LS12- Demand Side Policies

Question 1

Demand side policies

Answer 1

Monetary and Fiscal policies

Question 2

Monetary policies

Answer 2

Govt manipulation of monetary values- interest rates, money supply etc to change AD
- contraction to reduce AD or expansionary increase AD

Question 3

Monetary policies- interest rates

Answer 3

Interest rate- cost of borrowing, reward in saving money
Low interest rates- borrowing is cheaper, more borrowing occurs, more consumption, less saving
High interest rates- borrowing is more expensive, less borrowing occurs, less consumption, more saving

Question 4

Interest rates- consumer durables

Answer 4

Consumer durables such as s furniture, kitchen equipment, cars are bought on credit
Lower interest rates- more consumption of consumer durables

Question 5

Interest rates- housing market

Answer 5

Houses are mortgaged most of the time- mortgage payments based upon interest rates set by govt
Lower interest rates- houses are more affordable (cheaper mortgage payments)- demand for housing increases; more first time buyers; new house means new consumer durables as well.

Question 6

Interest rates- wealth effects

Answer 6

Assets such as property or stocks are affected by interest rates
Property- lower interest rates- more demand in housing market- price of houses rise- property value increases, homeowners feel better off
Stocks- lower interest rates- cheaper borrowing, consumption in stocks increases- demand for stocks/bonds increase- stock prices go up- increases wealth for shareholders

Question 7

Interest rates- investment

Answer 7

Interest rates can affect the returns on investment
Higher interest rates- more money to be paid back to bank after borrowing- less profits from investment returns- investment drops

Question 8

Interest rates- exchange rates

Answer 8

Exchange rates can be affected by the returns on saving- interest rates
Higher interest rate in the UK than USA- higher returns relative to USA so UK banks more attractive- increases exchange rate- exports more expensive, imports cheaper- net exports fall

Question 9

Quantitative easing

Answer 9

Central banks create more money digitally- uses this money to buy financial assets from banks- banks now have more money- increases the amount they are willing to lend- borrowing becomes cheaper- consumption increases- AD increases

Question 10

Fiscal policy

Answer 10

Govt intervention to manipulate AD- govt spending and taxes

Question 11

Direct vs indirect taxes

Answer 11

Direct- levied on a person or organisation- income tax, corporation tax, national insurance
Indirect- levied on a good or service but can be passed on to consumers- VAT, fuel duty

Question 12

Expansionary and contractionary DSPs

Answer 12

Expansionary -increasing AD- more govt spending, lower taxes, lower interest rates, more QE
Contractionary- lowering AD- less govt spending, more taxes, higher interest rates, less QE

Question 13

Weaknesses of demand side policies

Answer 13

Speed and effectiveness of DSPs
* Keynes – economy can be in recession period for years, unless govt intervention (DSPs) are utilised
* Classical – econmy normally corrects itself very quickly, without govt intervention; if it is recession for a long time, it is due to SSPs - DSPs will have no effects
Conflicting policies
* Keynes – govt should use both fiscal and monetary policy in cases of recession
* Right wing – monetary should be expansionary, fiscal should be contractionary in recession
National Debt - in a recession, expansionary fiscal policy can be used to stimulate growth, but this causes a rise in the ND, as the govt spends more and hence borrows more
* Keynes – govt can keep using QE to fund its spending, ND not a problem in short run
* Other views - ND is bad in long term, especially if borrowing money from foreign countries
Interest rates - IR not effectives in some cases - doesnt affect AD by a large enough factor
QE - can boost AD by a large factor - as consumers borrow more to finance consumption, driving AD; but it drives up prices of assets (houses, stocks) , people use money to buy second hand houses, not to build/buy new houses, pushing up price level, not AD
Time lags - DSPs take a long time to come into effect, so they need to be more focused to fix short term problems and not cause long term issues
Size of multiplier
* Classical – mulitplier is little to nothing, as fiscal policies such as reducing tax are financed by govt borrwing, meaning less money for private sector to borrow; increase in budget deficit is more inflation, not more output or AD
* Keynesian – multiplier is positive and can be large if govt targets spending and tax cuts
Fine tuning - almost impossible to get 100% desired outcome, always some unpredicatble shocks