Chapter 13 Econ

Demand-Side Policies (Demand Management)

Focus on changing aggregate demand, or shifting the aggregate demand curve in the AD-AS, to achieve several macroeconomic goals.

Two Types of Demand-Side Policies

- Monetary policy

- Fiscal policy

Supply-Side Policies

Focus on the production and supply side of the economy, specifically on factors aimed at shifting the long-run aggregate supply (LRAS) or Keynesian AS curves to the right, to increase potential output and achieve long-term economic growth.

Two Major Categories of Supply-Side Policies

- Market-based, which rely on the working of the market

- Interventionist, which rely on government intervention

Monetary Policy

Carried out by the central bank of each country.

Commercial Banks

Financial institutions whose main functions are to hold deposits for their customers, to make loans to their customers, to transfer funds by cheque electronically from one bank to another, and to buy government bonds.

Central Bank

Usually a government financial institution with several important responsibilities:

- Banker to the government and comemercial banks

- Regulator of commercial banks

- Conduct monetary policy

Inflation Targeting

The public announcement of medium-term numerical targets for inflation with an institutional commitment by monetary authority to achieve these targets.

Interest Rate (Rate of Interest)

The percentage of a loan charged by a lender for borrowing money, or the percentage paid by a bank to a saver for keeping money in an account.

Interest

The price paid for borrowing money or the return earned on lending and saving capital.

Money

Defined as anything that is acceptable as payment for goods and services; it includes currency (coins and paper money) and cheque (checking) accounts.

Supply of Money

The total amount of monetary assets (including physical cash, coins, and liquid bank deposits) available in an economy at a specific point in time.

The Money Market and Determination of the Rate of Interest Diagrams

Money Creation

The process by which the total money supply of an economy increases.

Minimum Reserve Requirement (Required Reserve Ratio)

The minimum percentage of customer deposits that commercial banks must hold in cash or at the central bank rather than lending out.

Monetary Multiplier

1 ÷ required reserve ratio

Open Market Operations

The buying and selling of government securities by a central bank to control the money supply and influence interest rates.

Minimum Lending Rate

The lowest interest rate a central bank charges commercial banks for borrowing emergency funds or reserves.

Quantitative Easing

An unconventional monetary policy where a central bank creates digital money to buy financial assets, such as government bonds, from commercial banks and other institutions.

Nominal Rate of Interest

The market rate that prevails at any moment in time.

Real Rate of Interest

The interest rate that has been corrected for inflation.

Real interest rate = Nominal interest rate - Rate of inflation

Effects of Expansionary Policy: Eliminating a Recessionary/Deflationary Gap

Expansionary Monetary Policy

Refers to an increase in the money supply by the central bank.

Contractionary Monetary Policy

Refers to a decrease in the money supply by the central bank.

Effects of Contractionary Policy: Eliminating an Inflationary Gap

Ratchet Effect

A process or economic cycle that moves easily in one direction but strongly resists going backwards.

Types of Government Expenditure

- Current expenditures

- Capital expenditures

- Transfer payments

Current Expenditures

Include the government’s spending on day-to-day items that are recurring and items that are used up or ‘consumed’ as a good or service is provided.

Capital Expenditures

Include public investments, or spending to produce physical capital, such as building roads, airports, harbours, school building, hospitals, etc.

Transfer Payments

Include payments by the government to vulnerable groups for the purposes of income redistribution (for example, unemployment benefits, child allowances, etc.).

Fiscal Policy

Refers to manipulations by the government of its own expenditures and taxes to influence the level of aggregate demand.

Expansionary Fiscal Policy

A government strategy to increase aggregate demand by raising spending, lowering taxes, or both.

Contractionary Fiscal Policy

A government strategy to increase aggregate demand by lowering spending, raising taxes, or both.

Crowding Out

An economic theory where increased government spending and borrowing reduce private sector spending and investment.

Crowding out of Private Investment (Diagram)

Automatic Stabilisers

Factors that automatically, without any action by government authorities, work toward stabilising the economy by reducing short-term fluctuations of the business cycle.

Keynesian Multiplier

Change in real GDP ÷ initial change in expenditure

Marginal Propensity to Consume

Defined as the fraction of additional income that households spend on consumption of domestically produced goods and services.

Marginal Propensity to Save

Defined as the fraction of additional income saved.

Marginal Propensity to Tax

Defined as the fraction of additional income taxed.

Marginal Propensity to Import

Defined as the fraction of additional income spent on imported goods and services.

Aggregate Demand, Real GDP and the Multiplier in the Keynesian Model

How the Effect of the Multiplier Changes Depending on the Price Level

Labour Market Flexibility

The speed and ease with which a workforce and its wages adapt to changes in the economy.

Market-Based Supply-Side Policies

Can be grouped under three headings:

1. Encouraging competition

2. Labour market reforms

3. Incentive-related policies

Privatisation

Involving a transfer of ownership of a firm from the public to the private sector, can increase efficiency due to improved management and operation of the privatised firm.

Deregulation

Involves elimination or reduction of government regulation of private sector activities, based on the argument that government regulation stifles competition and increases inefficiency

Labour Union

An association of workers in a particular profession, whose objective is to improve working conditions and defined rights of workers, representing its members in negotiation with employers.

Incentive-Related Policies

Involve cutting various types of taxes, which are expected to change the incentives faced by taxpayers, whether firms or consumers.

Capital Gains

Profits from financial investments (such as stocks and bonds) or from buying and selling real estate.

Interventionist Supply-Side Policies

Presuppose that the free market economy alone cannot achieve the desired results in terms of increasing potential output, and therefore government intervention is required.

Infrastructure

A type of physical capital, and therefore results from investments; it includes power, telecommunication, roads, dams, urban transport, ports airports, irrigation systems, etc.

Industrial Policies

Government policies designed to support the growth of the industrial sector of an economy. They include:

- Support for small and medium-sized enterprises or firms (SMEs)

- Support for ‘infant industries’