Demand-side Policies

Demand side policies

Policies designed to minimize the fluctuations in AD that brings about business cycle fluctuations in rGDP.

Fiscal policy

Manipulations by the government of its own expenditure and taxes to influence the level of AD

Monetary policy

Policies carried out by the central bank of each country to influence the level of AD

Expansionary fiscal policies

• increased government capital expenditures

• Increased transfer payments

• Income tax cuts

• Corporate tax cuts

Contractionary fiscal policy

• decreased government capital expenditures

• Decreased transfer payments

• Higher income tax

• Higher corporate tax

Automatic stabilizers

Factors that automatically stabilize the economy by reducing short-term fluctuations of the business cycle

Two automatic stabilizes + explain

• progressive taxes

• Unemployment benefits

Impact of fiscal policy on potential output

• government expenditure for R&D, education, training + tax cuts for R&D promote improvements in factors of production

Strengths of fiscal policy (5)

• pulling an economy out of a deep recession

• Dealing with rapid and escalating inflation

• Ability to target sectors of the economy

• Direct impact of government spending on AD

• Ability to affect potential output

Weaknesses of fiscal policies

• crowding out

• Time lags

• Inability to deal with supply side causes of instability

• Ineffectiveness tax cuts during recession

• Inability to fine-tune

• Political constraints

Role of the central bank

• banker to the government

• Banker to the commercial banks

• Regulator of the commercial banks

• Conduct monetary policies

Advantages of monetary policy targeting inflation

• a lower rate of inflation

• A more stable rate of inflation

• Improved ability of firms/consumers to anticipate the future rate of inflation

• Greater coordination between monetary and fiscal policy

• Greater central bank accountability and transparency

Disadvantages of monetary policy targeting inflation

• reduced ability of the central bank to pursue other macro objectives

• Educed ability of the central bank to respond to supply side shocks

• Reduced ability of the central bank to deal with unexpected events, such as financial crisis

• Finding an appropriate inflation target

• Difficulties of implementation

Strengths of monetary policies

• Relatively quick implementation

• Central bank independence

• No political constraints

• No crowding out

• Ability to adjust interest rates incrementally

Weakness of monetary policies

• time lags

• Possibly ineffective in recessions

• Conflict between government objectives

• Inability to deal with stagflation