LS12 - Demand Side Policies

Question 1

Demand side policies

Answer 1

Monetary and Fiscal Policies

Question 2

Monetary policies

Answer 2

Govt manipulation of monetary values - interest rates, money supply, to change AD

Question 3

Monetary policies - Interest rates

Answer 3

Interest rate - cost of borrowing money, reward in saving money
Low interest rates - borrowing is cheaper, more borrowing occurs, more consumption, less saving
High interest rates - borrowing is more expensive, less borrowing occurs, less consumption, more saving

Question 4

Interest rates - Consumer durables

Answer 4

Consumer durable such as furniture, kitchen equipment, cars are bought on credit
Lower interest rates - more consumption of consumer durables

Question 5

Interest rates - Housing market

Answer 5

Houses are mortgaged most of the time - mortgage payments based upon interest rates set by govt
Lower interest rates - houses are more affordable (cheaper mortgage payments) - demand for housing increases; more first time buyers; new house means new consumer durables as well

Question 6

Interest rates - Wealth effects

Answer 6

Assets such as property or stocks are affected by interest rates
Property - Lower interest rates - more demand in housing market - price of houses rise - property value increases, homeowners feel better off
Stocks - Lower interest rates - cheaper borrowing, consumption in stocks increases - demand for stocks/bonds increases - stock prices go up - increases wealth for shareholders

Question 7

Interest rates - Investment

Answer 7

Interest rates can affect the returns on investment
Higher interest rates - more money to be paid back to bank after borrowing - less profits from investment returns - investment drops

Question 8

Interest rates - Exchange rates

Answer 8

Exchange rates can be affected by the returns on saving - interest rates
Higher interest rate in the UK than USA - higher returns relative to USA, so UK banks more attractive - increases exchange rate - exports more expensive, imports cheaper, so net exports fall

Question 9

Quantitative Easing

Answer 9

Central bank creates more money digitally - uses this money to buy financial assets from banks - banks now have more money - increases the amount they are willing to lend - borrowing becomes cheaper - consumption increases - AD increases

Question 10

Fiscal Policy

Answer 10

Govt intervention to manipulate AD - govt spending and taxes

Question 11

Direct vs Indirect taxes

Answer 11

Direct - levied on a person or organisation - income tax, corporate tax, national insurance
Indirect - levied on a good or service - VAT, fuel duty

Question 12

Expansionary and Contractionary DSP

Answer 12

Expansionary - increasing AD - more govt spending, lower taxes, lower interest rates, more QE
Contractionary - lowering AD - less govt spending, more taxes, higher interest rates, less QE

Question 13

Weaknesses of DSPs

Answer 13

Speed and effectiveness of DSPs
* Keynes – economy can be in recession period for years, unless govt intervention (DSPs) are utilised
* Classical – econmy normally corrects itself very quickly, without govt intervention; if it is recession for a long time, it is due to SSPs - DSPs will have no effects
Conflicting policies
* Keynes – govt should use both fiscal and monetary policy in cases of recession
* Right wing – monetary should be expansionary, fiscal should be contractionary in recession
National Debt - in a recession, expansionary fiscal policy can be used to stimulate growth, but this causes a rise in the ND, as the govt spends more and hence borrows more
* Keynes – govt can keep using QE to fund its spending, ND not a problem in short run
* Other views - ND is bad in long term, especially if borrowing money from foreign countries
Interest rates - IR not effectives in some cases - doesnt affect AD by a large enough factor
QE - can boost AD by a large factor - as consumers borrow more to finance consumption, driving AD; but it drives up prices of assets (houses, stocks) , people use money to buy second hand houses, not to build/buy new houses, pushing up price level, not AD
Time lags - DSPs take a long time to come into effect, so they need to be more focused to fix short term problems and not cause long term issues
Size of multiplier
* Classical – mulitplier is little to nothing, as fiscal policies such as reducing tax are financed by govt borrwing, meaning less money for private sector to borrow; increase in budget deficit is more inflation, not more output or AD
* Keynesian – multiplier is positive and can be large if govt targets spending and tax cuts
Fine tuning - almost impossible to get 100% desired outcome, always some unpredicatble shocks