DEMAND MANAGEMENT POLICIES
Fiscal policies
Monetary policies
use of govt spending and taxation to influence AD to achieve macroeconomic objectives
Expansionary
↑ AD
Contractionary
↓ AD
Discretionary fiscal policies
Automatic fiscal stabilisers
deliberate changes by govt in tax rates or the level of govt expenditure happen with a decision making framework
no deliberate actions by govt / changes in tax and govt spending happen automatically according to the economy’s business cycle.
Govt spending
Operating Expenditure
Development Expenditure
Taxation
Direct tax (Paid directly to Government)
Indirect tax (Paid indirectly to the government via intermediaries)
↑ G ⇒ directly ↑AD
↓ T
↓personal income tax rate
↑households’ disposable income ←
↑purchasing power ←
Consumption of goods will ↑ assuming normal goods ←
Cd ↑ ←
↓corporate income tax rate
↑post-tax profits ←
↑expected returns from investment ←
Volume of investment ↑at every given interest rates ←
MEI shifts to the right ←
I ↑ ←
Strengths
Direct impact on AD, intended consequence is met.
Unintended benefits of an increase in AS, even though the policy intent could be an increase in AD only.
Limitations
Crowding out effect
G is financed by borrowing → Increase AD → ↑ dd for loans → Upward pressure on i/r → Higher cost of borrowing → ↓I and ↓Cd → Fall in AD
Negative effects of running a budget deficit
Conflict with other macroeconomic goals
- Inflation: if at or near full employment, excessive increases in AD cause demand-pull inflation
- BOP
Accuracy of prediction by government
- Depends on the accuracy of information gathered
- Dynamic changes not accounted for → likely intended consequences not achieved and require government to review the fiscal policy decision.