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DEMAND SIDE POLICIES (FISCAL POLICY (EXPANSIONARY FISCAL POLICY (ROLES:
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DEMAND SIDE POLICIES
FISCAL POLICY
INFLUENCING THE LEVEL OF AD AND ECON ACTIVITY
- government expenditure
- taxes
Can change G, I, S
- Government spending
- Consumption spending
- level of spending
STRENGTHS OF FISCAL POLICY
- pulling economy out of deep recession
- dealing with rapid and escalating inflation
- ability to target sectors of the economy
- direct impact on govt spending on AD
- ability to affect potential output
WEAKNESSES OF FISCAL POLICY
- problems of time lags
- political constraints
- crowding out
- inability to deal with supply-side causes of
- in a recession, tax cuts may not be very effective in increasing AD
- inability to fine tune the economy
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AUTOMATIC STABILISERS
Factors that automatically, without any action by government authorities, work to stabilising the economy by reducing the short term fl uctuations of the business
cycle. Two important automatic stabilisers
- progressive income taxes
- unemployment benefits.
EFFECTIVENESS OF AUTO STABILIZERS IN REDUCING FLUCTUATIONS IN ECON ACTIVITY IS DEPENDENT ON
- the size of govt sector: the greater the level of govt involvement, the more effective are AS
- the degree og progressivity of tax system
- the scope of welfare benefits system: more effective in countries with a wide-reaching welfare.
PROGRESSIVE TAX
- during economic boom, a progressive tax system means that govt receives more revenue from increase tax and consumption
- govt spending on welfare benefits falls due to rising levels of econ activity., thus dampening the increase in consumption.
- higher tax revenues, lower welfare benefits caused by higher levels of employment : help to reduce growth rate , avoiding the risks of an unsustainable econ boom and uncontrollable inflation.
MONETARY POLICY
INFLUENCING THE LEVEL OF AD AND ECON ACTIVITY
- interest rates: price of borrowing money or the return form saving money at financial institutions such as banks.
- money supply: refers to the entire qty of money circulating an economy , including notes, coins, loans, savings deposits in bank.
FACTORS THAT CENTRAL BANK SETS INTEREST RATES1. state of economy
- Ex: a deflationary gap may require a reduction in interest rates to prevent the economy from going into a deep recession.
2. rate of growth of nominal wages
- Ex: higher costs of labour usually mean that firms will increase prices. Higher IR might then be used to combat inflationary measrure.
3. business confidence levels
- lower IR tend to create incentives for investment expenditure due to the lower costs and hence risk of investment
4. house prices
- direct impact on consumer confidence, hence value of consumption and potential economic growth
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5. exchange rate
- lower IR might be needed to reduce demand for the currency on the foreign exchange market which will encourage the sale of exports.
ROLE OF CENTRAL BANK
- executor of monetary policy
- govt's bank
- banker's bank
- sole issuer of legal tender
- lender of last resort
- credit control
STRENGTHS OF MONETARY POLICY
- relatively quick implementation
- central bank independence
- no political constraints
- no crowding out
- ability to adjust IR incrementally (in small steps)
WEAKNESSES OF MONETARY POLICY
- time lags
- possible ineffectiveness in recession
- conflict between govt objectives
- inability to deal with stagflation
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