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Section 9 - Macroeconomic policy intstruments - Coggle Diagram
Section 9 - Macroeconomic policy intstruments
Monetary policy
Controlling money
Decisions about interest rates, money supply and exchange rates
Contractionary - reducing AD using high interest rates, restrictions on money supply and strong exchange rate
Expansionary - increasing AD using low interest rates, fewer restriction on money supply and weak exchange rate
Ensure price stability
MPC
Monetary policy committee
Sets interest rates in order to meet the 2% inflation target
Independece for the governments means rates can't be set at a level that wins votes
MPC looks at house prices, echange rates and output gaps
Factors considered
Unemployment rate - high unemployment means consumption is lo,w so MPC will drop interest rates
Savings rate - high savings rate causes interest rates to fall
Consumption - high consumption could lead to inflationary pressures, so MPC would increase interest rates
High commodity prices - could lead to cost-push inflation, so interest rates would increase
Exchange rate - weak pound makes UK exports cheap, an net exports would increase, so MPC might increase interest rate
Markets
Bank rate - lowest rate at which the Bank of England will lend to financial institutions
Increase in bank rate can lead to interest rates on mortgages and bank loans increasing
Bank often borrow money that they lend to firms. If lots of banks try to borrow at the same time, they'll have to pay higher interest rates themselves
Exchange rate
High interest rates led to financial institutions wanting to buy the pound to put money into UK banks
Hot money - short term movement of money
Increased demand for the pound causes prices to go up
Higher exchange rate makes UK exports more expensive
Balance of payments worsen
Low exchange rate
Reduction in exchange rate causes exports to become cheaper
Exports increase
Imports become more expensive, so the current account deficit improves
Imported materials increase in price, production cost to firms increase, which causes cost-push inflation
Interest rates
Future
Reducing interest rates won't cause sudden urge in consumption
Bank of England has to look up to two years into the future when its making decsions about interest rates
Changing interest rates takes tme to see effects
Used to help meet the government target of price stability
Bank controls the base rate, which ultimately controls the interest rates across the economy
High interest rates, high reward for saving, and high cost for borrowing
Low interest rates, low reward for saving, and low cost for borrowing
Quantitative easing
Necessary to adopt a loose monetary policy to stimulate AD when interest rates are already low
Increases the monetary supply which enable individuals to spend more
BOE creates new money and uses it to buy financial assets - mainly governmetn bonds
Using QE to bring up the rate of inflation keeps to currency week and increases competitivenss, which boosts exports
Boosts overall confidence
However, if financial institutions only lend it when the economy improves, then there might already be increased inflation, and demand-pull inflation may be harder to control
More demand leads to higher price for assets, this leads to a lower yield on government bonds
Bond price goes up, since interest rates are fixed, percentage yield of government bonds decrease
Interest rates go down lead to increased cash in the bank system and stimulate AD
Supply side policy
Basics
Expand the productive potential of an economy, make it more robust/ flexible
Governments create the right conditions to allow market forces to create growth
Structural changes are mad allowing higher efficienvy/ productivity
Free market supply-side policy - increase efficiency by removing things which interfere with the free market like privatisation and tax cuts
Interventionist supply-side policy - correcting market failure by increasing government spending on education, subsidies for research
Aims
Increase incentives by encouraging spending
Promote competition, reducing monopoly power and improve economic efficiency
Reform the labour market, by reducing trade union power which makes workers less restrictive. They could also subsidise relocation of workers to improve geographical mobility
Improve skills and quality of the labour force - subsidise training and spending more on healthcare can improve the quality of labour force
Improve infrastructure - improve roads and schools
Limitations
Not as good as demand side policies as dealing with cyclical unemployment which can reduce the size of a negative output gap
Significant time lags
Reducing the rate of tax could leads to a more unequal distribution of wealth