Class 15

Class 15 - Tools of Economic Policy Fiscal Policy...

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Tools of Economic Policy Fiscal Policy: executive/legislature increases aggregate demand/control deficit by spending or taxation Monetary policy: central bank controls supply of money by setting interest rates to control inflation What is the “interest rate”? Rate at which banks borrow from e/o (“overnight rate” currently target is 1% set by central bank) Affects how much money banks lend Lower rates = more lending = higher inflation Higher rates = less lending = lower inflation Central bank policy: When inflation is high, reduce lending by raising interest rates When inflation is very low or negative (risk of deflation = bad), increase lending Exchange rate: Affected by demand for a state’s exports Ex. If Canada is a net export to US, CDN$ will increase in value compared to to US$ Exchange rates can be fixed or floating Fixed: US central bank sells US$ when currency down; buys US$ when currency up Ex. China keeps buying US$ to maintain RMB Floating; exchange rate set by demand and supply Trade in a 2 product economy
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Class 15 - Tools of Economic Policy Fiscal Policy...

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