Demand-side policies: fiscal and monetary policy: key terms
16 terms. Say the definition out loud, tap to check, then say whether you knew it. Back to the topic
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Demand-side policy
Government or central-bank action intended to change the level of aggregate demand: fiscal policy through taxation and spending, monetary policy through interest rates and the money supply.
Examiners say The 50-part bank on this topic is mostly 'effects of' questions. Start every chain from the component of AD that the policy moves.
Fiscal policy
The use of government spending and taxation to influence aggregate demand and the economy, set in the Budget.
Examiners say Say which way the budget balance moves and which component of AD changes first.
Expansionary fiscal policy
Higher government spending and/or lower taxes, which raise aggregate demand and widen the budget deficit or reduce the surplus.
Examiners say The evaluation the examiners credit most: the multiplier size, crowding out, the state of the output gap and the effect on the national debt.
Contractionary fiscal policy
Lower government spending and/or higher taxes, which reduce aggregate demand and improve the budget balance; often called austerity when sustained.
Examiners say Link to the objectives it serves (lower inflation, smaller deficit) and the ones it harms (growth, unemployment) for the conflict marks.
Direct tax
A tax on income or wealth paid directly by the person or firm on whom it is levied, such as income tax, national insurance and corporation tax.
Examiners say A one-mark definition: give it in one sentence and move on. Reports note students writing half a page for one mark.
Indirect tax
A tax on spending, collected from the seller and passed on in the price, such as VAT and fuel duty.
Examiners say Defined well in the bank. The follow-up is usually about its effect on inflation (cost-push) or on the distribution of income (regressive).
Budget deficit
The amount by which government spending exceeds tax revenue in a year, financed by borrowing.
Examiners say The most-set definition in this topic. The confusion the reports flag is with the current account deficit, which is about trade, and with the national debt, which is the stock.
Budget surplus and balanced budget
A surplus is tax revenue exceeding spending in a year; a balanced budget is revenue equal to spending.
Examiners say The four-mark version wanted the definition plus a figure from the chart for the year it occurred.
National debt
The total stock of government borrowing outstanding, built up from past deficits, on which interest must be paid.
Examiners say Deficit is the flow, debt is the stock: a percentage of GDP comparison is the usual application mark.
Monetary policy
Action by the central bank to influence aggregate demand through the rate of interest, the money supply and the exchange rate, in the UK to meet the 2% CPI inflation target.
Examiners say Name the target and who sets the rate (the MPC) for the knowledge mark; the application mark comes from the chart.
Bank Rate (base interest rate)
The interest rate set by the Bank of England's Monetary Policy Committee at which it lends to commercial banks, which influences all other interest rates in the economy.
Examiners say The 'define interest rate' question was often missed: it is the cost of borrowing and the reward for saving, expressed as a percentage of the sum per year.
Monetary Policy Committee (MPC)
The nine-member committee of the Bank of England that sets Bank Rate and decides on quantitative easing, meeting eight times a year.
Examiners say The factors it considers were the question: inflation against target, the output gap, unemployment, wage growth, the exchange rate and consumer credit. One factor, explained with the chart, for three marks.
Transmission mechanism of interest rates
The chain by which a change in Bank Rate affects aggregate demand: borrowing costs, saving incentives, mortgage payments and disposable income, asset prices, confidence and the exchange rate.
Examiners say The March 2020 cut to 0.1% question: pick one channel and follow it to a component of AD and then to output or prices.
Quantitative easing (QE)
The central bank creating money electronically to buy financial assets, mainly government bonds, from the private sector, raising their prices, lowering long-term interest rates and increasing the money supply.
Examiners say Say what is bought and from whom; 'printing money' alone is not credited. Evaluation: asset-price inflation and inequality.
Crowding out
The reduction in private-sector spending that may follow an increase in government borrowing, if the extra demand for loanable funds raises interest rates or if the state uses resources the private sector would have used.
Examiners say The standard evaluation of expansionary fiscal policy. At the top level it is qualified: weak when there is spare capacity and interest rates are low.
Liquidity trap and interest-rate limits
A situation in which interest rates are so low that further cuts fail to stimulate borrowing and spending, limiting monetary policy.
Examiners say The 2009–2021 extracts make this a frequent evaluation point: a 0.1% Bank Rate leaves little room to cut.
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