Eco - Monetary and Fiscal policies

what are the three main types of policies to achieve government macroeconomic goals

monetary, fiscal and supply side policies

what do fiscal policies deal with?

• taxation

• govt spending

• govt borrowing

what is fiscal policy

fiscal policy is the use of government spending and taxation to influence the economy.

in fiscal policies what will the government spend tax on?

public goods, e.g) schools, roads, or healthcare

what is expenditure

Expenditure is the money the government spends on public goods, services, and programs to help manage the economy and provide services to citizens.

Fiscal: if government doesn’t have enough tax revenue to spend on public goods what will they do?

they will have to borrow to fund this expenditure

what is tax revenue

Tax revenue is the money that a government collects from taxes paid by individuals and businesses.

what is budget deficit?

Expenditure is greater than tax revenue

what is budget surplus?

tax revenue is greater than expenditure

what is balanced budget?

tax revenue is equal to expenditure

what is cyclical budget deficit?

budget deficit is caused by a decline in economic activity

what is structural budget deficit?

government is spending too much compared to how much tax revenue it has

what is a recession?

2 quarters of negative economic growth

if the economy is in a recession what will govt do?

govt will borrow and spend on public goods to create jobs

how does govt spending on public goods take an economy out of recession?

there will be an increase in GDP meaning economic growth will take place and the economy will eventually move out of a recession

what will govt do if the economy is in a boom phase

govt will cut expenditure and burrowing or they will increase tax

what is national debt?

the amount owned by a country to banks or other countries

what is the national debt usually expressed as?

its usually expressed a s a percentage of GDP

if NZ’s national debt is 35% what do we owe?

we owe 35c for every $1 produced

finish the sentence:

if Government has a……………..in one year it will add to a country’s national debt

budget deficit

finish the sentence:

extra revenue earned from …………….. can be used to pay off parts of the country’s national debt

budget surplus

when does national debt tend to increase

during a recession since govt spends more to save jobs and stimulate the economy

when there is military conflict what happens to the national debt

it increases significantly

what are the 5 disadvantages of national debt:

1) the country must pay interest on the national debt

2) oppurtunity cost: this interest could’ve been used for public goods

3) large national debts make banks, individuals etc reluctant to lend

4) borrowing large amounts push up the interest rate - foreign banks will charge more

5) we will have to pay off the debt leading to a large outflow of money within the country

what is tax avoidance

legal methods used to pay less tax

what is tax evasion

illegal methods used to pay less tax

what are 4 reasons for taxes

1) the marked has failed so we need to raise revenue to spend on public goods

2) to reduce or increase AD

3) progressive tax can be used to redistribute income from the rich to the poor

4) to discourage the consumption of demerit goods

what is current govt spending?

payment for state services

e.g) salary of a nurse at a public hospital

what is capital govt spending?

capital items:

public schools, hospitals and prisons

what is exhaustive govt spending?

Current + Capital govt spending

what is non exhaustive govt spending?

spending on social welfare

what are some reasons for govt spending?

1) to stimulate AD

• recession = +AD : boom = -AD

2) to increase AS - building of schools and heath facilities

3) to ensure people have a basic level of income, unemployed - dole

4) to spend on merit goods to overcome market failure

5) to win political popularity

what does expansionary fiscal policy aim to do

increase Aggregate demand

when is expansionary fiscal policy used?

in a recession when AD is low

how will govt use expansionary fiscal policy

by:

• cutting taxes

• increase spending

• increase borrowings and govt spendings

when is contractionary fiscal policy used?

used in an economic boom

what is the aim of the contractionary fiscal policy?

to lower Aggregate demand

how will the govt use the contractionary fiscal policy

• increase tax

• decrease govt spending

• decrease govt burrowing

what is discretionary fiscal policy?

when govt changes its policies it will alter its expenditure

e.g) desire to raise literacy levels - govt spends more on public schools

why might the contractionary fiscal policy not always work?

1) workers fighter for pay rises = cost of production rises

2) workers work fewer hours - GDP is not at full potential

3) People leave for countries with lower tax rates - brain drain

what is the successful outcome of the expansionary policy?

it stimulates GDP and creates job

what does the success of the expansionary policy dependent on?

1) it wont be effective if consumers and firms are worried about the future - they will not spend or invest

2) govt may overspend creating demand pull inflation

what is demand pull inflation

Demand-pull inflation is a rise in prices that happen when the demand for goods and services is higher than the supply

what is an automatic stabiliser?

forms of govt spending and taxation that change w/o any deliberate govt action, happens due to market changes

• they are used to stimulate AD

when will a budget deficit dissapear?

if there is a rise in govt tax revenue

or a reduction in govt spending

what is monetary policy?

use of interest rates, money supply, credit regulations and exchange rates to increase or decrease aggregate demand

what are the four aspects of monetary policy?

1) the reserve bank changing the rate of interest in the economy

2) changing the money supply

3) influencing the exchange rate

4) applying credit regulations

why does when the reserve bank changing the rate of interest in the economy stimulate AD

• used when inflation is rising, the reserve bank will raise interest rates to banks

• banks raise interest rates for homeowners, people pay more for thier house loans and they will have less money to spend - deman decreased and proces fall

when will the reserve bank drop interest rates

when inflation is falling

how does changing the money supply stimulate AD

• during a recession, the central bank will also target monetary supply to stimulate ad

• They will lend more money to commercial banks who will then lend more readily to the public

when will central banks curb lending to commercial banks

during a period of boom or inflation

how does influencing the exchange rate stimulate AD

• in extreme circumstances, the govt may raise exchange rates so overseas goods become cheaper to increase AD

• the govt may lower the exchange rate so overseas goods become more expensive to lower AD

how does applying credit regulations stimulate AG

• Setting minimum deposit (down payment) requirements for loans.

• Limiting how much banks can lend.

• Setting rules on who qualifies for loans.

• Requiring banks to keep a certain amount of money in reserve.

what does the expansionary monetary policy aim to do?

aims to increase aggregate demand

how does the expansionary monetary policy aim to increase aggregate demand?

• by reducing interest rates

• increasing money supply

what does the contractionary monetary policy aim to do?

aims to decrease aggregate demand

how does the contractionary monetary policy aim to decrease AD

• increasing interest rates

• decreasing money supply

what do monetarists argue?

that the only way to control inflation is by controlling money supply

what is the RBNZ’s target for inflation

1-3%

what happens if inflation rises beyond 1-3%

the govt will raise interest rates (contractionary monetary policy)

what is money supply?

Money supply is the total amount of money available in an economy at a given time. It includes cash, coins, and money held in bank accounts that people and businesses can use to make purchases.

Why might a rise in the OCR not reduce consumer spending?

Commercial banks are not required to raise their interest rates when the RBNZ raises the OCR. If borrowing costs do not increase much, consumers may continue spending.

Why might consumers continue spending even when interest rates rise?

If consumers are optimistic about the future (higher incomes, secure jobs, economic growth), they may continue spending despite higher borrowing costs.

How do higher interest rates affect business investment

• Borrowing becomes more expensive.

• Businesses delay expansion.

• Businesses buy less new equipment.

• Investment falls.

How can higher interest rates affect aggregate supply (AS)?

Higher interest rates reduce business investment, so businesses expand less. This can reduce the growth of aggregate supply.

What happens to savings rates when the OCR rises?

anks usually increase savings interest rates, making saving more attractive.

Why can higher interest rates increase the exchange rate?

Higher interest rates attract overseas investors seeking better returns. They buy NZ dollars to invest, increasing demand for the NZ dollar and causing it to appreciate.

What is the effect of a higher exchange rate on imports?

A higher exchange rate makes imported goods cheaper, so imports are likely to increase.

Explain the chain of events after the RBNZ raises the OCR.

OCR ↑ → Loan and savings interest rates ↑ → Overseas investment in NZ ↑ → NZ dollar appreciates → Imports become cheaper → Imports increase.

why might expansionary monetary policy not always work?

people and firms dont spend more bc their pessimistic about the future

• if interest rates are already low, any reduction will have no effect

• the RBNZ may print and distribute money to banks, but banks may not be able to lend since they dont have credit worthy customers

what is the effect of expansionary monetary policy on national income, real output and employment

if the economy isn’t operating at full employment then cutting interest rates and increasing money supply will result in increased output with smaller increased to overall prices

what is the effect of the contractionary monetary policy on national income, real output and employment

raising interest rate, reducing money supply will reduce national income, reduce output and reduce emplyoment

what is the effectiveness of the monetary policy in terms of money supply?

its difficult to control money supply since banks have an incentive to lend more since they make more profit

• they will try to get around the restrictions the RBNZ puts on their lending ability

what is the effectiveness of the monetary policy in terms of interest rates

time lags - it takes time before people slow down spending when interest rates are raised

when is the monetary policy ineffective

if some people and firms pay the higher interest rates and continue spending at the same level