Government policies

Question 1

What is fiscal policy?

Answer 1

spending more or reducing tax to put
money into the economy during downturns or cutting spending / increasing taxes to take money out of people’s pockets and control demand in boom times. The biggest
impact will come from increasing spending rather than cutting taxes since for every £1 of government spending, the government can ensure that £1 enters the economy. On the other hand, if taxes are cut by £1, some of this money may be saved and the economy will not grow by the full £1. Fiscal
policy can influence an individuals investment decisions as a result of tax changes for different assets and companies as a direct result of taxation of profits which in turn influence dividend distribution and decisions around financing
business operations (either via equity or taking on more debt). Alterations to taxation policies can also be used to impact budget deficits.

Question 2

What is monetary policy and what are the affects caused by tightening and easing monetary policy

Answer 2

controlling interest rates and the
supply of money. In the UK the Monetary Policy Committee of the Bank of England sets interest rates. Rising interest rates will reduce what people can afford to spend and reduce demand, curbing inflation. Falling interest rates will reduce debt repayments and hence give people more money in their pockets which they can then spend, stimulating demand and increase inflation. However when interest rates are kept lower than inflation (financial repression) this has a negative effect on retirees who rely on their savings to provide an income. When interest rates are low (and if they are lower than inflation) then this can erode the real value and spending power of their money. The positive for government finances is that low interest rates reduce any deficit there may be by reducing interest payments and increases GDP (as people spend more, inflation)

Question 3

What happens if the BOE misses the 2% inflation target?

Answer 3

They have to write an open letter to the chancellor explaining why and crucially what they are going to do about it. They must do this if they miss it by 1% either above or below the 2% target.

Question 4

Describe easing Monetary Policy

Answer 4

BOE reducing shorter term Interest rates then which in turn reduce longer term rates
if the financial markets agree with their inflation expectations. As a result of this asset prices should rise (e.g. property) which is a perfect cocktail for people and businesses to borrow money and then spend/invest it

Question 5

Describe tightening monetary policy

Answer 5

BOE increases shorter term interest rates. The opposite of easing monetary policy
should occur.

Question 6

What are the problems that can occur when the BOE makes changes to interest rates.

Answer 6

These decisions are not taken lightly as indications and expectations of the future movement of interest rates can
panic the financial markets and where rates are reduced by the BOE this can cause the markets to think that they will fall further, which can influence longer term rates accordingly, to follow suit, conversely the same can happen with a rate rise.