Economic Policy

Question 1

What is Economic Policy?

Answer 1

Any govt intervention in the economy.

e.g. monetary, fiscal, agriculture, etc.

Question 2

What are external variables?

Answer 2

• outside the influence of policymakers e.g wars, import prices

Question 3

What are instruments?

Answer 3

• adjust by policymakers to obtain the target e.g. interest rates, fiscal expenditure.

Question 4

What are Endogenous Variables?

Answer 4

• are affected by the exogenous variables

- whether a variable is exogenous or endogenous often depends on the model.

Question 5

fixed and flexible policies?

Answer 5

• govts can pursue fixed or flexible policies regarding the use of instruments.
  fixed policy rule:
  the use of the instrument is predetermined irrespective of whether the target is achieved.

Question 6

Flexible Policy Rule?

Answer 6

• the use of the instrument is contingent upon the outcome of the target variable.

Question 7

Discretionary policy?

Answer 7

• discretionary policy occurs when the use of and extent of use of instruments is determined on a case by case basis.

Question 8

Inflation?

Answer 8

• inflation is the rate of change of the average level of prices, almost always expressed as a %. usually on an annual basis.
  usually CPI consumer price index.

Question 9

The fisher equation and the cambridge equation

Answer 9

M: stock of money 
V: velocity of money
P: price level
Y: real output of goods and services
MV = PY

Question 10

Velocity of money?

Answer 10

• is the average number of times a unit of money is exchanged in a given period usually a year.

Question 11

causes of inflation/deflation?

Answer 11

inflation/deflation is determined by the money supply and the growth of real output in the long run.

• changes in the money supply will also influence inflation/defltion in the short term
• shofts in aggregate demand and short run agg. supply wil also affect inflation/deflation in the short term.

Question 12

Disadvantages to inflation?

Answer 12

• disincentivises lending (inc to the govt)
• one solution is inflation index bonds, adjustable rate mortgages, etc
• price adjustment costs known as menu costs.
• high inflation is associated with high volatility and muffled price signals
• misallocation of economic resources.

Question 13

Disadvantages of deflation?

Answer 13

• disincentivises borrowing for investment
• injurious to producers as lag between purchase of factor inputs and revenue
• potential effect on employment (and real output)

Question 14

What is hyperinflation?

Answer 14

• when monthly inflation exceeds 50%

Question 15

monetary policy: What is nominal income targeting?

Answer 15

• rather than target an inflation rate.

- central banks can target a nominal income growth rate

Question 16

disadvantages of nominal income targeting?

Answer 16

• inflation

- lower real output

Question 17

What are positive shocks?

Answer 17

• positive supply shocks
• e.g break up of cartels
• equates to inc. in supply
• technological innovation equates to incremental (more likely) of supply
• mineral discovery

Question 18

What are demand shocks?

Answer 18

• tax reductions
• large scale govt expenditure
• growth in export demand (decline in transport costs
• wars inc demand in arms
• uk growth inc. by 15% 39-45

Question 19

what are negative supply shocks?

Answer 19

• lower output and employment
• legislation
• natural disasters
• material input prices
  could be:
  tax inc.
  decrease in consumer spending

Question 20

what is definition of recession?

Answer 20

-2 consecutive quarters on negative negative output

Question 21

Effects of recession?

Answer 21

• reduce in demand for firms
• incomes decrease
• decline in firm sales
• workers get laid off
• rise in unemployment
• rise in crime
• rise in alcoholism