Demand Side Policy

Question 1

3 Broad Categories of Macroeconomic Policy

Answer 1

Fiscal Policy - Government Spending, Taxation and/or borrowing to affect AD

Monetary Policy - Interest Rates, Money Supply and/or exchange rate

Supply Side Policy - Increase productive potential, relation to increases in the quantity and/or quality of an economy’s factor of production

Question 2

What is Fiscal Policy

Answer 2

The use of government spending, direct and indirect taxation and government borrowing to affect the level and growth of aggregate demand, output and jobs

Question 3

Why is fiscal policy used

Answer 3

Change the pattern of spending on goods and services

Question 4

What is fiscal policy a means of

Answer 4

Redistribution of income and wealth

Question 5

What does fiscal policy affect

Answer 5

AD and AS

Question 6

What is it used to correct

Answer 6

Market failures - used in microeconomic government intervention

Question 7

Situations where Fiscal Policy is used

Answer 7

Finance of government spending

Changing the distribution of final income and wealth

Provide a safety net of welfare

Help manage the economic cycle

Improve long run competitiveness

Tackle market failures

Question 8

What tax rates and allowances have an effect on AD and how

Answer 8

Income tax and national insurance - direct effect on peoples disposable incomes

Corporation Tax - Post tax profit available for business to invest

National Insurance for Employers - Cost of employing extra workers

VAT - Affects real income of consumers

Question 9

Justifications for Government Spending

Answer 9

Provide a socially efficient level of public goods and overcome one or more market failures

Provide welfare benefits

Provide necessary infrastructure through capital spending

Manage the level and growth of AD

Promoting equity in the allocation of scarce resources

Catalyst for improving economic efficiency

Question 10

Describe Direct Taxes

Answer 10

Levied on income, wealth and profits

Burden of a direct tax cannot be passed on

Question 11

Example of direct tax

Answer 11

Income tax, inheritance tax, national insurance, capital gains, corporation tax

Question 12

Describe Indirect Tax

Answer 12

Taxes on spending

Burden can be passed on by producers - depends on elasticity of demand and supply

Question 13

Examples of indirect tax

Answer 13

Excise duties on fuel, cigarettes and alcohol

VAT

Question 14

How can changes in tax rates and allowances have an effect on SRAS and LRAS

Answer 14

Changes in VAT affects business costs

Changes in Direct tax can influence work incentives

Changes in business taxes might affect the level of foreign direct investment

Can affect the incentive to start a business or to spend money on R+D

Question 15

When is there a budget surplus / fiscal surplus

Answer 15

Government spending is less than tax revenues

Question 16

When is there a budget deficit / fiscal deficit

Answer 16

Government revenues are less than government spending

Question 17

Causes of a budget / fiscal deficit

Answer 17

A recession leads to rising unemployment- less taxes paid

Decrease in consumer spending and profits

Increase in economic activity

Use of fiscal stimulus by a government to lift AD and stabilise the economy

Increase in interest rates on debt

Question 18

What do Keynesian economists believe about fiscal policy

Answer 18

Most effect form of managing demand, output and confidence at times of economic instant

Question 19

What is fiscal policy

Answer 19

Policies that manage the level of and rate of growth of AD

Question 20

What is fiscal austerity

Answer 20

When government uses contradictory fiscal policy to decrease their budget deficit

Aim to not decrease AD but to slow the rate of growth of the national debt

Question 21

Policies used to reduce the size of a budget deficit

Answer 21

Cuts in government spending

Higher taxes

Supply side policies to encourage growth

Question 22

What is Monetary Policy

Answer 22

Changes in interest rates, supply of money and credit, and exchange rates by the central bank to influence AD

Question 23

How is the exchange rate of the £ determined

Answer 23

Demand and Supply in international foreign exchange markets

Not directly influenced by the Bank of England

Question 24

What is Monetary Stability

Answer 24

Stable prices and confidence in the currency

Question 25

Expansionary monetary policy mechanisms

Answer 25

Fall in nominal and real level of interest rates Expand the supply of credit - fall in credit interest Depreciation of the external value of the exchange rate

Question 26

Deflationary monetary policy mechanisms

Answer 26

Higher interest rates Tightening of credit supply (loans become harder to get) Appreciation of the exchange rate

Question 27

To who is the real rate of interest important and why

Answer 27

To businesses and consumers when making decisions

Question 28

What is the real rate of return on savings

Answer 28

Money rate of interest - Rate of inflation

Question 29

When can real interest rates be negative

Answer 29

Nominal rate of interest is less than inflation

Question 30

What can price deflation lead to

Answer 30

Increase in real interest rates

Question 31

What is the aim of fiscal austerity

Answer 31

To reduce the rate of growth of national debt

Question 32

Aims of Expansionary Fiscal Policy

Answer 32

``` Boost Growth Reduce Unemployment Increase Inflation Redistribution of Income Increase in AD ```

Question 33

Aims of Contractionary Fiscal Policy

Answer 33

Reduction in AD Reduce Budget Deficit and National Debt Redistribution of Income Reduce Current Account Deficit

Question 34

How does Expansionary Fiscal Policy affect the Keynesian curve

Answer 34

AD shifts to the right Price increases and output increases Not in the intention of EFP - just a side effect

Question 35

How does Expansionary Fiscal Policy affect the Classical curve

Answer 35

LRAS shifts to the right Decreases in price and increase in real output

Question 36

What does Expansionary Fiscal Policy help with

Answer 36

The multiplier effect - reduction in income tax increases MPC

Question 37

Cons of Expansionary Fiscal Policy

Answer 37

``` Demand Pull Inflation and Current Account Deficit - trade off Worsening of Gov Finances Crowding Out Effect X Inefficiency Time Lags ```

Question 38

What is the crowding out effect

Answer 38

When debt fuelled public spending reduces private sector investment due to an increase in interest rates

Question 39

What is X inefficiency

Answer 39

When government spending has excess costs

Question 40

Expansionary Fiscal Policy evaluation

Answer 40

Size of output gap - effectiveness of EFP depends on this Size of multiplier - increases of AD depends on this Animal spirits - tax cuts won’t increase spending to a noticeable effect Gov finances - bad state of finances means EFP can’t be afforded LR returns to the government - greater tax revenue down the line from increased economic activity Role of Automatic Stabilisers - strong stabilisers reduces the need for them and vice versa

Question 41

Expansionary Monetary Policy Goals

Answer 41

Increase inflation Increase growth Reduce unemployment

Question 42

Reasons why Contractionary Monetary Policy may be used

Answer 42

Hit Inflation target

Question 43

Contradictory Monetary Policies Goals

Answer 43

Reduce inflation Present asset ad credit bubbles Reduce excess debt and promote saving Reduce current account deficit

Question 44

Expansionary Monetary Policy effect on LRAS curve

Answer 44

AD shifts to the right Y increases and price increases Increase investment

Question 45

Expansionary Monetary Policy effect on classical curve

Answer 45

LRAS shifts to the right Price decreases and real gdp increases

Question 46

Cons of Expansionary Monetary Policy

Answer 46

Demand Pull Inflation and Current Account Deficit - trade off Liquidity Trap Negative Impact on Savers Time Lags

Question 47

Evaluation of Expansionary Monetary Policy

Answer 47

Size of output gap Animal spirits Size of rate cut Banks willingness to lend/pass on the full cut

Question 48

What are Automatic Stabilisers

Answer 48

Changes in tax revenues and government spending that come about automatically as an economy moves through the business cycle

Question 49

Pros of Budget Surplus

Answer 49

Confidence in Gov Finances Flexibility with Fiscal Policy Less Crowding Out Less X-Inefficiency Lower Inflation and Current Account Deficit

Question 50

Cons of Budget Surplus

Answer 50

Demand Side Shocks Risk of income inequality LR Returns of rising government spending and fall in taxation Incentives Distortion of an increase in taxation Micro and Macro impacts of a fall in govern,ent spending and increase in taxation

Question 51

Eval of Budget Surplus

Answer 51

Need for it Debt/GDP could rise Policies used Stage of economic cycle

Question 52

What is QE

Answer 52

Introduction of new money into the money supply by a central bank through government bonds

Question 53

What is QE an alternative to

Answer 53

Cutting interest rates

Question 54

How does QE work

Answer 54

Lowers interest rates and borrowing costs Increases the amount banks can lend and weakens exchange rates

Question 55

Steps to QE

Answer 55

Creation of Money by BoE Buy bonds Price of bonds rise, yields fall LR interest rates in the economy fall Cost reduces and ease of raising finance for banks increase Cheaper loans for firms & individuals More C & I thus more AD

Question 56

What is the Ricardian Equivalent

Answer 56

Government cuts income tax rates hoping households will spend extra disposable income RE is when households know a tax cut can't be afforded by the government So the government would have to raise other tax rates in order to fund tax cut Households save disposable income for future tax raises Todays tax cut = tomorrows tax raise

Question 57

Expansionary Fiscal Policy Eval

Answer 57

Crowding Out vs Crowding In (Promotes Economic Activity can be an incentive) Multiplier (Greater the multiplier, greater the effect) (Greater multiplier, reduces the need for heavy policies) Automatic Stabilisers (Stronger automatic stabilisers reduces need for discretionary fiscal policy, reduce fluctuations in business cycle) Tax Cuts (Laffer Curve and LR Returns, Ricardian Equivalent)