examples of it?

Answer 26

Direct taxation- tax levied directly on individual (personal income tax) or organisation (corporation tax- on company profits)- impacts AD- affects income e.g. income tax, corporation tax etc- spending plans based on disposable income (income after tax)

Question 27

What is indirect taxation and what are examples of it?

Answer 27

Indirect taxation- tax levied on 🚘 or 🧹- impacts AS- firms have to absorb some effects of ⬆️ VAT (if all affects absorbed by consumers in prices-> sharp ⬇️ in demand) … ⬇️ willing to sell

Question 28

What demand side policies were used in the Great Depression (1929 Wall Street Crash)?

Answer 28

Expansionary fiscal policy- used to bring back some consumer confidence & prevent ⬇️wards spiral of demand & output- by 🇺🇸 ( adopted earlier) & 🇬🇧 (acted later)

Question 29

What happened to expansionary fiscal after 1929?

Answer 29

1968- Keynesian policies discredited- expansion-> inflation

• After expansionary policies used & economy faced inflation- 🇬🇧 put on brakes & demand crushed-> ‘stop-go’ policy- experiencing inflation & unemployment same time (stagflation- ✖️ growing economy (unemployment) suffering from inflation)
• Friedman- expansionary fiscal policy only causes inflation & ✖️ be used- popular 🌎wide until 2008

Question 30

What fiscal policies were used in the Global Financial Crisis (2008)?

Answer 30

• 🇺🇸- Obama used fiscal policy to expand economy- involved in major construction 🏗 projects across 🇺🇸
• 🇬🇧- ⬆️ spending under Brown’s Labour Party BUT change in 2010 when new coalition government made fiscal made balance 1 of main short term objectives-> austerity in recession- BUT ✖️ experience double dip recession & although slow at first, growth ⬆️ to 🇺🇸 levels by 2014

Question 31

What are the evaluation points of demand side monetary policy?

Answer 31

👎- inflation- QE-> long term inflation as 💵 pumped into economy to ⬆️ 💵 supply … too much 💵 chasing too few 🚘
👍- shorter time ⏰ lag than fiscal
👎- BUT takes 18 months-2 years for full effect of interest rates & further delays due to fixed rate mortgages (✖️ effected by interest rate change)-> delayed spending
👎- ⬆️ interest rates-> ⬆️ production costs (firms loan payments ⬆️ expensive- e.g. if loan taken out to invest in capital- output of capital is same BUT cost per unit produced ⬆️)- FIRMS
Poor suffer as loan/debt (return payments ⬆️ expensive)- CONSUMERS
👎- worsen income distribution- e.g. ⬆️ interest rates means rich benefit as have savings and poorer ✖️ as likely to have ⬆️ loans

Question 32

What are the evaluation points of demand side fiscal policy?

Answer 32

👎- inflation- debt created to finance expansion funded by treasury bills which are very liquid … has same effect as printing 💵
👎- ⬆️ time ⏰ lag- fiscal policy mainly implemented in annual budget-> ⏰ lag in decision making ALSO implementation lag- tax changes ✖️ begin until new fiscal/tax year (April)
👎- crowding-out effects- EXAMPLE- newly built government hospital 🏥 means ⬇️ scope for private 🏥 providing same service