LS12 - Demand Side Policies Flashcards
(Discretionary) fiscal policies definition
demand side policies
- changes to government spending and taxation in order to influence AD
- expansionary to boost AD and contractionary to reduce AD
Reasons for expansionary fiscal policy
- boost economic growth
- reduce unemployment (cyclical) as labour is a derived demand
- increase demand pull inflation (may be necessary to reach inflation target)
- redistribute income
Reasons for contractionary fiscal policy
- reduce inflation
- reduce budget deficit
- redistribute income
- reduce current account deficit
Why is altering inflation only a reason for fiscal policy in theory?
Because it is the central banks job to control inflation, not the governments.
Examples of expansionary fiscal policies
- reduction in income tax
- reduction in corporation tax
- incease in government spending
Monetary policy
Changes to interest rates, the money supply and the exchange rate by the central bank in order to influence AD.
Quantitative easing (QE)
- an unconventional monetary policy tool where a central bank buys assets, like government bonds, to increase the money supply and lower long-term interest rates, aiming to stimulate economic activity when traditional monetary policy measures are ineffective
- increased demand for bonds due to central banks purchase drives up bond prices, reducing yields (interest rates)
- used when interest rates are already near zero and lowering interest rates are no longer effective in stimulating economic growth
What are automatic stabilisers?
Fiscal policy tools used to influence GDP and counter fluctuations in the economic cycle
What do automatic stabilisers do in a boom?
- push in demand to make sure the economy does not overheat
- in a boom, incomes are higher so workers are pushed into higher tax bands
- progressive taxation means higher average rate of tax -> slows down increases in consumption -> slows down increases in AD
- in a boom, unemployment will be lower so gov spending on benefits decreases further helping to cushion demand
- all of above reduces risk of wild demand pull inflation
What do automatic stabilisers to in a recession?
- they support demand/output and to prevent a deep recession
- econ growth negative so incomes falling - workers move into lower tax bands so a.r.t falls, preventing large drop in consumption and therefore AD
- unemployment will be higher so gov spending on benefits increases
2 main automatic stabilisers
- progressive income tax system
- welfare benefits (mainly u benefits)
Average rate of tax (a.r.t) definition
- amount of income tax paid as a proportion of total income
How do automatic stabilisers reduce the need for discretionary fiscal policy?
- automatic stabilisers allow for actual growth to deviate less from the trend rate of growth
- so, gov do not have to change gov spending and taxation levels as much
If the economy is in a budget surplus, what kind of policies are likely being used?
- contractionary fiscal policy (austerity policies)
Benefits of budget surplus
- confidence in gov finances - allows them to issue lower bond yields as they are more reliable + attracts inwards FDI
- less spending on debt interest payments, freeing up gov spending
Cons of budget surplus
4 points
- demand side shock by reducing AD so lower growth and higher unemployment (recessionary pressures)
- micro level individual impacts e.g. cuts in healthcare spending -> fall in living standards, or decline in education levels
- fall in spending in micro levels can mean fall in international competitiveness
- risk of income inequality due to e.g. cut in u-benefits
Evaluation of budget surplus points (contractionary fiscal policy)
- is it necessary to run a surplus? - depends on how stable gov finances are
- if policies are used so strongly that they shock GDP due to D-side shocks, debt/GDP ratios may rise so gov finances may look worse
- stage of the economic cycle - could argue its good to use when economy booming to cool down
