Demand side policies Flashcards
How many targets does the MPC have and what are they?
NOTE- MPC has single target of low inflation- BUT if under control- might allow other areas to benefit from ⬇️ interest rates
What is unique about interests rates and exchange rates?
NOTE- interest rates & exchange rates change in same direction
What are the 2 types of demand side polcies?
1) Monetary policy
2) Fiscal policy
What is monetary policy?
Monetary policy- decision making using monetary instruments e.g. interest rate to influence AD
What is the CPI inflation target and who is it set by?
CPI inflation target set by Chancellor of the Exchequer (now 2%)
What happens if inflation changes from its target?
If falls outside 1-3% range then open letter sent by Governor of 🏦 of 🏴 to Chancellor to explain why
What demand side tools are used by MPC?
2 main tools used by MPC- Bank/base 🏦 rate of interest & Quantitative easing (since 2009)
Why was QE introduced?
interest rates alone ✖️ enough to take economy out of recession so QE needed (limit to how interest rates can go- negative interest rates ✖️ viable)
How does an increase in interest rates introduced by the MPC affect consumers?
⬆️ interest rates-> ⬆️ cost of borrowing-> ⬇️ borrowing to finance consumer spending & ⬆️ saving (savers ✖️ spend due to ⬆️ interest rate gained on savings)-> ⬇️ AD-> ⬇️ in 🏠 prices as mortgages ⬇️ affordable-> ➖ 👎 wealth effects (ppl ⬇️ likely to spend BUT if 🏘 ⬆️ in value- owner could request mortgage equity release based on ⬆️ wealth) as 🏠 prices fallen ⬇️
- Mortgage payments ⬆️, hire purchases (loans on consumer durables e.g. 🚙 etc-> ⬆️ in repayments)- consumers delay major expenditures etc
How does an increase in interest rates introduced by the MPC affect firms/producers?
⬆️ interest rates-> ⬇️ investment from firms due to ⬆️ cost of borrowing-> ⬇️ in current AD & ⬇️ long term output prospects (investment in capital e.g. could-> ⬆️ output in future)
⬆️ production costs due to ⬆️ interest rates-> ⬇️ exports & ⬆️ imports
What is hot money and how does it work?
‘hot 🔥 money 💵’ attracted to ⬆️ interest rate- ppl rather put 💵 in a country’s 🏦 with ⬆️ interest rates as ⬆️ return on money than keeping in own country- NOTE exchange rate relatively ⬇️ at this point … reasonable amount of foreign currency exchanges to place in foreign 🏦- eventually after earning ⬆️ interest on money- take money back after exchange ⬆️- get more of own 💴 back as foreign currency has ⬆️ in value)
NOTE- ‘🔥💵’ ✖️-> ⬆️ in inflows & … ✖️ improve balance of payments as 💵 taken back soon after (✖️ spent in same country)
What do demand side policies effect?
REMEMBER- DEMAND SIDE POLICIES SO EFFECT DEMAND ONLY BUT may-> change in price/or output depending on shape of AS curve
How are interest rates set and how often?
🏦 rate set each month by MPC (aim to meet 2% inflation target)
What are monetary ‘transmissions mechanisms’?
Monetary ‘transmissions mechanisms’- chain of reactions set off in economy causing AD to shift
What is QE?
Quantitative easing- purchase of gilts (bonds) & other illiquid assets to make credit easier to access (increase liquidity/money supply)
How does QE lead to increased demand and spending in the economy?
1) Financial assets purchased (funded by central 🏦 reserves which are paid for by selling treasury bills (90 day loans- very liquid- effectively cash)- … buying assets (bonds, gilts etc) injects money into economy & increases 💵 supply-> ⬆️ asset prices (in the short term- more money chasing same amount of goods/assets … value of these assets rise- in the long term-> inflation as value increase eventually eroded due to inflation)-> ⬆️ spending in short term as ➕ wealth effects experienced … ⬆️ consumption and … ⬆️ AD
2) Spending ⬆️ because asset holders have portfolios (assets) higher ⬆️ in value due to eventual ⬆️ in demand for those assets (note interest rate ⬇️ at the same time to ⬆️ demand- cheaper loans & mortgages makes assets ⬆️ attractive hence ⬆️ in their value) & 💵 easily & immediately available-> holders feeling ⬆️ wealthy as assets now ⬆️ liquid (easily transferable into 💵)-> ⬆️ spending/consumption (AD) in short term as ➕ wealth effects experienced
ALSO ⬆️ likely that consumers request mortgage equity release based on ⬆️ value of their property … can use 💵 to finance spending
3) Consumers & businesses take on ⬆️ debt (loans) due to lower yields (interest rates) on financial assets
What are problems with QE?
- Nature of banking 🏦 sector:
- 🏦 still may be ⬇️ willing to lend despite ⬆️ 🏦 asset holdings & liquid assets due to QE- 🏦 concerned about their financial heath & … ⬇️ willing to lend - Inflation:
- ⬆️ money supply-> long term inflation (‘too much 💵 chasing too few 🚘’) … 🚘/🧹 ⬆️ in price & 💴 value ⬇️
What is the process of exiting QE?
- MPC tightens monetary policy (slows down growth) & QE assets resold in money markets (✖️ new assets bought)- bonds being resold has same affect as ⬆️ interest rates
- Credit ⬇️ easily available (lending made ⬆️ difficult)
- 💵✖️ longer pumped into economy as sharp growth taken economy out of recession- monetary policy now eased to maintain steady inflation at target 🎯
What is fiscal policy?
Fiscal policy- government’s management of its spending & taxation to influence AD
What is another way of saying expansionary fiscal policy?
Budget/Fiscal Deficit OR Loose Fiscal policy
What is another way of saying contractionary fiscal policy?
Budget/Fiscal Surplus OR Tight Fiscal policy
What is expansionary fiscal policy?
Budget/Fiscal Deficit (Expansionary (loose) Fiscal policy)- ⬇️ tax & ⬆️ government spending-> ⬆️ AD
What is contractionary fiscal policy?
Budget/Fiscal Surplus (Contractionary (tight) Fiscal policy)- ⬆️ tax & ⬇️ government spending-> ⬇️ AD
How does expansionary fiscal policy work and give an example of it
Aims to pump spending power into economy- multiplier magnifies effect
- Example- investment in 🏥-> ⬆️ jobs (doctors, nurses etc)-> their incomes spent in economy-> new incomes also spent
