2.6.2 demand side policies

demand side policies aim to

shift aggregate demand in an economy

fiscal policy

involves the use of gov spending and taxation to influence ad

gov responsible for setting fiscal policy

the uk gov presents their fiscal policies to the country each year when it delivers the gov budget

monetary policy

involves adjusting interest rates and the money supply so as to influence ad

Bank of England responsible for setting monetary policy

the bank's monetary policy committee meets 8 times a year to set policy

2 main instruments of monetary policy include

incremental adjustments tot heir interest rate

quantitative easing which increases the supply of money in economy

quantitative easing

a process whereby the central bank buys back uk gov securities from the open market

when a policy devision is made, it creates a

ripple effect through the economy -> known as a transmission mechanism

transfer payments

payments made by the gov for which no goods/services are exchanged

gov spending includes

direct expenditure but not transfer payments

transfer payments part of fiscal policy

but are not counted as gov spending in ad formula

transfer payments enter circular flow

when the recipients spend them

the gov budget

a document that presents the Govs revenue and expenditure plans for the fiscal year ahead

the gov budget is presented each year as a

balanced budget, a budget deficit or a budget surplus

balanced budget

gov revenue = gov expenditure

budget deficit

gov revenue < gov expenditure

budget surplus

gov revenue > gov expenditure

a budget deficit has to be financed through

public sector borrowing which is added to the public debt

public debt

the cumulative total of past gov borrowing which has to be repaid with interest

the main source of gov revenue is

taxation

direct taxes

taxes imposed on income and profits

they are paid directly to the gov by the individual/firm

indirect taxes

imposed on spending

the supplier is responsible for sending payment to gov

the lower a consumer spends

the less indirect tax they pay

monetary policy

adjustment of interest rates and money surplus so as to influence AD and meet the inflation target

bank rate

interest rate at which the central bank lends money to commercial banks

they meet 8 times a year so set the monetary policy

as this meeting they set the bank rate and discuss if quantitative easing is required

policy is decided by majority vote

can take up to two years for the full effects of decision to see in the economy

factors that influence the decision made by the MPC

- state of economy
- rate of real gdp growth
- current level of CPI inflation
- interest rate elasticity
- property market
- unemployment figures
- business and consumer confidence
- global outlook
- exchange rates

strengths of monetary policy

- Bank of England operates independently from the gov

- is able to consider the long-term outlook

- targets inflation and maintains stable prices

- depreciating the currency can increase exports

weaknesses of monetary policy

- conflicting goals e.g economic growth puts upward pressure on inflation

- time lags between policy and the desired impact

- expansionary policy is less effective in negative output gaps than when used with positive output gaps , consumers may not respond to lower interest rates when confidence is low

- cheaper credit can inflate asset prices in the long term

- the interest rate has limitations on downward adjustment

strengths of fiscal policy

- spending can be targeted on specific industries

- short time lag as compared with monetary policy

- redistributes income through taxation

- reduces negative externalities through taxation

- increased consumption of merit/public goods

- short term gov spending can lead to an increase in the long run aggregate supply

weaknesses of fiscal policy

- policies can fluctuate significantly as governing parties change

- increased gov spending can create budget deficits

2 categories of demand side policies

fiscal policy
monetary policy

the bank of England's monetary policy committee (MPC) has

9 members