Cambridge International as and a level Economics Ebook

cyclical defi cit
. A government is 
unlikely to be concerned about this as it will move towards a 
balance as economic activity increases. A government will, 
however, be concerned about a 
structural defi cit
. Th
is arises 
when a government is committed to too much spending 
relative to its tax revenue. In this case, the defi cit will not 
disappear when GDP increases. In practice, a budget defi cit 
may contain both cyclical and structural elements.
Cyclical budget deficit: 
a budget deficit caused by 
changes in economic activity.
Structural budget deficit: 
a budget deficit caused by an 
imbalance between government spending and taxation.
KEY TERMS
TOP TIP
Be very careful to avoid confusing a budget deficit and a 
current account deficit.
Monetary policy
Monetary policy
refers to any policy measures or 
instruments to infl uence the price or quantity of money. 
Th
e three instruments of monetary policy are the 
interest 
rate
, the 
money supply
and the exchange rate.
Monetary policy, like fi scal policy, seeks to infl uence 
aggregate demand. Again refl ationary or expansionary 
monetary policy is intended to increase aggregate demand. 
In this case, this may be achieved by a cut in the interest rate, 
an increase in the money supply and a reduction in the foreign 
exchange rate. To reduce aggregate demand, defl ationary or 
contractionary monetary policy may be adopted. Th
is might 
include a rise in the interest rate, a decrease in the money 
supply and an increase in the foreign exchange rate.
Monetary policy measures are usually implemented by 
the central bank of the country or area. In recent years, in 
a number of countries, changes in interest rates have been 
the main policy measure used to control infl ation and, 
more recently, to infl uence economic activity.
A central bank may also target the money supply in the 
economy as changes in the money supply can infl uence 
aggregate demand. Policy measures to change the money 
supply include those that seek to infl uence lending by 
commercial banks. Th
is is because such lending is a major 
cause of changes in the money supply.
Exchange rate measures include government decisions 
on what type of exchange rate system to operate and, in 
the case of a managed and fi xed exchange rate, at what rate 
to set the exchange rate.
The growth of Islamic finance
Financial institutions in more and more countries are 
off ering Islamic finance. Among the most important 
centres in the Middle East are Iran, Kuwait, the UAE and 
Saudi Arabia. In Asia, Pakistan, Bangladesh, China, India 
and Indonesia are leading providers of Islamic finance. 
In Europe the main centre is in London in the UK.
Islamic finance is finance that complies with sharia, 
the religious law and moral code of Islam. Sharia bans 
the charging and payment of interest and excessive 
risk-taking. Instead, it encourages the sharing of risks 
between financial institutions and their customers. For 
instance, mortgages may be given on the basis that those 
seeking to buy a house pay rent for a period of time. 
Savings accounts may be paid a proportion of the bank’s 
profits and firms that need finance may pay a proportion 
of their profits. Investment is permitted in shares in firms 
that do not produce alcohol, tobacco or pornography.