3.3.5, 3.3.6
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Last updated 12:02 PM on 12/5/22
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12 Terms
1
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Monetary Policy
money in the economy
Using money supply
Using interest rates
Using money supply
Using interest rates
2
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Fiscal Policy
The way the government manages the economy
Using government expenditure
Using tax rates
Using government expenditure
Using tax rates
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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
In a recession → they use expansionary policy to increase AD
In an inflationary period → they use contractionary policy to decrease AD
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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
Prints physical money and mints coins
Lender of 'last resort'
Issues bonds and other financial instruments
Regulates the banking system
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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
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
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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
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
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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
If there is low business confidence, then any change in the interest rate will not necessarily increase investment or consumption
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Strengths of Monetary Policy
Interest rates are flexible, and easy to adjust
Can be quick, and easily reversible
Can be quick, and easily reversible
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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
Reduce fluctuations in the business cycle
Equitable distribution of income
Create conditions for stable, long-term growth
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Limitations of Fiscal Policy
Politics
Time lags
Debt
Time lags
Debt
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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
Government spending and projects replaces the private sector
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A strength of fiscal policy
It’s easy to specifically target groups of people