2.6.2 Demand-side Policies

Question 1

What are demand-side policies

Answer 1

Policies designed to increase consumer demand, so that total production in the economy increases

Question 2

Monetary policies

Answer 2

Used by the government to control the money flow of the economy.
This is done with interest rates and quantitative easing.
This is conducted by the Bank of England, which is independent from the government.

Question 3

Fiscal policies

Answer 3

Uses government spending and revenues from taxation to influence AD.
This is conducted by the government.

Question 4

Monetary policy instruments

Answer 4

UK: the Monetary Policy Committee (MPC) alters interest rates to control the supply of money.
The 9 members meet each month to discuss what the rate of interest should be.
IR alters the cost of borrowing and reward for saving.

The bank controls the base rate, which ultimately controls the interest rates across the economy.
Reduction in base rate leads to a rise in AD.
- consumption and investment increase due to lower cost of borrowing
- higher consumption means asset prices increase. This leads to positive wealth effect
- saving becomes less attractive as a lower rate of return is offered. Mortgage interest repayments are lower so consumers have more income to spend
- lower IR reduce incentive for investors to hold their money in British banks, so demand for pound will fall. Pound will be weaker, so exports will be cheaper and imports more expensive. Net trade will increase.

Question 5

Quantitative easing

Answer 5

Used by banks to help stimulate the economy when standard monetary policy is no longer effective.
This has inflationary effects since it increases the money supply, and it can reduce the value of the currency.

QE is usually used where inflation is low and it is not possible to lower interest rates further.

QE is a method to pump money directly into the economy. Since the IR are already low, it isn’t possible to lower them much more. The bank bought assets in the form of government bonds using the money they have created. This is then used to buy bonds from investors, which increases the amount of cash flowing in the financial system. This encourages mor lending to firms and individuals, since it makes the cost of borrowing lower. The theory is that this encourages more investment, more spending, and higher growth. A possible effect of this is that there could be higher inflation.

If inflation gets high, the Bank of England can reduce the supply oof money in the economy by selling their assets which reduces amount of spending in the economy.

Question 6

Limitations of monetary policy

Answer 6

1. Banks might not pass the base rate onto consumers, which means that even if the Central Bank changes interest rate, it might not have the intended effect.
2. Even if cost of borrowing is low, consumers might be unable to borrow because banks are unwilling to lend. After the 2008 financial crisis, banks became more risk averse.
3. Interest rates will be more effective at stimulating spending and investment when consumer and firm confidence is high. If consumers think the economy is still risky, they are less likely to spend, even if interest rates are low.

Question 7

Expansionary fiscal policy

Answer 7

Aims to increase AD
Governments increase spending or reduce taxes to do this
It leads to worsening of the government budget deficit, and it may mean governments have to borrow more to finance this.

Question 8

Deflationary fiscal policy

Answer 8

This aims to decrease AD
Governments cut spending or raise taxes, which reduces consumer spending
It leads to an improvement of the government budget deficit

Question 9

Government budget surplus and deficit

Answer 9

1. Government has a budget deficit when expenditure exceeds tax receipts in a financial year
2. Budget surplus when tax receipts exceed expenditure