Fiscal & Monetary Policy

Question 1

Fiscal Policy

Answer 1

Actions taken by government to stabilise the business cycle (stimulating or limiting growth, taking expansionary or contractionary stance).
They do this through changes in taxation and government spending.

Question 2

Pros of Fiscal Policy

Answer 2

Short response-lag
Can address supply-side issues as well as increase aggregate demand
Can target speific areas of the nation
Can stimulate economy further where monetary policy can’t

Question 3

Cons of Fiscal Policy

Answer 3

Time lag between recognition of problem and implementation of solution (don’t meet too often)
Political constraints - political pressure or bias
Budget restrictions
Crowding out: If more government borrowing, interest rates increase and private investment ⬇

Question 4

Discretionary fiscal policy

Answer 4

Government deliberately changes the tax rate to influence aggregate demand.

Question 5

Non-Discretionary fiscal policy

Answer 5

Pre-existing spending & tax policies that don’t require new legislative action to take effect. Triggered by changes in economic conditions

Stabilises economy without government intervention.

Question 6

Monetary Policy

Answer 6

RBA manipulates cash rate to influence the 3 main objectives, the banks change the interest rates to maintain profit or remain competetive.

inflation (price stability), full employment, economic welfare

Question 7

Pros of Monetary Policy

Answer 7

Quick decision making - RBA meet every month except January
No political influence
Broad nationwide impact (though this is also a con)

Question 8

Cons of Monetary Policy

Answer 8

Significant response-lag
Can’t be targeted to specific industries/areas
Limited effectiveness when lowering cash rate. Can’t stimulate the economy past 0 interest. -> this is where fiscal comes in

Question 9

The crowding out effect

Answer 9

When government borrows excess money, it is harder for private sector to borrow because the supply of money decreases. Hence private investment decreases.

higher interest rates = expensive to invest.

Question 10

Wealth Effect

Answer 10

When prices are low, greater purchasing power, GDP expansion
More money moving through the economy.

Question 11

Interest Rate Effect

Answer 11

The change in interest rates offered by banks relative to the cash rate

Increase to maintain profit margins, decrease to remain competetive

Question 12

Foreign Exchange Effect

Answer 12

Strong currency = cheap to invest overseas, but lower returns.
Speculative investments play a role, high inflation is risky due to lower purchasing power and potential future depreciation.
But cheap currencies with potential to appreciate during the investment period sparks investor interest