Demand side policies Flashcards
what are demand side policies?
Demand-side policies are policies designed to increase consumer demand, so that total production in the economy increases.
what is monetary policy?
where the central bank or regulatory authority attempts to control the level of AD by altering base interest rates or the amount of money in the economy.
what is fiscal policy?
use of borrowing, government spending and taxation to manipulate the level of aggregate demand and improve macroeconomic performance.
what is the govs objective of economic growth?
In the UK, the long run trend of economic growth is about 2.5%. Governments aim to have sustainable economic growth for the long run. In emerging
and developing economies, governments might aim to increase economic development before economic growth, which will improve living standards, increase life expectancy and improve literacy rates.
what is the govs objective of low unemployment?
Governments aim to have as near to full employment as possible
what is the gov objective of low and stable inflation?
In the UK, the government target is 2%, measured by
CPI. This aims to provide price stability for firms and consumers and will help them make decisions for the long run
what is the gov objective of balance of payments equilibrium on the current account?
This is important to allow the country to sustainably finance the current account, which is important for
long term growth.
how does a rise in interest rates cause a fall in AD through increased borrowing for firms and consumers?
The rise in interest rates will increase the cost of borrowing for firms and consumers. This will lead to a fall in investment and consumption, reducing AD. Two
particular areas of consumption that will decrease are consumer durables and houses. Higher interest rates require higher rates of return for investment. It also makes savings more attractive, as the interest earnt on them will be higher.
how does a rise in interest rates cause a fall in AD through assets?
Since less people are borrowing and more are saving, there is a fall in demand for assets such as stocks, shares and government bonds. This leads to a fall in prices for these assets . Therefore, consumers will experience a negative wealth effect since the value of their assets fall, which will lead to a fall in consumption. Moreover, investment is less attractive since firms are likely to see lower profits if prices fall. AD falls because of the fall in consumption and investment.
how does a rise in interest rates cause a fall in AD through confidence?
People will become less confident about borrowing and spending if interest rates rise. The fall in consumer and business confidence leads to a fall in consumption and investment, causing a fall in AD. On top of this, other loans, such as mortgages, will become more expensive to repay and so consumers have to dedicate more of their income to paying back these debts. This means they have less income to spend on goods and services, so consumption will fall, causing AD to fall.
how does a rise in interest rates cause a fall in AD through exchange rates?
Higher rates will increase the incentive for foreigners to hold their money in British banks as they can see a higher rate of return. As a result, there will be increased demand for pounds and the value of the pound will rise . This means that imports will be cheaper, and exports will be more expensive. This decreases net trade and therefore AD
what are problems with high interest rates to decrease AD through the 4 key mechanisms?
o the exchange rate may be affected so much that exports fall significantly and imports rise significantly, causing a balance of trade deficit.
o Moreover, changes in interest rates take up to 2 years to have their full effect and small changes in interest rates may not affect people’s decisions.
o Sometimes, interest rates are so low that they cannot be decreased any further to stimulate demand. This is a particular issue for many countries today, and something most people never thought would be a problem.
o There are a range of different interest rates and not all of them are affected by the Bank of England base rate.
o A lack of confidence in the economy may mean that, no matter how low interest rates are, consumers and businesses do not want to borrow or banks do not want to lend to them.
o High interest rates over a long period of time will discourage investment and decrease LRAS.
what is quantitative easing in monetary policy?
This is when the Bank of England buys assets in exchange for money in order to increase money supply and get money moving around the economy during times of very low demand. ‘Quantitative’ means a set amount of money is being created and ‘easing’ refers to reducing pressure on banks. It can prevent the liquidity trap, where even low interest rates cannot stimulate AD.
