Fiscal and Supply side policy Flashcards
3 effects of expansionary fiscal policy
- Boosts economic growth
- Reduces unemployment
- decreases income inequality
3 effects of contractionary fiscal policy
- Redistribute income
- Reduce current account deficit
- Reduce budget deficit
2 Positives of automatic stabilizers
- reduces large fluctuation from trend rate growth
- reduces need for discretionary fiscal policy
2 examples of automatic stabilizers
benefits
progressive tax system (fiscal drag)
5 possible tradeoffs that could occur from fiscal policy
- Inflation (increase CA deficit)
- National dept increases
- Crowding out private sector
- x inefficiency (governments lack profit motive)
- Time Lags
what is the pneumonic to remember evaluation of fiscal policy
clock glums
C- confidence
L- Laffer curve
O- output gap
C - crowding out vs crowding in
K
G - state of gov finances
L - LR returns
U
M - Multiplier
S - self correction
what is a structural budget deficit
- when an economy is running at full capacity however government still has budget deficit
2 pros of a government deficit
- Public service provision
- Economics growth
3 cons of a government deficit
- National dept rises (increases cost of borrowing as credit rating of government bonds fall therefore government has to offer higher coupon rate meaning it is harder to raise finance)
- Harming FDI
- Crowding out
what is a cyclical budget surpluss
- budget surpluss in a boom
what is a structural budget surplus
- budget surplus when economy is at full employment
2 pros of a budget surpluss
- greater flexibility of fiscal policy
- higher business confidence and FDI
2 Cons of a budget surplus
- Austerity (harms long run growth rates, international competitiveness)
- lack of public sector investment
how will austerity worsen a budget deficit
- if GDP falls faster than the rate of dept then relative dept as a percentage of GDP will fall
what is the crowding out effect
- Governments finance there borrowing through issuing bonds which increases demand for loanable funds therefore increasing interest rates as lenders funds are more sought after, this makes it harder for firms to raise finance
what is the crowding in effect
increased government expenditure boosts overall demand in the economy creating favorable conditions for business investment. Government spending on infrastructure improvements can create confidence causing private firms to commit to long term investments. Confidence in growth prospects caused by government investment and the multiplier effect will cause firms to invest in order to withstand increases in demand.
when does the crowding in effect occur
- when there is a negative output gap and interest rates are already low
- when there is a lack of supply side shocks
Why are supply side policy’s good
of successful they hit all four macro objectives
three examples of interventionist SSP
- spending on education and health
- spending on infrastructure
- subsidies to firms to promote investment
three examples of Market based SSP
- competition policy’s
- tax reform
- labour market reforms
what is monatory policy
changes to interest rates and exchange rates by the central bank in order to influence AD
3 Reasons to use monatory policy
- Reduce CA deficit
- Reduce unemployment
- Hit inflation targets
2 examples of expansionary monetary policy
- Decreasing interest rates (works through the monetary policy transmission mechanism to influence AD)
- Devaluating exchange rate
what is the monatary policy transmision mechanism
changes in interest rates affects:
- savings rates
- mortgage rates
- business confidence (AD increases)
- exchange rates
- hot money flows
- current account surplus (AD increase)
3 evaluation points for the effectiveness of expansionary monetary policy
- Size of output fap
- consumer/business/bank confidence
- size of rate cut
3 negative effects of using expansionary monatary policy
- in a recession interests rates may loos effectiveness due to liquidity crisis.
- Demand pull inflation
- Time lags (cut in rate take 1-2 years to feed throuh)
2 pros of contractionary monetary policy
- Promote sustainable borrowing and investing meaning bad borrowers are less likely to join market therefore bubbles less likely to occur
- Discourage household dept keeping banks at less risk of insolvency
2 cons of contractionary monetary policy
- increases dept interest payments
- reduces investment
3 ways that BOE changes interest rates by manipulating’s supply of money
- Reserve requirements
- discount rates
- Open market operations
why does monetary policy have time lags
the monetary policy transmission mechanism
when will BOE use QE
when traditional monetary measure have failed
Explain process of QE
- central bank creates electronic money
- money is used to buy financial assets like bonds replacing illiquid assets with liquid ones
- demand for Gov bonds increases therefore decreasing yield on government bonds therefore making it easier for government to service debt
- the injections of cash into the economy increases the supply of money therefor making banks more liquid therefor more confident to give out loans reducing prices of borrowing to firms
- this stimulates consumption and investment
3 advantages of QE
stimulates growth
reduces unemployment
supports financial markets
4 disadvantages of QE
- increases wealth and income inequality
- asset bubbles could create more risk
- risk of inflation
- No guarantee banks will lend money they receive out.
