Macroeconomics: Fiscal and Monetary Policies (Evaluation of fiscal policy:…
Macroeconomics: Fiscal and Monetary Policies
Involves changing the interest rate or manipulation of the money supply by the monetary authorities.
In the UK monetary policy is managed by the BOE's, Monetary Policy Committee (MPC)
Aims of monetary policy
Control the rate of inflation
Maintain sustainable economic growth / low unemployment
Influence the exchange rate (not so important)
Uk monetary policy
Every month, the MPC meets to decide future interest rates.
If they feel that inflation is likely to go above target they will increase interest rates to moderate demand and keep inflation low.
If they feel that inflation is likely to fall below target they will likely lower interest rates to boost economic growth.
Effect of higher interest rates (tight monetary policy):
The cost of mortgages increases, therefore people have less disposable income, causing a fall in consumption. Therefore AD decreases
Saving money in a bank is more attractive, therefore there is less spending and relatively more saving
Make borrowing more expensive, therefore people spend less on credit. Firms will also be less willing to invest by borrowing money
Exchange rate increases, with higher interest rates, it's more attractive to save in UK banks. This increases the demand for the British Pound and increasing the exchange rate. A higher exchange rate will reduce the demand for (X-M) because exports are more expensive and imports cheaper.
Expansionary fiscal policy (Loose fiscal policy)
This involves lower tax rates and / or higher government spending, with the I'm to increase AD
Expansionary fiscal policy is likely to be used during a recession, when there is a negative economic growth
Expansionary fiscal policy will increase AD and increase the size of the budget deficit. It may also cause inflation, especially if economy is close to full capacity
In a liquidity trap, monetary policy can become ineffective. In this case, a government may use expansionary fiscal policy.
Evaluation of monetary policy:
Other components of the economy
such as if confidence is low or if taxes are rising.
there are may be time lag for lower interest rates to have an effect.
The effect of interest rates depends on the situation of the economy.
Such as if the economy is close to full employment.
Conflicts of objectives.
Monetary policy may conflict with other macroeconomic objectives. If MPC reduces inflation, this may lead to lower growth or higher unemployment.
Is the government's attempt to influence AD through changing spending and tax levels.
The aim of fiscal policy:
Maintain low inflation
Stimulate economic growth in a period of recession
Deflationary fiscal policy (tight fiscal policy):
The aim of deflationary fiscal policy is to decrease AD and inflation
Deflationary fiscal policy will also improve the budget deficit
This involves higher tax rates and / or lower government spending
Evaluation of fiscal policy:
It depends on other components of AD
. For example, if the government cuts income tax to increase AD, it may be ineffective if consumer confidence is low
Disincentives to work.
Higher income tax to reduce inflation can create disincentives to work, reducing productivity and AS
may reduce the accuracy of forecasting future economic growth and inflation
involved in influencing AD
, fiscal policy can also influence the supply side of the economy. If successful this can influence AD