4.4.2 demand-side policies

Question 1

What are demand-side policies designed to do?

Answer 1

Increase consumer demand, so that total production in the economy increases.

Question 2

How does Quantitative Easing have inflationary effects?

Answer 2

As it increases the money supply and can reduce the value of the currency.

Question 3

What is the method of QE?

Answer 3

It pumps money directly into the economy. Since interest rates are already very low, it is not possible to lower them much more. The bank buys assets in the form of government bonds using the money they have created, they then use this to buy bonds from investors increasing amount of cash flowing in the financial system, encouraging more lending to firms.

The theory is that increased investment means more spending, and therefore higher growth.

Question 4

How can banks control the inflationary effects of QE?

Answer 4

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

Question 5

What are the limitations of monetary policy? [3]

Answer 5

• Banks might not pass the base rate onto consumers, meaning that it might not have the intended effect
• Even if cost of borrowing is low, consumers might be unable to borrow as banks are more risk averse after the 2008 financial crash
• Interest rates will be more effective at stimulating spending and investment when consumer confidence is high

Question 6

What are direct taxes?

Answer 6

Taxes imposed on income and are paid directly to the government from the tax payer.

Question 7

What are some examples of direct tax? [4]

Answer 7

• Income tax
• Corporation tax
• National insurance
• Inheritance tax

Question 8

What are the limitations of fiscal policy? [6]

Answer 8

• Governments might have imperfect information about the economy. It could lead to inefficient spending
• Significant time lag with employing fiscal policy, could take months or years for effect
• If government borrows from the private sector, there are fewer funds available for the private sector
• Bigger the size of the multiplier, bigger the effect on AD and the more effective the policy
• If interest rates are high, fiscal policy might not be effective for increasing demand
• If government spends too much there could be difficulties paying back the debt, which can make it difficult to borrow in the future

Question 9

What are some trade offs the government might face in managing the macro-economy? [4]

Answer 9

• Environment vs competitiveness
• Progressive taxes vs inflation
• Fiscal vs monetary policy
• Interest rate vs Inequality

Question 10

What are some potential policy conflicts faced by policy makers? [5]

Answer 10

• Unemployment vs Inflation
• Economic growth vs Inflation
• Economic growth vs the current account
• Economic growth vs government budget deficit
• Economic growth vs environment