Monetary and Fiscal Policy

Question 1

What are the two types of demand-side policies?

Answer 1

Monetary and fiscal policy.

Question 2

What is monetary policy?

Answer 2

The manipulation of monetary variables, e.g. interest rates and the money supply, by the government.

Question 3

How could the government use monetary policy to boost AD?

Answer 3

By lowering interest rates so loans are cheaper and savings are less incentivised.

Question 4

What is the impact of the interest rate on consumer durables?

Answer 4

Some big ticket items, e.g. cars, are bought using credit. The higher the interest rate, the more expensive these goods are to consumers.

Question 5

What is the impact of the interest rate on the housing market?

Answer 5

For most households, their biggest expense is their mortgage repayment. If interest rates rise, this becomes more expensive, lowering disposable income.

Question 6

What is the impact of the interest rate on savings?

Answer 6

Higher interest rates makes saving more appealing, causing a fall in consumption and AD.

Question 7

What is the impact of the interest rate on the wealth effect?

Answer 7

Falling interest rates can create more demands for assets, e.g. houses, government bonds, shares, etc. This increases the value of the assets, making people wealthier, encouraging them to spend.

Question 8

What is the impact of the interest rate on the exchange rate?

Answer 8

A fall in the interest rate results in a fall of the value of the currency, resulting in fewer imports and more exports, boosting AD.

Question 9

What is quantitative easing (QE) (3)?

Answer 9

1) A method used to increase AD when interest rates are already very low.
2) It involves the central bank (e.g. the Bank of England) creating more money, and using it to purchase bonds from banks.
3) This gives the banks more money, instead of loans and bonds, which can be made available to consumers and businesses.

Question 10

What is the process of QE (6)?

Answer 10

1) The central bank creates more money.
2) The new money is used to buy bonds from financial institutions.
3) Interest rates fall further.
4) Businesses and consumers borrow more.
5) Spending rises, creating jobs.
6) AD rises, causing economic growth.

Question 11

Who controls monetary policy in the UK?

Answer 11

The Bank of England.

Question 12

What does the monetary policy committee (MPC) do?

Answer 12

The MPC makes decisions regarding the bank (base rate) of interest, that influences the interest rates across the UK. The key objective is to maintain an inflation rate of 2%.

Question 13

What is fiscal policy?

Answer 13

The use of taxes, government spending and debt in order to achieve its economic objectives.

Question 14

What are the two types of taxes?

Answer 14

Direct and indirect tax.

Question 15

What is expansionary fiscal policy?

Answer 15

Fiscal policy used to stimulate AD by increasing spending and lowering taxation.

Question 16

What is contractionary fiscal policy?

Answer 16

Fiscal policy used to reduce the budget deficit and lower pressure on prices, through higher tax rates and lower levels of government spending.

Question 17

What is national debt?

Answer 17

The money borrowed by the government in order to pay for a budget deficit.

Question 18

What is public sector net debt?

Answer 18

The balance of any debt.

Question 19

What is a direct tax?

Answer 19

A tax levied directly on an organisation or an individual.

Question 20

What are 3 examples of direct tax?

Answer 20

1) Income tax.
2) National insurance contributions.
3) Corporation tax.

Question 21

What is an indirect tax?

Answer 21

A tax levied on a good or service.

Question 22

What are 3 examples of indirect tax?

Answer 22

1) Value added tax (VAT).
2) Excise duties.
3) Council tax.

Question 23

What are two occasions of when demand-side policies were used to stimulate economic growth?

Answer 23

1) The Great Depression 1929.
2) The Global Financial Crisis 2008.

Question 24

What are the benefits of demand-side policies (3)?

Answer 24

1) Effective in generating a short-term boost in AD when economic resources are under-utilised and the economy is performing below its productive capacity.
2) Smooths out the extreme impacts of the trade cycle.
3) Helps to stimulate economic growth during a recession through debt, paying off the debt in a boom.

Question 25

What are the drawbacks of demand-side policies (3)?

Answer 25

1) Has a limited impact when AS falls and resources are not under-utilised, instead causing inflationary pressure.
2) Increases the national debt, which means more of the national budget is spent on interest repayments. Too much debt can cause economic collapse.
3) In periods of strong economic growth, governments are likely to increase debt further, rather than repay it.