4.4.2 Demand side policies Flashcards
What are demand side policies made off?
fiscal and monetary policy and both policies have the intentions to boost AD within the economy.
What is fiscal policy?
Fiscal policy is the policy involving government spending and taxation to influence AD.
What is the difference between expansionary and contractionary fiscal policy?
Expansionary fiscal policy is using the government spending and taxation to increase AD through either reducing income tax or increase governemnt spending. Contractionary fiscal policy is the opposite to “contract” AD reduce AD through increasing taxation or reduce government spending.
Explain expansionary fiscal policy
- Income tax can be reduced, this will increase the disposable incomes of househoulds increasing the MPC which causes for AD to rise which leads to economic growth.
- Coorporation tax can be reduced as this will leave firms with greater retained profits and greater profit margins. The marginal propenisty to invest will increase which is a component of AD so AD increases.
- Government spending can rise perhaps on education sector or healthcare. Government spending is a component of AD so will increase AD. Also government spending/injections are likely to have a multiplier effect further increasing AD.
Explain contractionary policy
Increasing income, coorporation tax and reducing government spending.
These are known as austerity measures.
Austerity measures are policies to reduce the governemnt budget defecit.
Explain the cons of expansionary fiscal policy
evaluation
- A diagram will show how expansionary fiscal policy always causes demand pull inflation creating inflationary pressure. Thus conflicting with macroeconomic objective of price stability.
- Going to worsen the government budget defecit and actually if househoulds know that the governemnt cant afford an income tax cut they may decide to save during the income tax cut in order to prepare for a later tax increase which the governemnt may implment to reduce the budget defecit.
- Also may conflict with macroeconomic objective of balance of payments. Reduced income tax will increase the MPM worseining the trade defecit on the current account.
How can it further be evalauted?
- Depends on the confiedence of households and firms, investemnt and consumption may remain the same despite expansionary fiscal policy measures due to the state of the economy so wont be effective.
- Depends on the size of the output gap, if the economy is operating already close to FE than the expansionary fiscal policy measures may have little impacts on the economy and the cons such as the demand pull inflation created may outweigh any benefits
- Can depend on the multiplier effect, if the value of the multiplier effect in an economy is very large than actually large spending and investements will not be required by the goverenment which they will benefit fromas they can still see an increase in AD but without having to spend lots which is good for reducing the budget defecit. Also if the multiplier effect is large than it can have continous cyclical effects boosting AD more than once.
What is monetary policy?
Monetary policy is the manipulation of interest rates and control over the supply of money to influence AD .
What is quantitive easing
quantitive easing is a policy used by the bank of england when expansionary monetary policy isnt effective due to banks being reluctant to lend out to households.
How does quantitve easing work in the economy?
The bank of England will electronically create money in the economy increasing the money supply. They will then use this money to buy governemnt bonds (financial assets) from financial institutions such as banks. The electric money the banks recieve now from the BoE buying government bonds from them will allow banks to the lend this money out increasing the availability of credit and banks willingness to lend out loans.
