Monetary and Fiscal Policy and Supply side policies Flashcards
Monetary Policy
the use of interest rates and the money supply to influence the level of aggregate demand in the economy
Bank of england raises base rate:
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
liquidity trap
when monetary policy becomes ineffective because, despite lower interest rates, people want to hold cash rather than spend
Affects of higher interest rates?
- 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)
Effects of rise in exchange rate?
- exports less price competitive
-
Effects of fall in exchange rate?
- boosts exports
- higher inflation, imports more expensive
Evaluation of monetary policy
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)
Fiscal policy
use of government spending, taxation and borrowing to influence the level of aggregate demand and aggregate supply
Types of government spending
1) Current
2) Transfer
3) Capital
Current spending
gov spending on day to day running of its services (eg public sector salaries)
transfer spending
welfare
capital spending
gov spending on investment projects eg infrastructure
progressive taxation
where those on higher incomes pay a higher proportion of their income in tax compared with those on lower income
regressive taxation
taxes that increase in relative size on lower income earners
proportional taxes
taxes that are paid in equal proportions by everyone
What does a rise in interest rates lead to?
A rise in the exchange rate
Why are interest and exchange rates directly propotional?
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.
Forward guidance?
announcements made by the central bank as to the likely future direction of monetary policy in advance of actual changes
Crowding out
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
Financial crowding out
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
Arguments for indirect taxation
- 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
Arguments against Indirect Taxation
- distribution effects = regressive
- Inflationary- trigger cost push inflation
- crime
crowding in
when an increase in government spending increases private sector investment through the multiplier effect and the accelerator effect
Labour market supply side policies
- lower rates of income tax
- reducing state benefits
- improved education and training
- trade union reforms
product market supply side policies
- privatisation and deregulation
- tougher competition policy
- lower rates of business tax
- allowing tax relief on capital spending
