How Fiscal Policy & Monetary Policy Affect The Economy Flashcards
What is the “Business Cycle”?
A pattern of expansion and contractions in an economy
What is “Fiscal Policy”?
A government’s decision regarding spending and taxing.
If the Government want to stimulate growt in the econom, it will increase spending for goods and services. This will increase demand for goods and services. Since demand goes up, production must go up to meet the demand. If producton goes up, companies may need to hire more people. People who were once unemployed now have jobs which give them salaries to spend on goods and services. This will further increase the demand and require more production; hompefully the cycle of grownth will continue.
Does Government spending tend to speed up economic growth?
Yes. Government spending tends to speed up economic growth. If the government thinks the economy is overheating (or growing too fast), it may decrease spending. A decrease in government spending will decrease demand in the overall economy; business will slow production; which means profits will decline, resulting in less hiring in business investments.
Does decreasing taxes tend to stinulate economic grownth?
Yes. Decreasing taxes tends to stimulate economic grownth. If taxes goes down, you will have more money in your pocket. (You can save it or spend it). IF ;you spend it, you increase demand and businesses will have to produce more. This means businesses will have to hire more people to meet the demand. These hired people will now have money to save or spend. However, if yo save the money (and put in your bank), the bank will have more monely to lend to borrowers who will in turn spend it on something.
Goverment spending + Reduction in Taxes = Crowding out effect.
Government spending + Reduction in taxes = Crowding out effect. What does this mean?
Government Spending and Taxes:
When the government spends money on things like building roads, schools, or providing services, it’s called government spending.
When the government reduces taxes, people and businesses have more money to spend.
Crowding Out Effect:
Imagine the economy is like a big pizza. Everyone (including the government, businesses, and people) wants a slice.
When the government starts spending a lot of money, it’s like the government taking a bigger slice of the pizza.
This means there is less pizza (money) left for everyone else (businesses and individuals).
As a result, businesses might find it harder to get loans or investments because the government is using a lot of the available money.
This is called the crowding out effect. It means government spending can sometimes “crowd out” private investment.
Simple Example:
Suppose the government decides to build a new highway, which costs a lot of money.
To pay for this, they borrow money from banks.
Because the government is borrowing a lot, there is less money available for businesses to borrow.
So, businesses might have to pay higher interest rates to borrow money, or they might not be able to borrow as much.
In simple terms, the crowding out effect happens when government spending and tax reductions lead to less money being available for businesses and individuals to borrow or invest. This can make it harder for the private sector to grow.
If the government doesn’t have enough revenue to support spending, what will it do?
If the government doesn’t have enough revenue to support spending, it will have to borrow the money from some other government like china, for example. Government borrowing tends to increase interest rates. Increased interest rates discourages borrowing of businesses to spend and invest.
Explain Government Borrowing and Interest Rates:
Government Borrowing and Interest Rates:
Government Needs Money: Imagine the government wants to build a new school but doesn’t have enough money from taxes.
Borrowing Money: The government decides to borrow money. This can be from other countries like China or from investors.
More Borrowing, Higher Interest
Rates:
When the government borrows a lot of money, it means they are taking out many loans.
Just like if many people want to borrow money from a bank at the same time, the bank might raise the interest rates because the demand for loans is high.
Higher Interest Rates:
With higher interest rates, it becomes more expensive to borrow money.
This affects everyone, not just the government.
Impact on Businesses:
Businesses Need Loans: Imagine a business wants to borrow money to buy new equipment or expand.
Higher Costs: Because the government is borrowing a lot and interest rates have gone up, the business now has to pay more to borrow the same amount of money.
Less Borrowing and Investment: The higher cost might discourage the business from taking the loan. They might decide not to expand or buy new equipment because it’s too expensive.
Simple Example:
Government Borrowing: The government borrows a lot of money to build new highways.
Interest Rates Increase: Banks and lenders raise interest rates because there’s a high demand for loans.
Business Impact: A company that wanted to borrow money to open a new store finds that the loan is now more expensive.
Decision: The company decides not to open the new store because borrowing costs are too high.
In simple terms, when the government borrows a lot of money, it can make it more expensive for businesses to borrow money due to higher interest rates. This can lead to businesses borrowing less, which means they might invest less in new projects or expansion.
