Cambridge IGCSE Economics: Fiscal policy measures and monetary policy (0455) – Revision Notes

These notes condense sections 4.3.7 to 4.3.9 and 4.4.1 to 4.4.3 of the Cambridge IGCSE Economics 0455 syllabus for examination in 2026, version 2. For full explanations, read the study guide. When you are ready, try the practice questions. Other links: the Cambridge IGCSE Economics hub, the printable checklist and the free diagnostics. Aggregate demand and aggregate supply are not required for 4.3.9, so explain effects through spending, incomes, firms and jobs. All names and figures are invented.

Definitions to learn

Term	Definition
Fiscal policy (4.3.7)	The use of government spending and taxation to influence the economy and achieve macroeconomic aims
Budget deficit	Government spending is greater than government revenue
Budget surplus	Government revenue is greater than government spending
Money supply (4.4.1)	The total amount of money in an economy
Monetary policy (4.4.1)	The use of interest rates, the money supply and the exchange rate to influence the economy and achieve macroeconomic aims
Interest rate	The price of borrowing and the reward for saving
Exchange rate	The price of one currency in terms of another
Appreciation	The currency buys more units of another currency than before
Depreciation	The currency buys fewer units of another currency than before

4.3.8 Budget balance

Budget balance = revenue − spending. A negative answer is a deficit; a positive answer is a surplus.

Method in steps:

1. Add up every revenue item.
2. Add up every spending item.
3. Subtract spending from revenue.
4. Name the result (deficit or surplus) and give the size with units.
5. If asked for a percentage of national output, divide the balance by national output and multiply by 100.

Worked reminder. Country A revenue 64, spending 70: balance = 64 − 70 = −6, a deficit of 6. Country G revenue 90, spending 84: balance = 90 − 84 = +6, a surplus of 6.

Which measures move the balance?

Measure	Direct effect on balance
Cut tax rates	Revenue falls, deficit rises or surplus shrinks
Raise tax rates	Revenue rises, deficit shrinks or surplus grows
Raise spending	Deficit rises or surplus shrinks
Cut spending	Deficit shrinks or surplus grows

Tax yield = tax rate × taxable base. A corporation tax cut from 25% to 20% on profits of 80 lowers the yield from 20 to 16, a fall of 4, if profits stay at 80. If lower tax encourages more activity, the base can grow and the fall is smaller.

Deficits are financed by borrowing, which raises the national debt. New debt = old debt + deficit. A surplus can repay debt or fund future spending.

4.3.9 Fiscal policy and the aims

Aim	Expansionary fiscal policy	Contractionary fiscal policy
Growth	Spending and lower tax raise household and firm spending, so output rises	Slows growth
Employment	More orders, so firms hire	Fewer orders, fewer jobs
Prices	Pressure on prices if firms cannot meet extra orders	Eases price pressure
Balance of payments	Higher incomes raise imports; the balance may worsen	Imports fall; the balance may improve
Redistribution	Progressive taxes and transfers narrow the gap	Cuts to transfers can widen it

Chain template

Policy change → whose spending changes → firms’ orders change → output and jobs change → prices or imports change → effect on the aim.

Example: a cut in income tax leaves households with more take-home pay → they spend more → shops sell more → shops hire → unemployment falls.

Progressive tax reminder

Income 60, allowance 12, tax rate 25% on the rest. Tax = (60 − 12) × 0.25 = 12. Tax as a share of income = 12 ÷ 60 = 20%. A higher earner pays a bigger share, so the system is progressive.

Evaluation points for fiscal policy

• Time lags between the decision and the effect.
• Borrowing means debt and later interest.
• Extra spending raises output only if there is spare capacity.
• Some extra income is spent on imports.
• Aims can conflict (jobs against prices; growth against the balance of payments).
• Tax rises and spending cuts are unpopular.

4.4.2 Monetary policy measures

Interest rates

Change	Borrowers	Savers	Spending and investment
Rate rises	Pay more	Earn more	Fall
Rate falls	Pay less	Earn less	Rise

Worked reminder. A loan of 50,000: at 4% interest is 2,000 a year; at 6% it is 3,000, which is 1,000 more.

Money supply

To raise it	To lower it
Central bank buys bonds, paying with new money	Central bank sells bonds
Lower the reserves banks must hold	Raise the reserves banks must hold

More money makes credit easier and tends to lower interest rates. Less money does the opposite.

Exchange rate

Higher interest rates tend to attract foreign savers, who need to buy the currency, so its value tends to rise. A central bank can also buy or sell its own currency.

Method for conversions:

• Price abroad = home price × units of foreign currency per unit of home currency.
• Home cost of an import = foreign price ÷ the same rate.

Worked reminder. 1 H-unit = 3 J-units. A good costing 30 H-units sells for 30 × 3 = 90 J-units. The H-unit appreciates to 1 H-unit = 4 J-units. The price becomes 30 × 4 = 120 J-units, a rise of 33.3%. Exports become dearer abroad; imports become cheaper at home.

Another reminder. A good priced 60 H-units, with 1 H-unit = 2 J-units, costs 120 J-units. If H depreciates to 1 H-unit = 1.5 J-units, the price falls to 90 J-units, a fall of 25%.

4.4.3 Monetary policy and the aims

Aim	Cut rate / depreciate	Raise rate / appreciate
Growth	Cheap credit and cheap exports raise spending and sales	Dear credit and dear exports reduce them
Employment	More output, more jobs	Fewer sales, fewer jobs
Prices	Risk of rising prices	Lower spending and cheaper imports ease prices
Balance of payments	Exports up, imports down	Exports down, imports up
Redistribution	Weak tool; borrowers gain, savers lose	Savers gain, borrowers lose

Evaluation points: time lags; banks may not pass changes on; low confidence stops borrowing; a lower exchange rate raises import prices; the balance of payments only improves if demand is price elastic enough; aims can conflict.

Must-know distinctions

• Fiscal policy uses tax and spending; monetary policy uses interest rates, money supply and the exchange rate.
• Deficit (annual shortfall) is not the same as national debt (the total owed).
• A rise in the interest rate is not a rise in the money supply.
• Appreciation makes exports dearer and imports cheaper; depreciation does the reverse.
• Fiscal policy can directly redistribute income; monetary policy does so only weakly.

Quick self-test

1. Define fiscal policy.
2. Revenue is 150 and spending is 138. State the balance and whether it is a deficit or surplus.
3. A tax rate falls from 25% to 20% on a base of 80. Calculate the change in revenue if the base stays the same.
4. A loan of 50,000 has an interest rate that rises from 4% to 6%. Calculate the extra interest per year.
5. 1 H-unit = 3 J-units. A good costs 30 H-units. Find its price in J-units, then after H appreciates to 1 H-unit = 4 J-units, and the percentage change.
6. Income is 60, the allowance is 12 and the tax rate is 25% on the rest. Find the tax and its percentage of income.
7. Define monetary policy.
8. Give two ways a central bank can raise the money supply.
9. Explain how a higher exchange rate may reduce inflation.
10. Give one limit of fiscal policy.

Answers

1. The use of government spending and taxation to influence the economy and achieve macroeconomic aims.
2. 150 − 138 = +12, a surplus.
3. Old revenue 0.25 × 80 = 20; new 0.20 × 80 = 16. Revenue falls by 4.
4. 50,000 × 0.04 = 2,000; 50,000 × 0.06 = 3,000. Extra interest 1,000 a year.
5. 30 × 3 = 90 J-units; 30 × 4 = 120 J-units; (120 ÷ 90 − 1) × 100 = 33.3% rise.
6. (60 − 12) × 0.25 = 12; 12 ÷ 60 × 100 = 20%.
7. The use of interest rates, the money supply and the exchange rate to influence the economy and achieve macroeconomic aims.
8. Buy bonds from banks with newly created money; lower the reserves banks must hold.
9. Imported goods and materials cost less in home currency, so firms’ costs and shop prices rise more slowly.
10. Any one of: time lags, debt from borrowing, imports taking extra income, little spare capacity, conflict between aims.

Where marks are usually lost

• Reversing the budget balance so a deficit is called a surplus.
• Forgetting units, or the word deficit or surplus after the figure.
• Giving the right measure but no chain to the aim.
• Mentioning aggregate demand when the question can be answered through spending and jobs.
• Treating a tax cut as always lowering revenue by the full amount.
• Confusing a rise in the exchange rate with a rise in the interest rate.
• Evaluating with a list of limits and no judgement about which matters most.
• Describing monetary policy as a way to redistribute income without any qualification.

Official syllabus

Cambridge IGCSE Economics 0455 syllabus for examination in 2026, version 2, published by Cambridge University Press & Assessment: sections 4.3.7 to 4.3.9 and 4.4.1 to 4.4.3.