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Demand Side Policies (Minimim Reverse Ratio (The reserve ratio is the…
Demand Side Policies
Minimim Reverse Ratio
The reserve ratio is the portion of depositors' balances that banks must have on hand as cash as a means of avoiding insolvency.
The purpose of having a minimum reserve is to restrict commercial banks' ability to create too much credit through excessive lending and to assure prudence to avoid a 'run on the bank'.
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The required reserve ratio is sometimes used as a tool in monetary policy, influencing the country's borrowing and interest rates by changing the amount of funds available to banks to make loans.
Bank lending is also restricted by capital requirements, which are arguably more important than reserve requirements, even in countries that have reserve requirements.
Capital requirements govern the ratio of equity to debt, recorded on the liabilities and equity side of a firm's balance sheet.
They should not be confused with reserve requirements, which govern the assets side of a bank's balance sheet - in particular, the proportion of its assets it must hold in cash or highly-liquid assets.
Monetary Policies
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An increase in interest rates, while intended to control inflation, might have the effect of attracting 'hot money' into the economy.
This may make the exchange rate stronger, or simply destabilise it.
While a stronger currency might help to control AD (exports become less competitive and imports relatively cheaper), these effects are not guaranteed. Increasing interest rates is often seen as being damaging to the supply side of the economy.
Monetary Aggregates
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In the United States and the UK, these are classified as 'narrow money', those most liquid of funds, and broad money, those funds which can be spent but not immediately.
The standardised monetary aggregates are labelled M0 (physical paper and coin),
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M2 (all of M1, money market shares and savings deposits)
an aggregate known as M3 (which includes time deposits and institutional funds) has not been tracked by the Federal Reserve since 2006 but is still calculated broadly by analysts.
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Fiscal Policies
Fiscal policy involves the government changing the levels of taxation (T) and government spending (G) to influence the level of Aggregate Demand (AD) and the level of economic activity.
The Purpose of Fiscal Policy
Stimulate economic growth in a time of recession
Keep inflation rates low and within target
Stabilise the level of economic growth (the bath water!), to avoid periods of boom followed by periods of recession ("Boom and bust")
Problems:
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in the long run it is thought that spending in these areas would help to improve the supply-side conditions in an economy.
The investment by a government on the infrastructure of an economy, the educational establishments or the health infrastructure will also have a direct impact on the costs of production of firms.
Overspending by governments may mean that there is a shortage of credit in the financial markets, and the shortage of liquid assets will push up the cost of credit - that is, the interest rate, so reducing private sector borrowing and investment.
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