2 - Demand Side Policies Flashcards
(29 cards)
What do demand side policies do?
They aim to manipulate AD to achieve macro objectives
What is fiscal policy?
Use of gov spending and tax to influence economy
What’s monetary policy?
Use of interest rates and money supply to affect AD
- run by BofE
What’s a direct tax?
A tax on income/wealth
- income tax
- capital gains tax
- corporation tax
What’s an indirect tax?
Tax on spending
- VAT
What’s a progressive tax?
Tax that takes higher proportion from those on higher incomes
What’s a proportional tax?
Tax that takes same proportion of income whatever the level of income
What’s a regressive tax?
Tax that takes lower proportion of income from those on higher incomes
What is public spending?
Spending by Gov to influence AD
What is current spending?
Spending on costs of running public services
- teachers wages
What is capital spending?
Gov investment in economy’s infrastructure
What is the fiscal/budget deficit?
The annual amount the gov borrows to make up gap between its income and spending
- G>T
What’s the fiscal/budget surplus?
G<T
What is monetary policy?
The use of
- interest rates
- changes in money supply
- changes in exchange rate
Run by the BofE
What is the base rate of interest?
Main interest set by Bank of England
- rate at which commercial banks can borrow from BofE
What are market interest rates?
Rates of interest available to borrowers and savers which vary depending on
- risk
- amount borrowed/saved
- access to savings
- typically follow bank base rate
What’s the inflation target?
2% (+/- 1%)
What’s the difference between nominal and real rate of interest?
Nominal is actual rate payed
Real is nominal rate adjusted for inflation
How changes in interest rates influence inflation and AD
- higher IR = higher borrowing costs, reducing c and I
—> reduces AD, prices decrease - higher IR = appreciation of currency
—> cheaper imports, helps reduce inflation - higher IR = increase return on savings
—> encourages saving, reduces inflationary pressures from excess AD
What is the central bank?
Monetary authority and major regulatory bank in a country
- responsible for operating monetary policy and maintaining financial stability
- consists of 9 members who meet 8x per year to set base rate and decide if QE/QT is needed
—> governor of bank has casting vote
Factors considered by BofE MPC when making bank base rate decisions
- rate of growth of real GDP and estimated size of output gap
- forecasts for price inflation
- rate of growth of wages and other business costs
- movements in country’s exchange rate
- rate of growth of asset prices
- movements in consumer and business confidence
- external factors like global energy prices and inflation in other countries
- financial market conditions including rate of growth of credit/money
What is QE?
The BofE’s asset purchase scheme to increase money supply
What does QE do?
- increases money supply in banking system
- encourages commercial banks to lend at cheaper interest rates to small/medium sized businesses
- form of expansionary monetary policy
- used as technique to stimulate AD when nominal IRs have fallen very low.
How does QE work?
- central bank credits their account electronically to make large purchases of assets (bonds) from private sector
- commercial banks receive cash from BofE asset purchases, increases their liquidity, encourages lending to customers, stimulates C + I
- increased demand for gov bonds increases market price
- higher bond price causes fall in yield on bond
- lower bond yields/LT interest rates can cause currency to depreciate
- those who have sold bonds can use extra cash to buy assets with higher yields, positive wealth effect
