Monetary Policy (Macroeconomics)

Monetary policy, liked with fiscal policy is another tool the government can use to control the economy. Monetary policy involves the use of exchange rates, interest rates and the money supply to manage the economy.

Firstly, interest rates. These are set by the MPC and are mainly used in the U.K to try and achieve the inflation target of 2.0%. The theory is that a reduction in interest rates will give consumers more disposable income through lower loan repayments and this will boost the consumption factor of Aggregate Demand. Also, it should make businesses take out loans more willingly as borrowing money becomes cheaper and thus the investment factor of Aggregate Demand will rise also. Overall, a fall in in interest rates should create a rise in the real GDP of the country. It works the opposite way with a rise in interest rates, this should reduce the real GDP of the country as well as control inflation.

Interest rate changes also effect the Balance of Payments. Interest rates in the U.K. rising will cause a flow of 'hot money' into the economy as people will benefit from the higher returns of putting their money in the U.K. This flow will increase the demand for the pound, so the value will appreciate. The knock on effect of an appreciation in the value of the pound is that our exports become more expensive and it becomes cheaper for us to import goods. This will worsen the Balance of Payments. Obviously, the opposite will occur with a fall in interest rates.

Exchange rates was another tool under the title of 'Monetary Policy'. By managing the exchange rate, the Bank of England can buy and sell pounds to influence the exchange rate. This will control the competitiveness of U.K. exports and therefore help control the Balance of Payments. However, the government doesn't generally take this approach as they let the free market determine the value of the pound. One instance where this is sometimes done is in China.

The final tool under the 'Monetary Policy' heading was the money supply. This is where the government can increase or decrease the amount of money in the economy. The idea behind increasing the money supply is that it should stimulate Aggregate Demand as people have more money to spend and businesses have more money to invest. However, this method is very inflationary and is widely avoided. Decreasing the money supply will have the opposite effect to the above.

That's it, the three parts involved in the 'Monetary Policy' tool the government has at its disposal. Thanks for reading.

Fiscal Policy (Macroeconomics)

Right, this post will discuss the basics of fiscal policy. Basically, fiscal policies are any policies that relate to government spending and government taxation - the government uses these two tools to manage the economy and redistribute resources.

The budget plays a big part in fiscal policies. Depending on what fiscal policies have been employed by the government depend on the position of the budget. If the government spends more than it receives through tax receipts then it will have a budget deficit. If it receives more than it spends then there will be a budget surplus.Two other terms that come about when talking about the budget are the following:

• Public Sector Net Cash Requirement (or PSBR) - This is an account of how much the government has to borrow in order to balance the budget.
• Public Sector Debt Repayment (or PSDR) - This is when the budget is in surplus and the government can pay back some loans.

When using taxation as a fiscal policy, the government can change the rates of direct taxation or indirect taxation. Direct is tax paid straight from the income, wealth or profit of individuals or firms (income tax or corporation tax). Indirect is tax paid on goods and services (VAT or council tax).

The effects of fiscal policies are as follows, generally:

• A rise in taxes / a cut in government spending leads to a fall in aggregate demand.
• A cut in taxes / a rise in government spending leads to a rise in aggregate demand.

Now for the rules. "The Golden Rule" is a rule relating to the Labour parties thoughts that fiscal policy should be stable and consistent. This rule states that tax receipts should cover all government spending and that borrowing by the government should only be done for investment purposes. This rule applies over an economic cycle, not on an annual basis.

Another rule is the "Sustainable Rule". This states that government debt should be kept at a stale level. This means that debt shouldn't rise above 40% of GDP, this target is to be met every year.

Fiscal policy basics complete. Thanks.