How_Money_Works_-_The_Facts_Visually_Explained

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GOVERNMENT FINANCE AND PUBLIC MONEY

Attempting control

How it works

Economic policy-making has been compared to trying

to operate a finely balanced machine. By adjusting

various policy “dials”, the government aims for the

best combination of key economic variables − usually,

a combination of low inflation and unemployment levels.

However, economists point to a trade-off between

inflation and unemployment, with low unemployment

coming at the cost of high inflation, and vice versa.

More recently, economists have concluded that

economies run best by themselves, with institutions

such as central banks controlling monetary policy,

while the state concentrates on “supply-side policies”

such as making markets more efficient.

Raising interest rates

The government, by setting its

inflation targets, directs the central

bank to change the base rate, which

in turn influences interest rates.

When rates rise, borrowing costs

becomes more expensive, people

spend less money, and businesses

may feel they need to reduce their

prices, so lowering inflation. Cutting

rates has the opposite effect.

Increasing spending

When the economy slows down

and there is a risk of a rising rate of

unemployment, the government

can try to stimulate the economy

through increasing spending. By

encouraging public spending,

the state increases the likelihood

of firms employing more people

to meet the extra demand. Cutting

spending has the opposite effect.

To reduce unemployment, the

government increases spending in

areas such as infrastructure to increase

the number of construction jobs.

Higher spending pumps money into

the economy, raising inflation.

With unemployment low, the

government raises interest rates,

increasing the cost of borrowing and

reducing the amount of money in

circulation to try and lower inflation.

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