Economic policy

supply-side policies

Government policies which aim to influence aggregate supply managed by government 

Demand-side Policies

Government policies which aim to influence aggregate demand. 

There are two types of demand side policy. The first is fiscal policy, which is managed by the UK government. The second is monetary policy, which is managed by the Bank of England.

Expansionary fiscal policy

When government increase government spending and decrease tax which increase injection and decrease withdrawal, expanding circular flow of income by increasing AD, expanding the economy-but worsen budget deficit

Contractionary fiscal policy

when government decrease government spending and increase tax which decrease injection and increase withdrawal, contracting circular flow of income by reducing AD, contracting the economy-but improving budget deficit

Monetary policy

Monetary policy is when the central bank manipulates the base interest rate or the money supply in order to influence aggregate demand within an economy

Fiscal policy

When the government uses tax and government spending to influence the economy.

UK’s target inflation rate

2% plus minus 1%

Role of central bank

Make sure inflation stays between 1%-3%

If inflation is below its target,

the Bank of England will want to increase AD in order to bring the price level up. To increase AD, they will need to reduce the interest rate. This will encourage consumers to save less and consume more. It will also encourage firms to invest as it is cheaper to borrow. Both of these will increase AD and inflation.

Base interest rate

The interest rate, set by the Bank of England, showing the rate at which they will lend money to highstreet banks.

Expansionary monetary policy

Decreasing the base interest rate or increasing the money supply in order to increase aggregate demand and increase the rate of inflation. 

Contractionary monetary policy

Increasing the base interest rate or decreasing the money supply in order to decrease aggregate demand and decrease the rate of inflation. 

Positive wealth effect

as value of individual asset prices increase, they’ll consume more, increase AD, increase economic growth

Quantitative Easing

When the central bank purchases financial assets from banks, increasing the banks’ supply of money and increasing lending to consumers and firms. This increases consumption and investment, shifting out AD.

Supply side polices

Any government policies which aims to increase the aggregate supply in the economy

Types of supply side policies

Interventionist policy, market based policy

Interventionist policy

When the government increases its intervention in the economy to increase aggregate supply

Market based policy

Policies where the government aims to increase aggregate supply by decreasing intervention in the economy and allowing the market to operate efficiently.