2.6.2 Demand-side Policies

• Budget Deficit


  Government spending is greater than tax revenues.
• Budget Surplus


  Tax revenues exceed government spending which can be used to pay some of the national debt
• Central Bank Policy Interest/ Monetary Policy Rate


  The official lending rate for loans set by a nation’s central bank e.g. the Bank of England or the European Central Bank.
• Corporation Tax


  A tax on the profits made by companies
• Cyclical Budget Deficit


  The size of the deficit is influenced by the state of the economy: in a boom, tax receipts are relatively high and spending on unemployment benefit is low.
• Discretionary Fiscal Policy


  Deliberate attempts to affect the level and growth of AD using changes in government spending, taxation and borrowing.
• Direct Taxation


  Taxes levied on streams of income and profits
• Exchange Rate Index


  The trade-weighted external value of a currency.
• Excise Duties


  Indirect taxes levied on specific goods, typically alcoholic beverages, tobacco and fuels.
• Expansionary Monetary Policy


  An effort to boost aggregate demand, output and jobs –includes lower interest rates.
• Expenditure-switching Policies

  Policies designed to ‘switch’ expenditure from imports to domestic goods to improve the balance of payments and stimulate GDP.
• Fine-tuning


  Changes in monetary or fiscal policy designed to gradually manage the level of AD and prices
• Fiscal Austerity


  Decisions by a government to reduce the amount of borrowing
• Global Financial Crisis

  A severe crisis that caused a global economic downturn resulting in bail outs and other fiscal measures to prevent the collapse of the world financial system
• Household Benefits Cap

  Welfare reform which limits total benefits at £500 weekly for a family and £350 weekly for a single person
• Import Tariff


  A tax on imports that may be ad valorem (%) or a specific tax
• Marginal Rate of Tax (MRT)


  The rate of tax on the next unit (£1) of income earned.
• Monetary Policy Committee (MPC)


  Bank of England committee of nine people (including the Governor) that meets every month to review the economy and set monetary policy interest rates for the UK
• National Debt


  A government's total outstanding debt
• Negative Interest Rate


  An interest rate that is below zero. For real interest rates, this can occur when the inflation rate is higher than the nominal interest rate.
• Office of Budget Responsibility


  A non-departmental public body that provides independent economic forecasts and analysis of the public‘s finances.
• Patent Box


  A reduced rate of Corporation Tax applied to profits from patents to stimulate research and innovation and improve the supply-side of the economy.
• Progressive Tax


  The marginal rate of tax rises as income rises
• Proportional Tax


  When the marginal rate of tax is constant leading to a constant average rate of tax.
• Quantitative Easing (QE)


  The introduction of new money into the national supply by a central bank eg. to buy financial assets
• Regressive Tax


  The rate of tax paid falls as incomes rise
• Structural Budget Deficit


  The part of the deficit which is not related to the state of the economy.
• Tax Burden

  Measures total tax revenues as a % of GDP
• Transmission Mechanism


  How a change in interest rates affects the behaviour of economic agents and thus leads to changes in AD, employment and inflationary pressures
• Welfare Cap


  Limit on the amount that UK government can spend on certain social security benefits and tax credits -excluding pensions and Jobseekers’ Allowance.
• Immobility of Labour


  Barriers to the movement of people between areas and between jobs.
• Relative Poverty


  The extent to which a household's financial resources fall below an average income threshold for the economy.
• Deflationary Monetary Policy


  Transmission Mechanism

  1. increased base rate and commercial rates
  2. Consumption decreases and higher reward for saving
  3. Negative wealth effect further decreases consumption as assets fall in price
  4. Investment decreases as there are less high return opportunities
  5. Decreased exports as exchange rates rise as the return of holding assets increases
• Impacts of Deflationary Monetary Policy

  Decreased output, disinflation, increased unemployment, worse current account balance (SPICED). However, increasing interest rates only works for demand-pull inflation.
• Yield


  The annual net profit that an investor earns on an investment if a bond increases in prices the profit from interest paid at maturity is lower
• Monetary Policy


  The manipulation of the base rate, the money supply and exchange rates to influence the rate of inflation
• Deflationary Monetary Policy

  Increasing interest rates or decreasing the money supply to decrease AD and inflation this only works for demand-pull inflation
• Reflationary Monetary Policy

  Decrease interest rates or increase the money supply to increase AD and inflation
• Reflationary Monetary Policy


  Transmission mechanism

  1. Decreased base rate leads to lower commercial rates
  2. Consumption increases and lower reward for saving
  3. Wealth effects further boost consumption as assets rise in price due to high demand
  4. Investment increases as more investment opportunities will provide a higher return
  5. Increased net exports as exchange rates fall as the return of holding assets in domestic currency falls (outflow of ‘hot money’)
• Impacts of Reflationary Monetary Policy

  Increased output, increased inflation and economic growth, decreased unemployment and an improved trade balance