Demand side policies 2.6.2

Question 1

what are demand side policies

Answer 1

Demand side policies are policies designed to manipulate consumer demand. Expansionary policy is aimed at increasing AD to bring about growth, whilst deflationary policy attempts to decrease AD to control inflation.

Question 2

2 types of demand side policies

Answer 2

Monetary policy: the manipulation of the rate of interest, money supply and the exchange rate to influence the level of economy, it is where the central bank attempts to control the level of AD

Fiscal Policy: involves the government changing the levels of taxation and government spending in order to influence the AD and the level of economic activity.

Question 3

Aims of monetary policy

Answer 3

Low inflation: UK target is 2%. low inflation is considered an important factor in enabling higher investments in the long run
Stable economic growth: Monetary policy is also concerned with maintaining a sustainable economic growth and keeping unemployment low.

Question 4

How many people are part of the committee

Answer 4

The Committee is made up of nine people: five are from of the Bank of England, including the Governor of the Bank of England, and the other four are independent outside experts, mainly economists.

Question 5

Since 2009, the MPC has kept the bank rate at…

Answer 5

Since 2009, the MPC has kept the bank rate at 0.5% and policy has become focussed on boosting economic growth and employment. It was reduced to 0.25% following the Brexit vote but rose again in November 2017 due to the inflation that the weak pound brought about. They plan to raise the interest rate once the negative output gap has been eliminated and the economy is growing strongly

Question 6

What does a rise in the cost of borrowing for firms and consumers do?

Answer 6

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.

Question 7

Since there are less borrowing and more savings, what does this do to the demand?

Answer 7

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.

Question 8

what does high rates lead to

Answer 8

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.

Question 9

Problems with monetary policy

Answer 9

• Firstly, the exchange rate may be affected so much that exports fall significantly and imports rise significantly, causing a balance of trade deficit.
• 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.
• High interest rates over a long period of time will discourage investment and decrease LRAS.

Question 10

quantitative easing

Answer 10

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. It can prevent the liquidity trap, where even low interest rates cannot stimulate AD. it increases consumption and investments which increases the AD and ensures the country meets its inflation target.

Question 11

what happend to the economy in 2008 when it was in liquidity trap?

Answer 11

in 2008, the economy was in liquidity trap. cutting interest rated to zero which failed to boost spending and economic growth. therefore the bank of England was forces to peruse quantitative easing

Question 12

what happens to assets when the bank buys them

Answer 12

Since the bank is buying assets, there is a rise in demand and so asset prices rise .This causes a positive wealth effect since shares, houses etc. are worth more so people will increase their consumption. Moreover, the cost of borrowing will decrease as higher asset prices mean lower yields (money earnt from assets), making it cheaper for households and businesses to finance spending.

Question 13

what happens when the money supply increases

Answer 13

Private sector companies receive more
money which they can spend on goods and services or other financial assets, which may increase investment or consumption and therefore increase AD. It may also push asset prices up further. Banks have higher reserves, meaning they can increase their lending to households and businesses so both consumption and investment
increase as people can buy on credit.

Question 14

Problems with quantitative easing

Answer 14

• It is very risky and, if not controlled properly, could cause high inflation
• There is no guarantee that higher asset prices lead into higher consumption through the wealth effect, especially if confidence remains low
• It had a large effect on the housing market by stimulating demand and leading to rapid price rises since 2013, helping to worsen the issues of geographical mobility. It also led to rising share prices which increases inequality, since the rich grow richer whilst the poor see none of the gains.

Question 15

2 main ways the government increases AD

Answer 15

reducing tax
increasing GS

Question 16

Purpose of fiscal policy

Answer 16

Stimulate economic growth in a period of a recession
keep inflation low
stabilise the economic growth

Question 17

Problems with fiscal policy

Answer 17

Government spending also impacts LRAS. For example, by cutting government spending to reduce AD, the government may be reducing the quality of education or spending on research and technology.
Taxes and spending have an impact on inequality, so some decisions aimed to reduce/increase demand may increase income inequality. They also have an impact on incentives, for example high taxes reduce incentives.
The government also has to worry about political issues, for example they may be unwilling to raise taxes in order to reduce demand as this may lead to them being voted out of government

Question 18

Evaluation of demand side policies

Answer 18

• There is a time lad between their introduction and the full effect
• The biggest issue of demand-side policies is that, in most cases, an expansionary policy is inflationary whilst a deflationary policy brings unemployment.Thus, through demand management, the government cannot bring about both low and stable inflation and
  high economic growth/low unemployment.

Question 19

Monetary vs Fiscal Policy

Answer 19

Monetary policy is useful as the government is able to increase demand without having to increase their spending, which would result in a larger fiscal deficit. Classicists argue that if demand management is going to be done only monetary policy should be used.

Fiscal policy can have significant impacts on the supply side of the economy, for example increases in spending on education to increase AD will also increase LRAS. Moreover, it is more effective at targeting specific groups and reduce poverty, for example by increasing benefits it can increase AD and reduce inequality