MACRO - LS12 - Demand-Side Policies (Part 1)

Question 1

Demand Side Policy

Answer 1

focuses increasing or decreasing AD to influence unemployment, real output, and the price level in the economy

Question 2

monetary policy

Answer 2

manipulation by government of monetary variable, such as interest rates and the money supply (QE) to achieve it’s objectives

Question 3

who decides interest rates

Answer 3

MPC - meet once a month
- interest rate that commercial banks pay to borrow money from the BofE
- Commercial banks raise their own lending/deposit rates for customers

Question 3

fiscal policy

Answer 3

the use of taxes, government spending and borrowing to achieve its objectives

Question 4

how does monetary policy affect consumer durables

Answer 4

• include furniture, cars, kitchen equipment
• higher interest rates, higher monthly repayments
• so high interest rates lead to lower durable goods sales

Question 5

how does monetary policy affect the housing market

Answer 5

• lower interest rates, lower mortgages - houses more affordable
• increases AD
• increases demand for new housing - classified as investment in national income accounts
• moving houses stimulates purchase of consumer durables

Question 6

how does monetary policy affect wealth effects

Answer 6

• as interest rates fall assets price may increase
• causes an increase in demand for housing - causes prices to increase
• wealth effect occurs so spending increase
• if interest rates fall gov bonds price inceases
• these finance gov borrowing
• rises in bond prices cause wealth effect

Question 7

how does monetary policy affect savings

Answer 7

• high interest rates increase saving
• causes a decrease in AD

Question 8

how does monetary policy affect investment

Answer 8

• low interest rates, reduces cost of borrowing, makes projects more profitable
• investment and AD increase

Question 9

how does monetary policy affect exchange rate

Answer 9

• as interest rates fall so does currency (depreciation)
• raises demand for british currency and goods, so exports increase as well as AD

Question 10

Evaluation of monetary policy

Answer 10

• delays - some impact immediately, some take longer - full effect of a change in official rates is said to take 2 years
• size of impact - difficult to gauge/measure given all the other variables in the economy
• effect on income inequality - if rates rise, borrowers (young, poorer) are worse off. if rates fall, pensioners (old, poor) are worse off

Question 11

How does Quantitative Easing work in the UK?

Answer 11

• BofE creates money electronically to make large purchases of assets (gov bonds)
• so financial institutions have an increased amount of capital (potentially improving liquidity of banks)
• leads to increased demand for financial assets which increases their market price - rise in price of bonds leads to lower interest rates
• financial institutions thereby have an increased supply of loanable funds - reduces interest rates
• lower interest rates & increased cash in banking system, stimulates consumption & investment

Question 12

what does the MPC do

Answer 12

• control interest rates
• tries to keep inflation between 2%
• if its above 3% or less then 1% governor has to write to chancellor explaining why and it’s actions

Question 13

how does QE affect currency

Answer 13

causes increase in money supply, currency depreciates, exports increase, imports decrease

Question 14

benefits/disadvantages of QE

Answer 14

• stops slump
• borrowers gain
• savers loose
• increases asset prices
• higher prices for first time buyers