2.6.2 Demand-side Policies

Question 1

What are the three types of policies

Which are demand-side and which are supply-side

Answer 1

Demand-side: Fiscal and Monetary Policy

Supply Side policies

Question 2

What is Fiscal Policy

Answer 2

Policies that include Gov Spending, Taxation and/or borrowing to affect AD

Question 3

What is monetary policy

Answer 3

Policies relating to interest rates, money supply and/or the exchange rate

Question 4

What is supply-side policy

Answer 4

Policies that increase the productive potential of an economy, usually in relation to increase in quantity/quality of an economy’s factors or production

Question 5

What is expansionary fiscal policy used for

Answer 5

1. To boost economic growth
2. Reduce (cyclic) unemployement
3. Increased demand-pull inflation
4. Redistribution of income

Question 6

What is contractionary fiscal policy used for

Answer 6

1. Reduce inflation - demand pull
2. Reduce budget deficit/national debt
3. Redistribution of income
4. Reduce current account deficit

Question 7

Gives examples of how expansionary fiscal policy works

Answer 7

1. Reduction in income tax (in particular on lower income)
2. Reduction of Corporation Tax
3. Increase in Gov spending (reducing regressive taxes may have a bigger effect because lower income households have a higher MPC)

Question 8

How would you show expansionary fiscal policy on a Keynesian AD/AS diagram

Answer 8

Expansion in AD outwards

Question 9

What can expansionary fiscal policy also have an effect on

Answer 9

LRAS

lower taxes could move more economically active into employment = increased productivity

lower cooperation tax = higher investment, increasing the economy stock in capital

Question 10

What are automatic stabilisers

Answer 10

Fiscal Policy tools to influence GDP and counter fluctuations in the economic cycles

It used:

1) Progressive Income tax
2) Welfare benefits

Question 11

How do automatic stabilisers work in a boom

To cushion demand

Answer 11

1. Increased income, pushes workers into higher tax bands, increasing average rate of tax, slowing down the rate of consumption
2. Unemployment will be lower = less Gov spending on welfare benefits

Question 12

How do Automatic stabilisers work in a recession

Support output

Answer 12

1. Income falls, pushes workers into lower tax bands, decreasing the average rate of tax return, preventing a drop in consumption
2. Increased welfare spending

Question 13

What is discretionary fiscal policy

Answer 13

Deflationary policy onto of automatic stabilisers

Question 14

What are the two biggest sources of Government revenue

Answer 14

Income tax

VAT

Question 15

What is direct tax

Answer 15

is levied on income, wealth and profits

It includes income tax, inheritance tax, national insurance capital gains, and cooperation tax

This burden of tax cannot be passed on

Question 16

What is indirect tax

Answer 16

examples: exercise duties on fuels, cigarettes, and alcohol and VAT

Producers may be able to pass on all tax depending on elasticity

Question 17

UK income tax is progressive or regressive?

What is the tax-free allowance on income?

What are the rates on tax

Answer 17

prgressive

££12,570

20%, 40%, 45%

Question 18

What is the standard rate of VAT

Which products have a reduced rate

Which products are VAT free

Answer 18

20% since 2011

domestic fuel + power, children’s cars seats, have a 5% rate

Food, house construction, books have a 0% VAT

Question 19

What is monetary policy

Answer 19

Changes in interest rates, money supply and the exchange rates by central banks in order to influence AD

Question 20

What is the use of expansionary monetary policy

Answer 20

1. Increase demand-pull inflation
2. Economic growth
3. Reduced unemployment

Question 21

What is the use of contractionary Monetary policy

Answer 21

1. Reduced inflation
2. Prevent excessive house price growth and credit in the economy
3. Reduced excess debt + promote saving
4. Reduce current account deficit = less income spent on imports

Question 22

What is the transmission mechanisms

Answer 22

various channels affecting variables in AD

Question 23

Describe the expansionary monetary policy transmission mechanism

Answer 23

1. Decreased credit card interest rates = increased consumer spending
2. Decreased saving rates = increased consumption
3. Decreased Mortgage rates = increased consumption
4. Decreased rates of business loans = increased investment
5. Weaker exchange rate = increasing exports

Question 24

Describe a graph for expansionary monetary policy

Answer 24

Expansion on AD

Question 25

What can expansionary monetary policy also have an effect on (besides AD)

Answer 25

LRAS Increased **I**nvestment through lowered interest rates Leads through increased long-run economic growth by increasing Net stock in capital

Question 26

Evaluate expansionary monetary policy

Answer 26

1. Demand pull inflation 2. Current account deficit 3. Interest rates have a lower band before they have no effect (liquidity trap) 4. Negative impact on savers 5. Time lag (18-24 months)

Question 27

What does the effectiveness of monetary policy depend on

Answer 27

Depends on size of output gap (spare capacity) Consumer + Business confidence Banks are willing to lend or change in base vs interest rates Size of rate cut

Question 28

What is Quantitative easing (QE)

Answer 28

Involves the introduction of new money into the national supply by a central bank The new electronic money is used to buy assets (mainly bonds) from financial institutions such as insurance, pensions and commercial banks

Question 29

Where has QE been used

Answer 29

UK USA EU

Question 30

Describe the transmission mechanism of QE

Answer 30

1. New electronic money is created by the central banks 2. This is used to buy assets e.g. bonds from financial institutions 3. This increases price of bonds 4. Causes interest rates to fall 5. Increases liquidity in financial sector 6. Incentives to lend more 7. Causes a positive wealth effect, from rise in asset prices

Question 31

What is the overall purpose of QE

Answer 31

to increase AD

Question 32

What is the wealth effect

Answer 32

lower yield (interest) rates leads to higher share + bond prices Leading to people feeling wealthier and therefore spending more

Question 33

What is the borrowing cost effect

Answer 33

QE lowers interest rates on long term debt = Gov bonds and mortgages

Question 34

What is the lending effect

Answer 34

QE increases the liquidity of banks, increases income and spending in the economy

Question 35

What is the currency effect

Answer 35

lower interest rates have a side effect of causing the exchange rates to weaken = more competitive exports

Question 36

Why would you use QE

Answer 36

In normal circumstance, you would just reduce interest rates However liquidity trap means that interest rates are too low, they have no effect

Question 37

A QE of £120Bn cut interest rates by

Answer 37

1%

Question 38

Problems with QE

Answer 38

QE is not meant to be permanent What happens if the reverse of QE happens

Question 39

What policies were used after the 2008 Financial Crisis

Answer 39

Demand side

Question 40

What were the key origins of the 2008 recession

Answer 40

1. **Sub-prime lending** - leading to high risk home buyers 2. **Financial Innovations** - e.g credit default swaps 3. **Asset Price bubbles** - excessive asset growth in house pricing 4. **Regulator capture** - failure of credit rating industries

Question 41

What was the central Government response to the 2008 crisis

Answer 41

1. Lower interest rates (expansionary monetary policy) 2. QE 3. Bank bailouts 4. Financial Stimulus

Question 42

Arguments in favour (expansionary) policies

Answer 42

1. Prevent depression - strong fiscal + monetary stimulus to increase demand 2. Create jobs - labor-intensive infrastructure having a positive multiplier effect 3. Avoid price deflation = price + wages falling 4. Support confidence - investment + consumption

Question 43

Weakness/limits to the 2008 stimulus

Answer 43

1. Keynesian liquidity trap 2. Moral Hazard - bailing banks may allow them to become risker 3. Savers - adverse effect of savers e.g. pensioners 4. Rising property prices - wealth effect from QE and lower interest rates