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Economics - Policies - Coggle Diagram
Economics - Policies
Fiscal Policy
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During a recession, the government may employ expansionary fiscal policy by lowering tax rates to increase aggregate demand and fuel economic growth.
Lower taxes = more money to spend = higher consumption and therefore demand
Higher demand = firms hire more, decreasing unemployment and in turn creating competition for labour and raising wages to increase consumption
Eventually, economic expansion can get out of hand—rising wages lead to inflation and asset bubbles begin to form. High inflation and the risk of widespread defaults when debt bubbles burst can badly damage the economy and this risk.
In the face of mounting inflation and other expansionary symptoms, a government may pursue a contractionary fiscal policy.
The government does this by increasing taxes, reducing public spending, and cutting public-sector pay or jobs.
This policy is rarely used, however, as it is hugely unpopular politically. Public policymakers thus face a major asymmetry in their incentives to engage in expansionary or contractionary fiscal policy. Instead, the preferred tool for reining in unsustainable growth is usually a contractionary monetary policy, or raising interest rates and restraining the supply of money and credit in order to rein in inflation.
Monetary Policy
Some of the available tools include revising interest rates up or down, directly lending cash to banks, and changing bank reserve requirements.
By a nation's central bank
If a country is facing high unemployment due to a slowdown or a recession, the monetary authority can opt for an expansionary policy aimed at increasing economic growth and expanding economic activity.
As a part of expansionary policy, the monetary authority often lowers the interest rates in order to promote spending money and make saving it unattractive.
Increased money supply = ^ Investment and consumer spending
Lower interest rates = businesses and individuals can get loans on more favourable terms
A contractionary monetary policy increases interest rates in order to slow the growth of the money supply and bring down inflation.
This can slow economic growth and even increase unemployment but is often seen as necessary to cool down the economy and keep prices in check.
Supply-side policies
Supply-side policies are government attempts to increase productivity and increase efficiency in the economy. If successful, they will shift aggregate supply (AS) to the right and enable higher economic growth in the long-run.
Free market oriented
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Flexible labour markets - reduce power of trade unions, min wages and regulations
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Limitations:
Productivity growth depends largely on private enterprise and trends in technological innovation. There is a limit to which the government can accelerate the growth of technological change and improvements in working practices.
Supply-side policies can be counter-productive. For example, flexible labour markets may reduce costs for business – but if they cause job-insecurity, workers may become demotivated and labour productivity stagnates
In a recession, supply-side policies cannot tackle the fundamental problem which is lack of aggregate demand
Time. All supply-side policies take a long time to have an effect. Some policies, such as education spending may not influence the economy for 20-30 years.
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