Monetary and Fiscal Policy and Supply side policies

Question 1

Monetary Policy

Answer 1

the use of interest rates and the money supply to influence the level of aggregate demand in the economy

Question 2

Bank of england raises base rate:

Answer 2

1) increased reward for saving
2) increased costs of borrowing
3) decreased loans, decreased consumption and decreased investment
4) decrease aggregate demand
5) decreased GDP, increased unemployment

Question 3

liquidity trap

Answer 3

when monetary policy becomes ineffective because, despite lower interest rates, people want to hold cash rather than spend

Question 4

Affects of higher interest rates?

Answer 4

• reduced inflation due to lower AD

- rise in exchange rate (attracts hot money into that currency due to higher returns that can now be obtained)

Question 5

Effects of rise in exchange rate?

Answer 5

• exports less price competitive

-

Question 6

Effects of fall in exchange rate?

Answer 6

• boosts exports

- higher inflation, imports more expensive

Question 7

Evaluation of monetary policy

Answer 7

1) demand side policies can’t achieve all objectives ( eg interest rates to stop inflation = decrease GDP
2) Time lags (takes 18-24 months for full effect)
3) longer term issues (impact on AS, lower investment, further decrease in aggregate demand)

Question 8

Fiscal policy

Answer 8

use of government spending, taxation and borrowing to influence the level of aggregate demand and aggregate supply

Question 9

Types of government spending

Answer 9

1) Current
2) Transfer
3) Capital

Question 10

Current spending

Answer 10

gov spending on day to day running of its services (eg public sector salaries)

Question 11

transfer spending

Answer 11

welfare

Question 12

capital spending

Answer 12

gov spending on investment projects eg infrastructure

Question 13

progressive taxation

Answer 13

where those on higher incomes pay a higher proportion of their income in tax compared with those on lower income

Question 14

regressive taxation

Answer 14

taxes that increase in relative size on lower income earners

Question 15

proportional taxes

Answer 15

taxes that are paid in equal proportions by everyone

Question 16

What does a rise in interest rates lead to?

Answer 16

A rise in the exchange rate

Question 17

Why are interest and exchange rates directly propotional?

Answer 17

higher interest rates attract hot money into that currency due to the higher returns that can now be obtained. THe higher demand for the currency leads to an increase in its value.

Question 18

Forward guidance?

Answer 18

announcements made by the central bank as to the likely future direction of monetary policy in advance of actual changes

Question 19

Crowding out

Answer 19

rapid growth of government spending leads to a transfer of scarce productive resources from the private sector to the public sector where productivity may be lower

Question 20

Financial crowding out

Answer 20

explains how a budget deficit can lower the levels of private sector investment

• if gov runs big budget deficit will have to sell debt to the private sector
• selling debt to individuals and firms may require higher interest rates due to a higher demand for loanable funds
• a rise in interest rates may ‘crowd out’ private investment causing a negative impact on AD

Question 21

Arguments for indirect taxation

Answer 21

• flexibility can be changed more easily than direct taxes
• correcting externalities, internalise the external costs
• choice, people have a choice to buy products with indirect taxes whereas direct taxes inevitable leave people with less take home pay

Question 22

Arguments against Indirect Taxation

Answer 22

• distribution effects = regressive
• Inflationary- trigger cost push inflation
• crime

Question 23

crowding in

Answer 23

when an increase in government spending increases private sector investment through the multiplier effect and the accelerator effect

Question 24

Labour market supply side policies

Answer 24

1. lower rates of income tax
2. reducing state benefits
3. improved education and training
4. trade union reforms

Question 25

product market supply side policies

Answer 25

1. privatisation and deregulation
2. tougher competition policy
3. lower rates of business tax
4. allowing tax relief on capital spending