2.6.2 Demand side policies Flashcards
what are the two types of economic policies?
- demnd side policies (affect AD)
- supply side policies (affect AS)
aim to control the business cycle and acieve 7 macro objectives
what are the side effects of demand side policies?
although intended to affect AD also affect AS
eg:
ALL policies have both supply side effects as well as demand side effect
what are demand side policies?
goverment policies which aim to influence aggregate demand
what are the two types of demand side policies?
who are they managed by
- fiscal policy (goverment )
- monentary policy (B of E )
what two things do the central bank manipulate in monetary policy?
- base intrest rate
- money supply
in oreder to infulence AD
what is the base intrest rate?
the intrest rate set by the central bank which impacts other commericial banks
infulences commerical intrest rates to consumers
what is the central bank?
the bank of banks
who are the monetary policy commitee?
a group of 8 economist and governer (9 total)
* job is to keep inflation rate at 2% goal
* every few weeks decide monetary policy
what does is expansionary monetary policy
decrease base intrest rates (inflation is below target )
* consumers will be encouraged to spend more and save less
* consumption (60% ) will increase, increasing AD
* deand pull inflation
what is contrationary monetary policy?
increase in base intrest rates ( inflation rate above target)
* consumers encourages to save more and spend less
* consumption (60%) will decrease, AD will decrease
* decrease in inflation
contracts the economy
define monetary policy
when the central bank changes the base intrest rate or the money supply in order to influence aggregate demand
define base intrest rate
the intrest rate set by the bank of england, showing the rate at which they will lend money to highstreet banks
define expansionary monetary policy
decreasing the base intrest rate or increasing the money supply in order to increase aggregate demand and increase the rate of inflation
define contractionary monetary policy
increasing the base intrest rate or decreasing the money supply in order to increase aggregate demand and decraese the rate of inflation
what are the 4 things that base intrest rates affect?
- savings
- investment
- mortgage
- (net) exports
SIME
what are the effects of cutting the base intrest rates? (savings)
evaluation point
- discourage saving and encourage spending
increase in (MPC), increase in consumption - 1 in 6 people are pensioners who rely on return from their savings, less disposable income/ consumption
what are the effects of increasing the base intrest rate? (savings)
evaluation point
- encouraged saving instead of spending , MPC decreases, MPS increases, AD decreases
- 1 in 6 are pensioners, rely on return from savings as income, so they will have more disposable income
what are the effects of cutting the base intrest rates? (mortgages)
evaluation point
- mortagages become more affordable, more demand for housing, increased house prices, positive wealth affect , increased AD
*
wealth affect 0 in european countries (evaluation)
what is the effect of higher intrest rates on mortgages?
- less people can afford, demand for housing will decrease, house prices will decrease, negative wealth affect
- wealth affect neutral in european countries
increased price of borrowing, contractionary
what is the effect of lower intrest rate on investment?(demand side effects and supply side effects)
- cost of borrowing has decreased
- incentive for firms to borrow money to invest in capital
- demand side effect: increase in AD as increase in investment
- supply side effect: increase in LRAS as an increase in productivity from new machinary
what is an evaluation point to there being a cut in intrest rates and the effect of this on investment?
However, this may not happens as if animal spirits are low, then firms may be worried that they may not even be able to meet the small cost of borrowing and go bankrupt. Therefore, invesmtent will not necessiarily increase
what is the effect on investment when there is a increase in intrest rates?
- increased cost of borrowing= decreased incentive for firms to take out loan and invest in capital, decraese in investment, decrease in AD, decrease in price level controlling inflation
- for firms that choose to invest, increased cost borrwoing, increase in firms costs, decreased SRAS passed down to consumers by an increase in prices, cost push inflation , against the point of the monetary contrationary policy
what is the effect on the pound of increasing the base intrest rate?
since there is a higher return on savings
* an increase in demand foreign will increase the value of the pound (appreciate)
what is the effect of increasing the base intrest rate on imports and exports?
- stronger pound= imports cheaper
- increased import expenditure, decreased export income, net trade will decrease
- worsening current account balance
evaluation point for increase in base intrest rate effects on imports and exports
the UK in a net importer of raw materials
* reduction in cost for firms who import raw materials
* lower prices make the firms internationally more competitive
* incraesed demand for exports and increased export revenue
* UK consumers may find it cheaper to buy dometic goods than international, decraesing import expenditure
improving the current account deficit
what is the effect of decreasing the intrest rates on the value of the pound?
a decrease in the value of the pound, less return and so less demand from foreign investors
what is the effect of decreasing the base interest rate on imports and exports?
- decreased value of the pound
- decraesed import expenditure, increased export revenue
- increased in net trade and AD, economic growth
- improving the current account balance
what is the evaluation point for the effect of decreasing the base intrest rate on imports and exports?
- However, the UK is a net importer of raw materials imports become more expensive so firms have to increase their prices
- decreasing international competitivness, decrease in export revenue
- less consumers would buy domestic goods over foreign goods as they are more expesnive, increase in import expediture
- worsening the current acount deficit
what is the zero lower bound?
intrest rates cannot be negative so lowest interest rate possible is 0
when close to zero banks use quantitive easing
what is quantitative easing?
- the central bank makes electronic money
- they then buy financial assets such as bonds from high street banks
- this increases high street banks supply of money,increasing amount that they can lend
an expansion monetary policy
what are the two effects of quantitative easing?
- increase in AD from increase in consumption and investment
- depreciation of pound, net trade will increase, increase in AD
what are the negative consequences of quantitative easing?
- increase in AD, increase in price level = demand pull inflation
- inflation effects may outweigh increase in real GDP
what is fiscal policy?
changing tax and goverment spedning to influence the economy
what is expansionary fiscal policy?
loose fiscal policy
when gov decrease taxes and increase government spending in order to increase AD
worsening the budget deficit
what is contractionary fiscal policy?
when the government increases tax abd decreases government spending in order to decraese AD
expansionary fiscal policy (chains of analysis)
(expansionary fiscal policy)
1. increase in government spending–> increase in injections
2. decrease in taxes —-> decrease in withdrawals
3. injections> withdrawals so the circular flow of income expands, expandning the economy
4. worsening the government budget deficit
lower income tax (chains of analysis)
- higher dispoable income , increase in consumption increase in AD. Firms make more sales and profit, increase in investment, increase in AD
- increase in corporation tax and VAT revenues will increase government spending, increase in AD
- as firms expand, derived demand for labour increases, more jobs, more incomes and more spending ….
lower income tax (evaluataion)
- cut in income tax, less revenue, less to spend on benefits, healthcare, education. Government spendning decraesimg will decrease AD
higher income tax (chains of analysis)
(contractionary fiscal policy)
- helps bring down the inflation rate
- decraesed budget deficit
- can spend on other things
higher income tax (evaluation points)
- may decrease incentive to work, less hours worked, quanity of labour (LRAS)
- migrate away to countries where income tax = 0%, no income tax at all
- using clever accountants to avoid the income tax
higher benefits (chains of analysis)
(expansionary fiscal policy)
* increase C (not GS ) for low income workers–> economic growth
* decrease in income inequality
define benefits
payments or transfers made by the government to low income or unemployed workers
higher benefits (evaluation)
- if benefits too high –> benefits trap:
- reduced incentive for unemployed people to work, increase in unemployment
what is the benefits trap?
when benefits get too high and unemployed workers are actually better off staying unemployed and claiming benefits than working
lower benefits (chains of analysis)
(contractionary fiscal policy)
* reduction in consumption–> lower inflation
* decrease in budget defict
* increased incentive to work –> lower unemployment
lower benefits (evaluation)
- those who are poor get poorer–> increase in income inequality
- decrease in consumption (not GS ) —> decrease in economic growth
higher corporation tax (chains of analysis)
(contractionary fiscal policy)
* reduced government budget deficit
* increased government spendning–> economic growth
what is corporation tax?
tax paid on firms profits
higher corporation tax (evaluation)
- decrease in I, decrease in AD
- reduce investment in capital –> depreciation in qualit productivity–> less LRAS
lower corporation tax (chains of analysis)
- (supply side) decrease in costs, SRAS shift to the right
- increase in investment–> more productive capital –> LRAS shifts out
- increase in investment, increase in AD
