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 (see

pp.132–135). More recently, economists have concluded

that economies run best by themselves, with limited

intervention. Other institutions have control over policy,

while the state concentrates on “supply-side policies,"

such as making markets more efficient.

Raising interest rates

A government that directly controls

the central bank (see pp.100–103)

can try and move interest rates.

When interest rates rise, borrowing

becomes more expensive, leading

people to spend less money, and

businesses may feel pressure to

reduce their prices, thereby

lowering inflation. Cutting interest

rates has the opposite effect.

Increasing spending

When the economy slows

down and there is a risk of rising

unemployment, the government

can try to stimulate the economy

by 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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