Monetary and Supply-Side Policy: Question 1

Worked solution

Step 1: Recall the three types of policy

• Monetary policy works through the interest rate, the money supply and the exchange rate, and is generally carried out by the central bank.
• Fiscal policy works through changes in taxation and government spending, mainly to manage the level of demand in the economy.
• Supply-side policy aims to raise the economy’s long-run productive capacity, for example through education and training, deregulation, privatisation, infrastructure spending, labour market reforms, or lower direct taxes and other incentives to work and invest.

Step 2: Classify each option

• A: Changing the interest rate is a monetary policy measure, not supply-side.
• B: Paying out more in unemployment benefits is extra government spending, which is a fiscal policy measure.
• C: A vocational-training scheme raises the skills of the workforce, increasing the economy’s productive capacity over time. This is the classic supply-side measure of “education and training”.
• D: Value-added tax is an indirect tax. Supply-side policy specifically involves lowering direct taxes (such as income tax) to strengthen incentives; raising an indirect tax like VAT is a fiscal policy decision, usually aimed at raising revenue or managing demand.

Step 3: Why the other options are wrong

Options A and D are both policy tools, but neither is designed to raise the economy’s productive capacity: A changes the cost of borrowing (monetary), and D changes a tax rate mainly to raise revenue or dampen spending (fiscal). Option B is simply higher welfare spending, a fiscal measure, with no direct effect on the economy’s capacity to produce.

Final answer

The vocational-training scheme, option C, is the supply-side policy measure.