Policy

Question 1

What is monetary policy?

Answer 1

A type of demand-side policy, typically conducted by the central bank aiming to change interest rates and influence the money supply in order to influence aggregate demand.

Question 2

Why is monetary policy considered to have limited effectiveness in increasing AD if an economy is in a deep recession? (4 responses)

Answer 2

• Interest rates are already close to zero
• Spending depends on confidence/ indebtedness as well as interest rates
• Money demand may be highly sensitive (elastic/flat) with respect to interest rates
• Investment/consumption may not be sensitive to changes in interest rates.

Question 3

What is fiscal policy?

Answer 3

the set of a government’s policies relating to its expenditure and taxation rates in order to influence aggregate demand

Question 4

3 reasons why fiscal policy may prove effective in lfting an economy out of a deep recession

Answer 4

• Spending by the government will often directly increase employyment and thus confidence levels
• There may be a multiplier effect as a rise in income leads to a rise in consumption
• Lowering income taxes increases disposable incomes and thus may positively affect spending as well as confidence levels.