Demand Side Policies
Fiscal Policies
The Government
Expenditure
Transfer Payments
Welfare payments without corresponding returns (eg: unemployment benefits, child allowances)
Current Expenditure
Spending on goods or services that are consumed within the current year.
Capital Expenditure
Long-term investments to increase economy's productivity and productive capacity
Sources of Revenue
Taxes
Privatisation (selling government-owned enterprises)
Sale of goods and services (Postal services)
Budget Outcomes
Budget surplus
When government revenue is greater than government expenditure for the current fiscal year
During booms of the business cycle - when taxes are high and transfer payments are low
Balanced budget
Budget deficit
Possible during a recession of the business cycle - when taxes are low and transfer payments are high
When government expenditure is greater than the revenue for the current fiscal year
Requires government borrowing so this increases the public debt
Reduces the public debt
Can impact the level of aggregate demand in the economy
Expansionary Fiscal Policy
Government spending increases
Taxes decreases
Aggregate Demand increases
Contractionary Fiscal Policy
Government spending decreases
Taxes increases
Aggregate Demand decreases
Closes a recessionary (deflationary) gap by increasing AD
Lowers unemployment and boosts economic growth
May cause inflation if economy is close to or at full-employment of resources
Advocated by keynesian economists
Closes an inflationary gap by decreasing AD
Lowers rate of inflation
May increase unemployment and slow down economic growth
Advantages
Direct impact on aggregate demand
Can target specific sectors of the economy
Effective at promoting economic activity in a recession
Disadvantages
Time lags
Political constraints
Crowding out
Inability to deal with supply side causes of instability
Monetary Policies
Uses interest rates and money supply to influence the aggregate demand
Central Banks
Regulators of commercial banks
Bankers to the government
Are responsible for interest rates and exchange rates
Definitions
Interest Rates
Cost of borrowing or the return from saving money at financial institutions
Money Supply
Total amount of money circulating in the economy at any given point
Influences money by..
Being the sole issuer of legal tender
Setting and changing the cash reserve ratio
Buying and selling government securities
Changing the bank rate
Advantages
The central bank independent
Interest rates can be adjusted and increased incrementally
Changes can be implemented regarding interest rates relatively quickly
Disadvantages
Time lags
Limited effectiveness in increasing AD if economy is in deep recession
Conflict among government's macroeconomic objectives may occur