2.6.2 Flashcards
demand side policies (31 cards)
what are demand side policies
Demand-side policies aim to shift aggregate demand (AD)in an economy
There are two categories of demand-side policies
Fiscal policy and monetary policy
what is fiscal policies
Fiscal policy involves the
use of government spending and taxation to influence AD
The government is responsible for setting fiscal policy
The UK Government presents their fiscal policies to the country each year when it
delivers the Government budget
what is a monetary policy
Monetary policy involves adjusting interest rates and the money supply so as to
influence AD
The Bank of England (UK central bank) is responsible for setting monetary policy
The Bank’s Monetary Policy Committee meets 8 times a year to set policy
two insruements of monetary policy
The two main instruments of monetary policy include
Incremental adjustments to the interest rate (usually not more than 0.25%)
Quantitative easing which increases the supply of money in the economy
The Central Bank creates new money and uses it to buy open-market assets
what is a transmission mechanism
When a policy decision is made, it creates a ripple effect through the economy
effect of official rate decreasing on loans -mp
official rates decrease by 0.25%→market rates decrease→ loans are cheaper →
consumers borrow more→ consumption increases → AD increases → inflation increases
effect of official rate decreasing on mortgages -mp
Official rate decreases by 0.25%→market rates decrease→mortgages are cheaper →
property buyers borrow more→ demand for houses increases → asset prices increase
effect of official rates decreasing on market rates decreasing -mp
Official rate decreases by 0.25%→market rates decrease→ buyers borrow more→ asset
prices increase→ households with assets feel wealthier → consumption increases → AD
increases → inflation increases
effect of official rates decreasing on hot money -mp
Official rate increases by 0.25%→ hot money flows increase→ the exchange rate
appreciates → exports more expensive and imports cheaper → net exports reduce→ AD decreases → inflation decreases
effect of official rate decreasing on market rates increasing -mp
Official rate increases by 0.25%→market rates increase→ existing loan repayments now
more expensive to repay → discretionary income falls → consumption decreases → AD
decreases → inflation decreases
what is the Quantitative Easing Transmission Mechanism
The Bank of England commits to buy £60bn of gilts a month → commercial banks receive
cash for their gilts → liquidity in the market increases → commercial banks lower lending
rates → consumers and firms borrow more→ consumption and investment increase→ AD
increases → inflation increases
two fiscal policy instruements
Fiscal Policy involves the use of government spending and taxation to influence
aggregate demand in the economy
Government spending includes direct expenditure,but not transfer payments
Transfer payments are part of fiscal policy,but are not counted as government
spending in the AD formula
Transfer payments enter the circular flow when the recipients spend them
effect on government increasing vat -fp
The Government increases VAT from 20% to 22%→ consumers pay more tax →
discretionary income reduces → consumption reduces → AD reduces → inflation eases
effect of government decreasing corporation tax
The Government decreases corporation tax → firms net profits increase→ investment by
firms increases → AD increases → inflation increases
effect of government reducing pubic sector pay
The Government freezes/reduces public sector pay → consumer confidence falls →
consumption decreases → AD decreases → inflation decreases
effect of government increasing universal credit
The Government increases the allowances in the Universal Credit(unemployment benefits)
→ house hold income increases → consumption increases → AD increases → inflation
increases
what is a balanced budget
government revenue=government expenditure
what is a budget deficit
government revenue<government expenditure
has to be financed through public sector borrowing
This borrowing gets added to the public debt
what is a budget surplus
government revenue>government expenditure
where does most government revenue comes from
taxation
what are direct taxes
Direct taxes are taxes imposed on income and profits
They are paid directly to the government by the individual or firm
E.g. Income tax, corporation tax, capital gains tax, national insurance
contributions, inheritance tax
what are indirect taxes
Indirect taxes are imposed on spending
The supplier is responsible for sending payment to the government
Depending on the PED and PES producers are able to pass on a proportion of the
indirect tax to the consumer
The lower a consumer spends the less indirect tax they pay
E.g Value Added Tax (20%VAT rate in the UK in 2022),taxes on demerit goods,
excise duties on fuel etc.
what are expansionary demand side policies
Demand-side policies that aim to increase aggregate demand are called expansionary
policies
Expansionary monetary or fiscal policy will shift aggregate demand to the right
examples of expansionary demand side policies
Reducing taxes; decreasing interest rates; increasing government spending; increasing
quantitative easing
