3.3.5, 3.3.6

Monetary Policy

money in the economy
Using money supply
Using interest rates

Fiscal Policy

The way the government manages the economy
Using government expenditure
Using tax rates

What do monetary and fiscal policy share?

Both seek to influence aggregate demand
In a recession → they use expansionary policy to increase AD
In an inflationary period → they use contractionary policy to decrease AD

Central bank

Determines the money supply and interest rate
Prints physical money and mints coins
Lender of 'last resort'
Issues bonds and other financial instruments
Regulates the banking system

tools of fiscal policy

Raise revenue through taxes
Indirect Taxes (on goods and services)
Direct Taxes (on income)
Sales of goods and services from state owned companies
Sale of government assets
Government expenditure

Monetary supply

Can fix quantity of money supplied at Q1 or Q2
Therefore, the more money supplied, the lower the interest rate
Lower interest rates help increase AD
Increasing money supply helps in recessions (C, I)
Prints physical money, increase money in align with GDP
Replace physical currency
Lender of last resort means that they can provide credit if there is a bank run
Can sell bonds to raise money for the government
Also regulates banking industry, sets reserve requirements, which is how much physical cash banks must carry

Limitation of Monetary Policy

If interest rates are close to 0 then we can’t exactly use expansionary monetary policy
If there is low business confidence, then any change in the interest rate will not necessarily increase investment or consumption

Strengths of Monetary Policy

Interest rates are flexible, and easy to adjust
Can be quick, and easily reversible

Goal of fiscal policy

Same as our macroeconomic objectives
Reduce fluctuations in the business cycle
Equitable distribution of income
Create conditions for stable, long-term growth

Limitations of Fiscal Policy

Politics
Time lags
Debt

Crowding out

When G replaces I → therefore, the increase to AD is not as large as thought
Government spending and projects replaces the private sector

A strength of fiscal policy

It’s easy to specifically target groups of people