Fiscal, Monetary, and Supply-side Policies

For OCR Economics: Unit 2 (F582)

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Fiscal Policy

  • Fiscal policy: the taxation and spending decisions of a government.

  • Aim of fiscal policy is to influence Ad.

  • Government can rise AD by increasing its own spend and/ or by reducing taxes.

  • E.g. a cut in income tax will cause an increase in people’s disposable income raising consumption and thus, AD.

  • Reflationary: of policy measures designed to increase AD.

  • Deflationary: of policy measures designed to reduce AD.

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Fiscal Policy cont.

Other reasons for changes in taxation or government spending: 

  • Encourage consumption of merit goods.
  • Discouraging consumption of demerit goods.
  • Altering distribution of income.
  • Altering incentives and simplifying the system.

Government may seek to influence AD to ensure it matches AS, avoid inflation and unemployment.

Discretionary fiscal policy: deliberate changes in government spending and taxation designed to influence AD.                                                                                             

 E.g. government spending on job seekers allowance falls when economic activity rises.

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Monetray Policy

  • Monetary policy: Central bank and/or government decisions on rate of interest, the money supply and the exchange rate.
  • Main monetary policy instrument currently used in UK, USA and the rest of Europe and many others, is the rate of interest.
  • When the central bank increases its short-term interest (also known as the base rate), commercial banks usually change theirs also.
  • Changes in money supply can also be used to influence AD.
  • If the government produces more money or makes it easier for people to get money from the banks then they rate likely to spend more.
  • If a country wants to reduce the exchange rate they can reduce interest rates or sell money.

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Monetary Policy- Limitations

  • High interest rates tend to reduce consumption, but, are likely to encourage foreigners to place money in the UK. This rise in the demand for the pound would then increase the exchange rate, thus reducing exports.
  • Could lead to demand pull inflation- interest rate and quantative easing (supply of money).
  • Household debt - People will spend more, than saving if interest rates are low so may choose to take out loans ("payday") which they can't pay back on savings.
  • Other economies- e.g. EU- one interest rate.
  • Question suverys and costs.
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Supply- side Polices

  • Supply-side policies: polcies desgined to increase AS by improving the efficiency of Labour and product market.
  • Aim to raise macroeconomic performance by improving the performance of particular markets.

Product market:

  • Deregualtion
  • Tarrifs and quotas
  • Subsidies
  • Taxation
  • Privatiastion

Labour market:

  • Education
  • Training
  • National Minimum wage
  • Benefits- if reduce creates an incentive to work.
  • Trade Union reforms.
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