27/01/15
Lesson 2: Gov. & Central Bank
Learning Objective: I can explain how governments can use monetary and fiscal policy to alter the level of AD in an economy.
DA: Illustrate an AD diagram and explain how it can shift left or right.
Governments have two broad categories of policies available to affect level of AD:
- Fiscal
- Monetary
Fiscal = Set of government's policies relating to its spending and taxation rates (direct/indirect). Governments use expansionary fiscal policy to increase aggregate demand and contractionary, or deflationary to reduce AD.
Expansionary
- Encourage greater consumption, lower income taxes and increase disposable income, increase AD.
- Encourage greater investment, lower corporate taxes so that firms enjoy higher after-tax profits that can be used for investment, increase AD.
- Government investment projects to improve or increase public services, increasing AD.
Monetary = Set of official policies governing the supply of money in the economy and the level of interest rates.
- Controls money supply
- Primary responsibility is to maintain a low stable rate of inflation. Federal Reserve currently have a target of 2% inflation (.7%).
- Expansionary or loose monetary policy = low interest rates, increase AD
- Contractionary or tight monetary policy = higher interest rates, decrease AD
SWP 14.8: Decide whether the following would lead to an increase or decrease in AD, explain which component(s) are in question and why.
- Fall in house prices.
- Rise in consumer confidence
- Increase in foreign incomes
- Fall in the consumer confidence index
- Decrease in interest rates
Activity: Identify and summarize a real world example of how fiscal and monetary policies have been used in the past (150-200 words).
Exam questions: Complete all four exam questions. Two will be selected for the exam.