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Fiscal Policy AND Monetary Policy
Page: 125-133
Fiscal Policy: is concerned with decisions about government expenditure,
tax rates and government borrowing. These operate largely through the
government annual budget decisions.
Social security, health service, education, defence, law and order
They use Tax to pay for these services such as – income tax, value added tax , corporation tax
Spending and Tax plans for governments = difference between them is
called either budget deficit or budget surplus
Government budget deficit: the value of government spending exceeds revenue from
taxation
Government budget surplus: taxation revenue exceeds the value of government spending.
Raise government
spending
Increase in aggregate demand
Recession
Lower tax rates
When Fiscal policy matters
Increase in output and employment
Reduce Government spending
Reduction in aggregate demand
Boom
Raise Tax rates
When fiscal policy matter
Reduce output, employment and inflation
Monetary Policy: is concerned with decisions about the rate of interest and the supply of
money in the economy
Decisions about interest rates and
supply of money
The most likely effect on the economy by using this method
would an increase in interest rates
The impact of higher rates will be:
• Highly geared business cash flow will be highly effected by
high interest rates
• Business would most likely borrow less due to high interest
rates
How else will this policy effect us?
Fiscal policy: concerned with government spending - as mentioned before.
Decisions about government spending, taxes, and borrowing
• Raise direct tax rates
• Raise indirect tax rates
• Reduce government spending
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Consumers disposable income would fall
Demand for products will fall
Business profit would decline
Retail prices of goods will increase
Exchange rate policy: Should it ‘float’ be ‘fixed’ or join a ‘common’ currency as euro
Why doesn’t the United Kingdom join the euro?
Disadvantage of floating or benefits of joining a common current
• Frequent appreciation and depreciation of a currency against others
which many cause many problem across different industry ( See
page:128 figure 7.8)
• Fluctuating prices of imported raw materials and components, making
cost of products difficult.
• Fluctuations in export prices and overseas competitiveness, which lead
to unstable levels of demand.
• Uncertainty over profit to be earned from trading abroad or from
investing abroad- the value of overseas assets also varies with currency
fluctuations.
If you Join a Common currency then
• All the suppliers would have the same currency
• Movement in the market would be come much easier and quicker
• Comparison between goods and services would become much easier across
different countries
• The world economy has become increasingly dependent on overseas
investment, much of it in the form of foreign factories and offices. The
danger is that if the currency continues to float and if the common currency
is not adopted, much of this foreign investment could be lost to countries
with a common currency where there will be fewer exchange rate risks and
costs
• Business strategy may have to adapt to the country remaining outside the
common currency. So we could say that in order to avoid the currency costs
and risks, the UK businesses that trade extensively in Europe may decide to
relocate into a Eurozone country.
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