Economics

Demand Side Policies

Policies that aim to influence aggregate demand to reduce unemployment, control inflation, and boost growth.

Fiscal Policy

Policies that involve spending and taxation to influence AD.

Monetary Policy

Adjusting Interest Rates and Money Supply to influence AD.

Nominal in economics

Metric not adjusted to inflation

Nominal Interest Rate

Interest rate not adjusted to inflation

Real Interest Rate

The nominal interest rate minus the rate of inflation

Expansionary Monetary Policy

Monetary policy that increases aggregate demand. Ex: reducing interest rates, depreciating exchange rate, Selling Government Bonds to remove or increase Money Supply.

Contractionary Monetary Policy

Monetary policy that reduces aggregate demand. Ex: Increasing Interest Rates, decreasing/stopping QE, appreciating Exchange Rate.

What makes Expansionary Monetary Policy increase AD?

Lower interest rates cause Increase in Investment and Consumption, which are components of AD.

What makes Contractionary Monetary Policy decrease AD?

Increase Interest Rates, cause decrease in Investment and Consumption. Decrease in Net External Demand, as it is likely to worsen as both exports and imports reduce (exports more expensive due to higher exchange rate and imports cheaper but households have less income for imports).

Net External Demand

Difference between exports and imports.

Benefits of Monetary than Fiscal

1. Faster Implementation

2. Independence from Politics (Controlled by Central Banks)

3. Targets Inflation Directly (Incentive Citizens to Save, and not borrow money to spend)

Weaknesses of Monetary Policy

1. Less Effective during Deflationary Stage (Consumer may not react to Decrease interest Rates due to low consumer confidence).

2. The interest rate has limitations on downward adjustment

The closer it gets to zero the less effective changes. (Even though, there is a limit of how low taxes can go for Fiscal Policies, there is government spending as well.)

Reserve requirement

the percentage of deposits that banking institutions must hold in reserve.

Open Market Operations

The buying and selling of government securities to alter the supply of money.

Quantitive Easing

Where Central Banks create new electronic money to buy Government bonds from commercial banking to make it easier to lend money to businesses and consumers. (Encourage more lending, Investment, and spending)

Impact of Open Market Operations on Economy.

Injects or withdraws money from circulation.

Impacts Interest Rates by increasing commercial banking reserves → Increasing Lending Capacity for CB → lowering Interest Rates.

Impacts Interest Rates by increasing commercial banking reserves → Increasing Lending Capacity for CB → lowering Interest Rates.

Expansionary Fiscal Policy

An Increase in government spending or taxation to control Aggregate demand.

Contractionary fiscal policy

Increasing taxation and reduction in government spending to reduce AD.

Sources of Government Revenue

1. Indirect and Direct Taxation

2. Sales of Good and Services

3. The sale of government owned assets

2. Sales of Good and Services

3. The sale of government owned assets

Categories of Government Expenditure

1. Current Expenditure

2. Capital Expenditure

3. Transfer Payments

Current expenditure

Government spending on the day-to-day running of the public sector, including raw materials and wages of public sector workers.

Capital Expenditure

money spent by a business or organization on acquiring or maintaining fixed assets, such as land, buildings, and equipment.

Transfer Payments

Payments by the government to households for which the government does not receive a new good or service in return. Ex: Unemployment Benefits or disability payments.

Keynesian Multiplier

Ratio of change in real income to the injection that created the change (1 / 1 -MPC)

The multiplier process

The idea that one individual's spending is another individual's income.

Marginal Propensity to Consume (MPC)

Measures how much of any extra income you receive you will spend on consumption. MPC = (Saving, Taxation, imports.)

Factors that affect MPC

1. Change in Taxes (Increase = multiplier reduces)
2. Interest Rate (Increase = Saving, Consumption decrease
3. Confidence in the economy (consumption Increases)
4. More Money Spent on Imports = lower multiplier

2. Interest Rate (Increase = Saving, Consumption decrease

3. Confidence in the economy (consumption Increases)

4. More Money Spent on Imports = lower multiplier

Imports

Goods produced abroad and sold domestically -Economy

Exports

Goods and Services sold to other countries. +For Economy

Strengths of Fiscal Policy

1) Pulling an economy out of a deep recession.

2) Dealing with rapid and escalating inflation.

3) Redistribute Income

Automatic Stabilizers

Automatic Fiscal Changes that occur while economy moves through the buisness cycle.

Weakness of Fiscal Policy

1. Political Pressures (Policies fluctuate when new governments are elected. Ex: Infrastructure Projects)

2. Unsustainable Debt

3. Time Lags: (Takes time to plan and implement)

Crowding out

Government spending, can result in a reduction of private sector spending or investment. → Government competes with others who want to borrow → Competition causes Interest rate to rise and Investment to decrease