Performance & Policies - Year 1 Macroeconomics Flashcards
1
Q
term
A
definition
2
Q
What are the limitations to fiscal policy?
A
• Governments might have imperfect information about the economy. It could lead to inefficient spending. • There is a significant time lag involved with employing the fiscal policy. It could take months or years to have an effect. • If interest rates are high, fiscal policy might not be effective for increasing demand.• If the government spends too much, there could be difficulties paying back the debt, which could make it difficult to borrow in the future.
3
Q
Discuss what is meant by a ‘positive wealth effect’?
A
A psychological phenomenon stating that when asset values rise, this makes individuals feel wealthier, leading to increased spending and a boost in overall consumption and economic activity
4
Q
How are goods and services weighted in the basket of goods?
A
Weighted based on their share of total consumer expenditure, which are typically determined using data from surveys or expenditure data. The more frequently and extensively a good or service is purchased, the higher its weight in the basket of goods.
5
Q
What is meant by cost-push inflation?
A
An increase in cost of production or a decrease in the availability of resources leading to an inward shift of supply causing higher prices.
6
Q
Define shoe leather costs.
A
The increased time and effort spent by individuals and businesses in response to inflation, such as more frequent trips to the bank to withdraw cash, in order to minimize the loss of purchasing power.
7
Q
What is the effect of a strong pound on the net trade balance?
A
SPICED. Strong Pound Imports Cheap Exports Dear.Net trade balance worsens as import demand rises and export demand falls.
8
Q
What is meant by fiscal policy, and what is its purpose?
A
Fiscal policy is a demand-side policy which refers to the use of government spending and taxation to influence the overall state of the economy, stimulate economic growth and reduce unemployment
9
Q
What is Monetary policy, and what is its function?
A
Monetary policy refers to the regulation of the money supply through adjustments to basal interest rates. It’s primary function is to stimulate aggregate demand, and maintain price stability (2% CPI).
10
Q
What are the main free-market based supply-side policies?
A
• Reduction of income and corporation tax rates: Incentivise work, investment, and business activity• Privatisation: By reducing government involvement and allowing private ownership, privatisation aims to increase market competition and efficiency in the allocation of resources.• Deregulation: Removing unnecessary regulations and bureaucratic burdens to enhance market efficiency and promote competition.• Reduce minimum wages and welfare benefits• Trade liberalisation: Reducing trade barriers to expand market access and promote international competitiveness
11
Q
Explain how GDP (Gross Domestic Product) is calculated.
A
Sum of the total value of all goods and services produced within an economy during one year. GDP = C + I + G + (X-M)
12
Q
Discuss GDP’s limitations in evaluating standards of living within an economy
A
GDP does not consider several key factors such as:• Where the wealth is stored, ie. income inequality• Environmental sustainability• Access to, and the provision of public/merit goods such as healthcare• Economic and price stability• Availability of credit, education opportunities and basic necessities (such as water, food and energy)
13
Q
Describe what is meant by GNI (Gross National Income)
A
The total income earned by a country’s residents, including both domestic, and international sources
14
Q
What may be a better depiction of standards of living within an economy?
A
GDP per capita, or Gross National Happiness (GNH)
15
Q
Define Purchasing Power Parity (PPP).
A
A comparison of the relative purchasing power of different currencies by equalizing the prices of a basket of goods and services across countries
16
Q
Give an example of when Purchasing Power Parity may be useful.
A
Used for accurate international comparison of living standards and economic indicators like GDP between countries with different currencies, and price levels.
17
Q
Discuss the various components within the circular flow of income model.
A
- Households: Pay firms for goods and services.2. Firms: Pay households for human capital/labour.3. Governments: Collect tax revenue from both households and firms; Pay firms to buy goods and services; Pay welfare benefits to households.4. Financial Sector: Collect savings, Pay withdrawals5. Other Nations: Collect imports, Pay for exports.
18
Q
Give 3 examples of withdrawals, and injections into an economy.
A
Withdrawals:• Savings• Imports• TaxationInjections:• Withdrawals• Exports• Government spending
19
Q
What is depicted on the economic cycle?
A
Depicts fluctuations in economic activity over time, involving periods of boom (positive output gap) and recession (negative output gap).Trend rate of GDP growth (on the PPF) is the economy’s productive potential.Actual rate of GDP growth is the economy’s current position in terms of economic activity.
20
Q
What factors have the potential to cause long-run economic growth?
A
• Technological advancements and innovation.• Investment in physical and human capital.• Improvements in education and skilled workforce.• Access to financial resources and credit• Infrastructure development• Research and development
21
Q
What are the main benefits of economic growth?
A
• Lower levels of unemployment• Higher nominal incomes –> Higher standards of living• Greater fiscal dividends (tax revenue) for the Government to reinvest back into providing higher quality public services• Attractive to foreign investors looking to start-up in the UK• More production in the economy –> More exports, leads to higher competitiveness in the global trade market
22
Q
What are the main negative consequences of economic growth?
A
• High likelihood of demand-pull inflation• Environmental degradation and resource depletion• Increased carbon emissions leading to climate change• Mental health and social issues - workers forced to work longer hours than they would like• Economic instability
23
Q
What factors affect the level of Consumption within an economy?
A
• Disposable income: Higher levels of income generally lead to increased consumption.• Consumer confidence• Interest rates: Lower interest rates can incentivize borrowing and increase consumption.• Availability of credit: Easy access to credit can facilitate higher levels of consumption.• Wealth and asset prices: Rising asset prices, such as housing or stock market values, can boost consumer spending.
24
Q
What factors affect the level of consumer confidence within an economy?
A
• Unemployment rates and level of price stability• Value of consumer assets and house prices• Standards of living• Average incomes• Consumer expectations (anticipations of future economic growth and/or job opportunities)
25
How do you calculate the Marginal Propensity to Consume (MPC)?
MPC is calculated as the change in consumption divided by the change in disposable income.
26
Discuss what is meant by a multiplier effect.
When an initial injection of money into the economy leads to a proportionately larger final increase in AD.
27
What factors affect the level of Investment within an economy?
• Availability of credit and financing• Business confidence• Level of economic growth• Interest rates• Value of privately owned assets• Foreign demand for exports• Technological advancements
28
What factors affect the level of business confidence within an economy?
• Availability of credit and financing• Unemployment rates and level of price stability• Level of economic growth• Interest rates• Competition within markets and market demand• Availability of commodities/resources
29
Discuss what is meant by an accelerator effect.
When changes in investment spending have a magnified impact on the level of economic output
30
Define animal spirits.
Keynesian ideology stating that psychological factors driving economic behavior and decision-making. Factors such as confidence, optimism, risk-taking, and herd mentality can influence individuals and businesses in their economic choices.
31
How do you calculate the Marginal Propensity to Withdraw (MPW)?
MPS + MPT + MPM
32
How do you calculate the spending multiplier co-efficient in an economy?
1 / 1-MPC = 1/MPW
33
What is a credit crunch?
A credit crunch is a sudden reduction in credit availability, leading to restricted borrowing and higher borrowing costs.
34
Describe the factors that can cause a credit crunch.
• A financial crisis• Banking system instability• Excessive lending and borrowing• A decline in asset values• Loss of confidence in the economy
35
Define economically active.
Individuals who are either employed or actively seeking employment, indicating their participation in the labor market and their willingness and ability to work
36
Define unemployment
Proportion of economically active individuals within an economy who are willing and able to work but can not find a job.
37
Define cyclical unemployment
Unemployment resulting from fluctuations in the business cycle and economic downturns.
38
Define frictional unemployment
Unemployment resulting from the time taken for individuals to switch jobs or find new employment.
39
Define structural unemployment
Unemployment arising from reduced or eliminated jobs and skills mismatch in the labor market.
40
Define seasonal unemployment
Unemployment that occurs due to predictable, temporary fluctuations in demand for labor during certain seasons or specific times of the year, such as agricultural or tourism-related industries.
41
Define real-wage unemployment
Unemployment caused by wages being set above the equilibrium level, resulting in a surplus of labor, as employers are unwilling or unable to hire workers at the prevailing wage rate.
42
Define hysteresis.
Hysteresis occurs when a temporary shock or disturbance to an economy leads to lasting or permanent changes in variables such as employment, output, or productivity, preventing a return to the previous state.
43
What is the difference between those who are economically active, and those who are employed in a job?
Economically active individuals are those who are either employed or actively seeking employment, employed have a job or are engaged in work, regardless of their level of economic activity.
44
What are the benefits to using the claimant count to measure the rate of unemployment?
• Claimant count data is often available on a monthly basis, providing more timely information about the state of unemployment compared to other measures.• Relies on existing administrative records, making it a relatively cost-effective and efficient way to estimate unemployment rates• Provides a consistent measure over time, allowing for meaningful comparisons and analysis of trends in unemployment.
45
What are the drawbacks to using the claimant count to measure the rate of unemployment?
• Excludes individuals who are unemployed but not eligible for, or not claiming benefits• Some individuals may choose not to claim benefits due to the stigma associated with unemployment or personal reasons• Includes individuals who voluntarily leave their jobs, making it difficult to differentiate between voluntary and involuntary unemployment
46
What are the benefits to using the Labour Force Survey (LFS) to measure the rate of unemployment?
• Captures a wide range of demographic and labor market information, providing a comprehensive view of the workforce beyond just those eligible for unemployment benefits.• Uses rigorous sampling techniques to ensure the data represents diverse groups and regions accurately• Collects detailed data on employment status, occupation, industry, and hours worked• Regularly conducted, the LFS enables tracking of trends over time, providing valuable insights into changes in employment rates, workforce participation, and unemployment dynamics
47
What are the drawbacks to using the Labour Force Survey (LFS) to measure the rate of unemployment?
• Sample may not fully represent the entire population, leading to potential inaccuracies, especially for smaller subgroups or localized areas• Voluntary responses in the LFS can introduce response bias, because certain individuals may be more or less likely to participate• LFS is conducted less frequently than administrative data sources, limiting the timeliness of the information provided
48
What is meant by underemployment, and how can this have negative impacts on the economy?
Underemployment refers to workers who are employed in jobs that do not fully utilize their skills, or work desired working hours. This reduces productivity, dampens economic growth, and leads to wasted human capital, resulting in lower income levels, decreased consumer spending, and overall economic inefficiency.
49
What is the impact of high unemployment rates on individuals?
High unemployment rates can result in financial stress, reduced well-being, career setbacks, social isolation, and negative health consequences for individuals.
50
What is the impact of high unemployment rates on firms?
High unemployment rates can lead to reduced consumer spending, lower production and output, decreased business investment and increased market competitiveness, so wages decrease.
51
What is the impact of high unemployment rates on the Government?
High unemployment rates increase government spending on social welfare programs while reducing tax revenue, causing a fiscal deficit to become worsened.
52
What is the impact of high unemployment rates on the trade balance?
High unemployment has the potential to improve the net trade balance. Low levels of productive output, leading to less net exports, leading to a worsening of the net trade balance.It can also be argued that high unemployment rates can contribute to a decrease in imported goods due to reduced domestic demand, resulting in an improvement in the trade balance.
53
Define inflation
The sustained rise in general price level over a given time period.
54
Define Consumer Price Index (CPI).
A newer measure of inflation, monitors the change in the price level within an economy for a basket of goods purchased by households which is used to monitor inflation.
55
How are index numbers calculated?
(Index / Base Year) * 100The base year is always set at an index value of 100.
56
State an advantage and disadvantage of using CPI to measure the rate of inflation within an economy.
Advantage of CPI: Comprehensive measure of inflation tracking changes in prices of goods and services.Disadvantage of CPI: May not fully reflect inflation experienced by specific demographic groups with different consumption patterns.
57
Define Retail Price Index (RPI).
An older measure of inflation, less commonly used than CPI, although works on the same basis of monitoring the value of a basket of goods.
58
State an advantage and disadvantage of using RPI to measure the rate of inflation within an economy.
Advantage of RPI: Broader inclusion of housing-related costs such as mortage repayments and council tax.Disadvantage of RPI: Tends to yield higher inflation figures, potentially overstating true inflation rate.
59
What are the main differences between RPI and CPI measures of inflation?
1. Calculating method2. Weighting method3. Coverage of housing costs (CPI includes housing costs, whereas RPI tracks mortgage repayments and council tax)
60
Define Consumer Price Index for Housing (CPIH).
A measure of average price level changes in an economy for goods and services that includes housing costs for homeowners, used to track inflation and cost of living.
61
State an advantage and disadvantage of using CPIH to measure the rate of inflation within an economy.
Advantage of CPIH: Includes housing costs, providing a more comprehensive measure of inflation that reflects the impact on households.Disadvantage of CPIH: Relies on certain assumptions and imputations for estimating owner-occupier housing costs, which may introduce potential inaccuracies in measurement.
62
What is meant by the 'basket of goods'?
A selected set of goods and services that most accurately depict the spending habits of an economy, which are used to calculate price indexes.
63
Why are goods and services weighted in the basket of goods?
Goods and services are weighted in the basket to reflect their importance in consumer spending patterns, and provide a more accurate measure of inflation and costs of living.
64
What is meant by demand-pull inflation?
When the level of aggregate demand within an economy rises and beyond the productive potential output (supply remains constant) resulting in higher prices of goods and services.
65
Define menu costs.
Menu costs are the expenses and inconveniences that businesses face when changing their prices due to inflation.
66
What is the difference between cost-push and demand-pull inflation?
Cost push inflation is derived from an increase in production costs (ie. from a supply shock), whereas demand-pull inflation is derived from excess demand within an economy forcing producers to drive up prices.
67
What is a wage-price spiral.
When higher wages lead to higher price levels throughout the economy, resulting in workers demanding for even higher wages, creating an inflationary cycle.
68
What are the consequences of sustained high rates of inflation?
• Reduced purchasing power: High inflation diminishes the value of money, reducing individuals' ability to buy goods and services.• Reduced savings and investment: Inflation erodes the value of savings, discouraging saving and reducing funds available for investment.• Increased production costs: Businesses face higher production costs due to rising wages and input prices, potentially squeezing profit margins.• Income redistribution: Inflation affects different income groups unevenly, widening income disparities.• Macroeconomic instability: High inflation decreases economic confidence and can lead to currency depreciation
69
What is the impact of high inflation rates on firms?
High inflation rates increase production costs, creating uncertainty in planning and pricing decisions, and potentially reducing investment and growth opportunities.
70
What is deflation, and why is it not a good thing?
Deflation is a sustained decrease in the general price level of goods and services. It can lead to a negative wealth effect and worsened confidence within the economy.Deflation can:• Reduce consumer spending and hinder economic growth• Increased debt burdens, ,• create a cycle of falling prices causing businesses to cut production, investment, and employment, (exacerbating the economic downturn)
71
What is the impact of high inflation rates on individuals?
High inflation rates reduce individuals' purchasing power, erode real wages, create financial uncertainty, distort economic decision-making, and can widen income disparities.
72
What is the impact of high inflation rates on the Government?
High inflation rates impact the government by reducing the purchasing power of government spending, and makes it more costly to borrow money, potentially worsening national debt in the long run.
73
What is the impact of high inflation rates on the trade balance?
High inflation rates can potentially decrease imports and improve the trade balance as the reduced purchasing power of domestic currency makes imported goods relatively more expensive.
74
Why is there often a trade off between the rate of inflation and unemployment?
Policies that aim to reduce unemployment can potentially lead to higher demand-pull inflation, and policies targeting inflation reduction may result in increased unemployment.
75
What does the Phillip's curve depict?
The Phillips curve depicts the inverse relationship between unemployment and inflation (in the short run). As unemployment decreases, inflation tends to increase, and vice versa, implying a trade-off between the two variables.
76
What are the limitations to the analysis of the Phillips curve?
Long-run inconsistency due to factors like inflation expectations, changes in economic structure, and supply-side shocks; the presence of unstable policy trade-offs between unemployment and inflation; the influence of structural changes in the economy such as technological advancements
77
What is meant by stagflation, what can cause stagflation and what are the potential implications?
Stagflation refers to a situation of stagnant economic growth coupled with high inflation, which can be caused by supply-side shocks or a combination of factors such as rising energy prices, declining productivity, or government policies.
78
What are the 4 sections in the current account balance?
1. Trade of goods / visibles (X-M)2. Trade of services / invisibles (X-M)3. Primary income: Wages, profits and commissions earnt from abroad.4. Secondary income: Money transfer payments sent abroad.
79
Why do high relative inflation rates reduce global economic competitiveness?
High relative inflation rates reduce global economic competitiveness by eroding the price competitiveness of domestic goods and services, leading to a decline in exports, reduced market share, and potential negative impacts on employment, economic growth, and trade balance.
80
What are the reasons an economy may face a current account surplus?
• A weak relative currency can reduce the price of exports, leading to greater export demand.• Individuals moving 'hot money' over in the form of transfer payments (ie. remittance) because of higher differential interest rates.• Lower incomes can lead to lower import demand
81
What are the implications of a trade surplus?
• Improved current account balance:• Increased foreign currency reserves as money is injected into the economy• Boost to domestic industries and employment• Potential currency appreciation: A trade surplus can lead to an increase in demand for the country's currency, potentially resulting in currency appreciation
82
What are the reasons an economy may face a current account deficit?
• Strong relative currency can increase the demand for imports, while decreasing the demand for exports• Hot money flowing into other economies due to higher reward for saving elsewhere can cause a deficit in secondary income flow• Borrowing and interest payments: An excessive amount of external debt to foreign creditors can lead to an outflow of money from the economy• Dependence on imported raw materials and resources causes a constant outlflow of money from the economy
83
What are the implications of a trade deficit?
• Increased foreign debt as financing may be conducted from foreign creditors• Hindrance of economic growth (lack of domestic competition between firms)• Dependence on foreign production• Potential currency depreciation as demand for domestic currency decreases
84
What is the effect of a weak pound on the net trade balance?
WPIDEC. Weak Pound Imports Dear Exports Cheap.Net trade balance improves as import demand falls and export demand rises.
85
What does the J-curve depict?
Shows that a depreciation of the currency will cause a short-term deterioration of the net trade balance followed by a subsequent improvement.
86
What are the limitations to the analysis of the J-curve?
• Assumes that the price elasticity of demand for exports and imports remains constant over time• Does not consider other factors that can influence the trade balance, such as non-price competitiveness, productivity, and changes in domestic and foreign economic conditions• The time frame for the adjustment depicted by the J-curve can vary, and the actual magnitude and duration of the impact may differ in different situations
87
What is the effect of a depreciation of a currency's value on the net trade balance?
A depreciation of a currency's value will typically cause a deterioration of the trade balance, but will lead to an improvement in the trade balance as exports become relatively cheaper and imports become relatively more expensive - as long as the Marshall-Lerner condition is met.
88
Explain the Marshall-Lerner condition.
A devaluation in the value of a currency leads to a temporary worsening of the trade balance, but causes an improvement in the long-term net trade balance only if the sum of the price elasticity of demands of exports + imports is greater than 1.
89
Why does a devaluation of a currency initially lead to a worsening of the current account balance?
• Costlier imports: A devalued currency makes imports more expensive, which can negatively impact the current account balance.• External debt burden: Devaluation can increase the cost of servicing foreign currency-denominated debt, putting pressure on the current account balance.• Time lag in export benefits: While a devaluation can enhance export competitiveness, it takes time for export volumes to increase and offset higher import costs, initially worsening the current account balance.
90
What do Neo-Classical economists believe?
The economy will always return to the long-run productive potential level of output despite any temporary shifts made to AD or SRAS. A shift in AD does not have the power to cause economic growth in the long run.An increase in AD will cause demand-pull inflationary pressures, causing costs of production to rise, hence SRAS shifts back to meet the LRAS equilibrium point of output, along with increased price levels.
91
What do Keynesian economists believe?
Government intervention through the use of demand-side policies is most effective at stimulating economic activities and mitigating the likelihood of a recession.
92
What did Hayek believe?
Friedrich Hayek believed in free-market capitalism, limited government intervention, and the importance of individual liberty and personal responsibility in driving economic and societal progress.
93
Why does a decrease in tax revenue not necessitate a decrease in Government spending?
The Government can choose to finance the fiscal deficit through borrowing or other means to maintain spending levels.
94
What are the Government's main sources of revenue.
• Direct Taxation: Income tax, Corporation tax, Capital gains tax etc. • Indirect Taxation: VAT, Excise Duty• Borrowing: Issuance of bonds allows them to finance public projects or budget deficits, however it can add to the overall debt burden• Fees/Fines: Typically for failing to follow Government rules and regulations
95
Where does the Government typically spend its revenue?
Social protection (welfare benefits etc.), Healthcare, Education, Public services, Infrastructure.
96
What is meant by discretionary austerity measures?
A form of contractionary fiscal policy taken by the government to reduce public spending and/or increase income taxe rates in order to address budget deficits and control national debt.
97
How do automatic fiscal stabilisers work, and what do they do?
Automatic fiscal stabilisers work by reducing the magnitude of output gaps within an economy.When an economy is in a positive output gap, or a boom, individuals are pushed into higher tax bands, meanwhile Government spending on welfare benefits is reduced, hence AD shifts inwards.When an economy is in a negative output gap, or a recession, individuals are pushed into lower tax bands, increasing consumption, meanwhile Government spending on welfare benefits is increased, hence AD shifts outwards.
98
What are the problems of a fiscal deficit?
• Inflationary pressures, as excessive government spending can fuel demand and lead to rising prices.• Reduced fiscal flexibility, and worse access to credit, limiting ability to respond to future economic challenges.• Increased government borrowing and accumulation of national debt..• Corrective measures such as tax increases or spending cuts can have adverse effects on economic growth / society as a whole.
99
What are the problems of a fiscal surplus?
• Reduced public investment• Inefficient allocation of resources leading to Government failure (collection of more revenue than needed)• Adverse effects on economic growth• Potential opportunity costs on where the revenue could have been spent
100
How can a Government correct a fiscal deficit?
• Increase tax rates (both direct and indirect)• Cut government spending• Stimulate economic growth to collect more tax revenue• Implement austerity measures (eg. reductions in social welfare benefits, minimum wage freezes etc.)
101
Fiscal policy evaluative statements (what does its effectiveness depend on).
• Depends on the Marginal Propensity to Consume.• Depends on the size of the multiplier• Depends on the position on the Laffer Curve (although this is impossible to empirically find out)• Depends on the state of the economy
102
What does the Laffer curve depict?
The Laffer curve depicts the relationship between tax rates and tax revenue, illustrating that at a certain point, increasing tax rates beyond a certain threshold may lead to a decrease in tax revenue.
103
What are the limitations to the analysis of the Laffer curve?
The analysis of the Laffer curve is limited by the difficulty of precisely determining an economy's position on the curve and by relying on simplistic assumptions.
104
Why does tax revenue fall after T* on the Laffer curve?
• Reduced incentive to work if tax rates are too high, leading to high unemployment rates and therefore less tax revenue• Reduced incentive to investment if tax rates are too high, leading to lower economic activity• People may move to nations with lower tax rates if they feel the burden of income tax is excessive
105
Define interest rate.
The cost of borrowing money & The reward for saving
106
What is meant by basal interest rates?
Basal interest rates refer to the benchmark interest rates set by the Bank of England, which serve as the foundation for determining other interest rates in the economy.
107
Which financial institution is responsible for adjusting Monetary Policy?
The Monetary Policy Committee (MPC) within the Bank of England (BoE) is responsible for setting basal interest rates, and performing quantitative easing/tightening after a thorough analysis of the performance of the UK economy.The UK Government is responsible for setting the Bank of England an inflation target for price stability, set at 2% CPI.
108
Briefly state the monetary policy transmission mechanism.
1. Basal interest rates decrease2. Lower reward for saving, Lower cost of borrowing3. Reduces the incentive to save, increases the incentive to borrow/invest4. Increases consumption and investment --> Increase in AD
109
What is the impact of interest rates on the exchange rate?
High interest rates can attract foreign investors seeking higher returns, increasing the demand for the domestic currency and potentially causing it to appreciate in value against other currencies.
110
What is the impact of interest rates on the trade balance?
High interest rates can lead to an appreciation of the domestic currency, making exports relatively more expensive and imports relatively cheaper, which can result in a deterioration of the trade balance
111
Define hot money.
Hot money refers to short-term, speculative capital that is quickly moved between countries or financial markets in search of higher returns or to exploit interest rate differentials.
112
How does Quantitative Easing work?
1. BoE artificially generates money electronically2. BoE uses this money to buy Government bonds from financial institutions (ie. commerical banks)3. Higher demand for bonds causes their value to appreciate, leading to lower long-term yields4. Financial institutions loan money out or invest in riskier corporate bonds5. Price of corporate bonds increases, and their long-term yield decreases6. Access to credit improves, general i.r falls7. Incentivises borrowing, consumption and investment rise leading to greater AD. QE is used if inflation rates are below price stability targets.
113
When was Quantitative Easing first introduced?
March 2009 in response to the Global Financial Crisis, basal interest rates were already very low, but to stimulate economic activity QE was implemented alongside standard issue monetary policy.
114
What is Quantitative Tightening?
Quantitative tightening refers to the process of reducing the size of a central bank's balance effectively decreasing the money supply and tightening monetary conditions in the economy.QT is used if inflation rates are above price stability targets.
115
What are the limitations to Monetary policy?
• Time lag for any effect on the economy • Liquidity trap - can only lower the cash rate so much • Banks don't always pass on full interest rate changes (profit)• Can't deal with supply-side constraints.• Can be in conflict with fiscal policy
116
What is a liquidity trap?
A liquidity trap is a situation where monetary policy loses its effectiveness because interest rates are already very low (possible even 0), and people and businesses hoard cash instead of spending or investing it.
117
Why may a liquidity trap occur within an economy?
A liquidity trap may occur within an economy when there is a significant decline in consumer and business confidence, leading to increased saving and reduced investment, despite low interest rates. Additionally, it can be triggered by deflationary pressures and a lack of available profitable investment opportunities.
118
Why is there a time lag in the Monetary policy transmission mechanism from time of action to the time of impact?
People have fixed-rate contracts such as mortgages, meaning it takes time for changes in policy to impact borrowing, spending, and economic activity in the economy.
119
Monetary policy evaluative statements (what does its effectiveness depend on).
• Depends on the Marginal Propensity to Consume (MPC)• Depends on the state of the economic cycle (output gap)• Depends on business and consumer confidence• Depends on the presence of supply-side constraints in the economy
120
How do supply-side policies work?
Supply-side policies aim to stimulate economic growth and improve productivity by reducing barriers to production and promoting market efficiency in an attempt to increase the long-run productive potential of an economy.
121
What do supply-side economists believe?
Supply-side policies focused on promoting economic growth such as reducing taxes and deregulating industries can increase the long-run productive potential for an economy (increase in LRAS) without sacrificing price stability.
122
What is the difference between market-based and interventionist supply-side policies?
Market-based supply-side policies aim to create favorable conditions for markets to operate efficiently, meanwhile interventionist supply-side policies involve direct government intervention to correct market failure
123
What are the main interventionist supply-side policies?
• Spending on education and training• Spending on infrastructure• Subsidies to promote investment and entrepreneurship• Subsidies for research and development• Subsidies to smaller firms
124
Supply-side policy evaluative statements
• No guarantee of sucess• Cost of implementation• Time lags• Supply side policies need to be targeted at specific areas• Effectiveness highly depends on consumer and business confidence throughout an economy
