2.6.2 demand-side policies (copy)

what are the two sections of demand-side policies?

fiscal and monetary

who/what controls fiscal policy in the UK?

the government

who/what controls monetary policy in the UK?

the Bank of England

what are demand-side policies used to do?

influence the level of AD

what are the fiscal policy instruments?

government spending and taxation

what are the monetary policy instruments?

interest rates and asset purchases (QE)

what is fiscal policy?

the use of government spending and taxation in order to influence AD

what is expansionary fiscal policy?

-an increase in government spending and a decrease in taxes

chains of reasoning - expansionary fiscal policy

-increase G and decrease T -greater injections into circular flow -leads to positive multiplier effect -outward shift AD -causes increase in real GDP -thus economic growth

EVAL - expansionary fiscal policy

budget deficit demand-pull inflation (but demand-pull might not occur on Keynes LRAS)

what is contractionary fiscal policy?

-an increase in taxation and decrease in government spending

chains of reasoning - contractionary fiscal policy

-increase T, decrease G -greater leakages from circular flow -leads to negative multiplier effect -AD shifts inwards -leads to fall in real GDP -thus slows/reduces econ growth -will reduce budget deficit and may lead to budget surplus

EVAL - contractionary fiscal policy

It depends on the size of the multiplier. If the multiplier effect is large, then changes in government spending will have a bigger effect on overall demand.

government spending accounts for what percentage of GDP?

around 40% (so changes in it can have big impacts on AD)

how does the govt raise finance for govt spending?

taxation

bonds/gilts

what is the crowding out effect?

government borrowing increases interest rates and decreases private investment

what is monetary policy?

involves using interest rates and other monetary tools to influence AD and achieve price stability

what part of the BoE is responsible for monetary policy?

Monetary Policy Committee

How many people sit in the MPC?

9 people

what is deflationary/contractionary/tight MP?

increase in IR by MPC

what is reflationary/loose/expansionary MP?

decrease in IR by MPC

what is meant by 'hot money flows'?

a rise in IR will tend to increase the exchange rate

what is quantitative easing?

buying of govt bonds by the central bank to increase money supply and stimulate the economy

progressive tax

tax based on income/earnings (e.g 45% for highest bracket)

regressive tax

proportion of income paid in tax decreases as income increases

proportional tax

tax remains constant as income increases (e.g Hong Kong)

current govt expenditure

day-to-day govt spending on goods and services (e.g NHS wages)

capital govt expenditure

long-term investment expenditure on capital projects (e.g HS2, new schools, new motorways)

economic cycle

the natural fluctuation of the economy between periods of expansion and contraction

automatic stabilisers

changes in govt spending or tax revenue that occur automatically, without deliberate govt action

fiscal/budget surplus

when tax revenue > government spending

fiscal/budget deficit

when government spending > tax revenue

national debt

represents the total of a governments outstanding debt that has accumulated over time

corporation tax percentage

25% (as of April '23)

EVAL government spending

-time lags -inflationary pressure -debt burden -crowding out effect -trade offs (macro econ objectives)

chains of reasoning - impact of rising income tax on households

-households have less disposable income -leads to a fall in consumption -leads to fall in AD -AD curve shifts inwards

interest rate definition

the cost of borrowing money, and the reward for saving

real interest rate

IR adjusted for inflation

how often do the MPC meet?

every 6 weeks/8 times per year

base rate in March 2009 after the financial crisis

0.5%

current base rate

4.25%

chains of reasoning - impact of rising IR on UK households

-(if variable rate) mortgage repayments increase -households have less disposable income -marginal propensity to consume decreases and marginal propensity to save increases -leakages occur -consumption decreases -AD shifts inwards

EVAL - problems with interest rates

-time lags -inflationary pressure -magnitude -confidence

what is the aim of negative interest rates?

ultimate aim is to stimulate econ growth -encourages investment/consumption/spending -discourages saving and rewards borrowing -AD shifts outwards

why did the BoE use QE after the financial crisis in 2008?

expansionary monetary policy failed to stimulate AD

after the financial crisis, what value of bonds did the BoE puchase?

£200bn

when was QE first introduced in the UK?

2009

what is the liquidity trap?

a situation in which a period of very low IR and high amounts of cash balances held by consumers and firms (banks) fails to stimulate AD as cash is 'hoarded'

EVAL - monetary policy

-despite low base rate and high demand for loans, banks may be unwilling to lend or do not pass on the low base rate (liquidity trap) -depends on consumer and business confidence -those on fixed rate loans/mortgages are not affected by low IR -time lag of up to 18 months for changes to make an effect -impact on hot money (a high base rate will appreciate the pound adversely impacting exports)

direct tax

a tax levied on income

indirect tax

a tax levied on goods or services

what are the problems with excessive govt borrowing?

-demand-pull inflation could occur as govt borrowing increases the money supply -as borrowing can cause inflation, it can also cause a rise in IR (higher IR will discourage firms investing and make currency rise in value, meaning that exports are less price competitive) -increases national debt -other countries may stop lending if debt is high

are there any problems with a budget surplus?

yes -might suggest that taxes are too high -or might suggest that govt is not spending enough -both of the above could harm or constrain economic growth

what was the Great Depression?

-a period of falling output, deflation and high unemployment around the world -began in the US in 1929 and then spread -lasted until the late 1930s

what did the Great Depression do to govt finances? how?

-worsened them -govt revenue fell and the cost of providing unemployment benefits rose -govt was expected to face an increasing budget deficit

what policies did the govt use during the Great Depression?

-the govt followed deflationary fiscal policy (in the 1920s, the classical economic idea that balancing the budget is the govt's most important economic goal was a mainstream view) -they cut public sector pay and unemployment benefits -income tax raised -this made things worse, UE kept rising and the economy stayed in recession -intro tariffs on imports

what is the Gold Standard? what did this mean for monetary policy?

-a system where currency can be swapped for a fixed amount of gold from the central bank, so the amount of money in the system is fixed, depending on how much gold the central bank holds -countries in the GS couldn't use expansionary monetary policy (and meant that exchange rates were effectively fixed)

Was monetary policy expansionary or contractionary during the Great Depression?

contractionary because of Britain's membership of the Gold Standard

when could the economy recover after the Great Depression? why?

1931 when Britain left the Gold Standard

what was the US approach to the Great Depression?

-their policies were laissez-faire -this means leaving the economy leaving the economy to market forces -taxes kept low however as revenue fell, taxes increased to avoid budget deficit -in 1933, Roosevelt became new president of USA - he ended laissez-faire policies and intro 'New Deal' -this included expansionary policies

demand-side policies used in financial crisis 2008 (uk)

-tax cut intro for basic rate -cut in VAT from 17.5% to 15% -£3 billion worth of investment spending brought forward from 2010 -after 2010, focus moved to reducing budget deficit -three rounds of QE used to boost money supply -MPC cut IR from 5.75 to 5.5% in dec 2007 -- down to 0.5% in march 2009