DEMAND SIDE POLICIES
MONETARY POLICIY
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FISCAL POLICIY
Definition : set of gov policies relating to expenditures and taxation rates
AIMS
maintenence of low and stable rate of inflation
low unemployment rate
reduce fluctuation of business cycle
promote equitable distribution of income
CONSTRAINTS
TWO TYPES
EXPANSIONARY FISCAL POLICY - increase AD
CONTRACTIONARY FISCAL POLICY - reduce AD
greater investment : lower corporate taxes
increase gov spending
greater consumption : lower income taxes
sustainable debt
effect on net exports
political pressure
crowding out effect
time lags
inability to achieve specific targets
COST OF HAVING HIGH GOV DEBT
interest increase - effect on areas of sending
high taxation to fund expenditure
crowding out of private investment
decrease ability of gov to respond to emergencies
definition : set of official policies governing the supply of money and level of interest rate in economy
interest rate
base rate (discount rate or prime rate) - set by central bank
AIMS
low unemployment rate
stable economic environment for long term growth
reduce fluctuations in business cycle
TYPES
EXPANSIONARY MONETARY POLICY - increase AD
CONTRACTIONARY MONETARY POLICY - reduce AD
lower base of interest rate - reduce cost of borrowing and lead to increase in in consumption and investment
increase supply of money - lower its price
shift in AD to the right
iinflationary pressure as average prive level rise
increase in real output - increase in national income, economic growth, decrease unemployment
STRENGTHS
no political intervention - central bank adjust it which is usually independant
absence of crowding out
quick to put into place
ability to make small changes
LIMITATIONS
ineffectiveness when interest rates are low - eventually approach zero and no room left for further cuts
low consumer and business confidence
time lags - take time to have effect one conomy
TOOLS TO CONTROL MONEY SUPPLY
OPEN MARKET OPERATION
CHANGES IN CENTRAL BANK MINIMUM LENDING RATE
MINIMUM REVERSE REQUIREMENT
QUANTITATIVE EASING
larger minimum reverse requirement, smaller money multiplier
to reduce money supply : increase minimum reserve requirement
reduce ability of banks to create credit so reduce money supply
buying or selling of gov securities (bond) in open market by central bank
reduce money supply : sell more bond
reducing money that commercial banks have to lend
fall in supply, cost of borrowing increase and interest rate, the price of money increase
base rate, discount rate or refinancing rate
rate of interest which central bank charges n loan and advances to commercial banks
contractionary : rase minimum lending rate
banks and financial institutions increase lending rates and interest paid to people who save
discourage consumers and business from borrowing and encourage saving
reduce consumption and investment, redusing AD
Introduction of new money
form of expansionary
process
central bank inject new money directly by purchasing assets from commercial banks and financial institutions with newlu created electronic cash
effects
lower interest rates - reduce debt, increase consumer and business confidence
lower interest rate - exchange rate fall, export less expensive and import expensive, increase in (X-M)
increase reserves of commercial banks - increase liquidity and ecourage to lend more to households and firms, increasing consumption and investment