University of Chicago
Type of paper: Thesis/Dissertation Chapter
Analyse and Evaluate the significance of Fiscal Policy rules
L1. Monetary policies are where the government use changes in the base rate of interest to influence the rate of growth of aggregate demand, the money supply and ultimately price inflation.
In the short run economic growth is an increase in real GDP, In the long run economic growth is an increase in productive capacity (the maximum output an economy can produce)
Economic Stability – the avoidance of volatility in economic growth rates, inflation, employment and unemployment and exchange rates.
International Competitiveness – The ability of an economy’s firms to compete in international markets and, thereby, sustain increases in national output and income.
L2. Monetary policies can be used to promote economic growth, Economic (this stability reduces uncertainty, promotes business, consumer confidence and investment) and International Competitiveness. This causes an ? in AD, which can be good for an economy. For example if a Government ? interest rates, people will have an ? in disposable income, because payments on credit cards will ?, mortgage payments will ? and it is not worth saving due to the reduced rate of interest, meaning they have more to spend on goods and services, thus AD ?.
L3. Monetary policies can promote economic growth and stability and international competitiveness as changes in the interest rate affects Domestic Demand (Consumer Expenditure, Investment and Government Spending) and National Demand (Net Exports) via Exchange Rates as when the interest rate ? so the does the currency’s strength. So if the rate of interest increases, so does the strength of the pound, meaning that there is an ? in international competitiveness as more economies want to purchase our currency. This causes an ? in AD causing the AD curve to shift to the right, from AD1 to AD2. Causing and ? in employment, ? production and ?economic growth, ?international competitiveness and ?international competitiveness
If economic growth becomes too rapid it can also be dampened nby an ? in interest rates causing AD to ? due to the fact that their credit card charges and mortgages have ? and it has become more worthwhile to keep money in the bank and reap the rewards from a higher interest rate rather than spend. So peoples disposable income ?.
Monetary Policy can promote economic growth and stability because of the Monetary Policy Transmission mechanism; the way in which Monetary Policy affects inflation rates through the impact it has on other macroeconomic variables.
It is said that low and stable rates of inflation provide the framework for economic stability as inflation reduces the purchasing power of money. When the government uses monetary policy to reduce the rate of inflation inflation targeting) they can stop economic stability from becoming unstable as when inflation occurs, and usually wage growth ? there is a danger that inflation will become out of control so much so that producers and consumers are no longer able to use the signalling function so it can become clear what goods and services consumers most want. Inflation targeting makes the consumers and investors more clear about the future and so they know what to expect so they can plan ahead. This can cause an ? in C and I and therefore and ? in AD (shifting the AD curve to the right). The fact that inflation targeting is flexible means it meets the policy target.
The government can use Monetary to policy to ? the supply of money, so banks have more money to lend, so it is easier for consumers to take loans so there disposable income ?, this can cause and ? in Consumer Expectations and vestments, causing an ? in AD, ?production, ?international competitiveness, ?employment, ? economic stability and ?economic growth
L4. HOWEVER whether the Monetary policy is affective depends on many factors, for example it depends on how big the increase or decrease in interest rate is, a small change could make little or no difference for example if income interest is reduced by 0.00000000000000000000001% then people are unlikely to start spending more and it will have little or no effect on AD. It also depends on when interest rates are changed as to what else is going on in the economy at that time, for example if there is a fiscal policy causing income tax to ? at the same time as a ?in interest rates the affects of the Monetary Policy may be cancelled out by the fiscal policy.
It depends on Central Bank bringing creditability to the target as the central bank has to build up a reputation for meeting targets. This can lead to low economic growth being traded off for low inflation in the short run, but not the long run, which is what is needed for an economies economic growth to be sustainable!
The Central bank must be good at forecasting inflation, as the Monetary Policy works with time lags, there can sometimes be a two year delay! So the Central bank will have to set today the interest rate to affect the rate of inflation it expects in two years time! For example Inflation targeting has to be guided by forecasts of inflation and all macroeconomic variables that affect inflation.
It also costs a great deal to employ people who have the ability to forecast inflation well which could cost a lot to employ someone capable of doing this, this means that it ? costs, which means the possibility of an opportunity cost involved as that money could have been spent on something else for example new hospitals.
There can also always be unforeseen circumstances such as unexpected recessions and natural disasters such as the tsunami, this affects the Central Banks ability to deliver economic stability and economic growth as they do not know if they may need to be doing other policies to help these unexpected situations, as they may only be able to do so when the economies conditions are stable.
To conclude Monetary rules and Fiscal Policy targets and constraints can promote Economic Growth, Economic Stability and International Competitiveness, however there are many factors to take into account when doing so.