2.6.2 Demand-side policies Flashcards
What are the two different types of policies that a government can use?
- Demand-side policies
- Supply-side policies
Aim of demand-side policies
To shift AD in an economy.
Aim of demand-side policies
To shift AD in an economy.
What are the two different types of demand-side policies?
- Fiscal Policy
- Monetary Policy
Fiscal policy
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 budget each year.
Monetary policy
Monetary policy involves adjusting interest rates and the money supply to influence AD
- The Bank of England’s Monetary Policy Committee is responsible for setting monetary policy.
Interest rates
The cost of borrowing / return for saving
Economic effects of higher interest rates
- Consumer spending→ reduces effective disposable income
- Household saving → return on saving rises so higher MPS
- Investment → borrowing more expensive, less investment
- Exchange rates → appreciation of domestic currency due to hot money inflows , SPICED, decreases AD as spending on foreign goods rises
- Asset prices → fall in value, negative wealth effect, confidence falls
Factors considered when setting bank rate
- Rate of growth of Real GDP & estimated size of output gap
- Inflation forecasts
- Growth of business costs & wages
- Exchange rate
- Rate of asset price growth
- Confidence
- External factors → energy prices, inflation abroad
- Financial market conditions
Monetary policy
Monetary policy involves making decisions about interest rates, the money supply and exchange rates.
Is monetary policy a demand-side or supply-side policy?
Demand side policy, because it impacts AD.
Most important tool of monetary policy
The ability to set interest rates.
- Changes to interest rates affect borrowing, saving, spending and investment.
Types of monetary policy
- Contractionary (‘tight’)
- Expansionary (‘loose’)
Contractionary monetary policy
Contractionary monetary policy involves reducing aggregate demand (AD) using high interest rates, restrictions on the money supply, and a strong exchange rate.
Expansionary monetary policy
Expansionary monetary policy involves increasing aggregate demand (AD) using low interest rates, fewer restrictions on the money supply, and a weak exchange rate.
Main aim of monetary policy in the UK
To ensure price stability – i.e. low inflation.
- It also aims to promote economic growth and reduce unemployment.
Two main instruments of monetary policy
- Adjustments to interest rates
- Quantitative easing (which increases the supply of money in the economy)
What happens if the UK misses the inflation target?
If the inflation rate misses the 2% target by more than 1% in either direction (i.e. if it’s less than 1% or more than 3%), then the governor of the Bank of England has to write to the Chancellor.