2.6.2: Demand-side policies

• Demand side policies: Policies designed to manipulate consumer demand
• Expansionary policy: Policy aimed at increasing AD to bring about growth
• Deflationary policy: Policy aimed at decreasing AD to control inflation
• Monetary Policy: Where the central bank controls AD by altering base interest rates or amount of money in the economy
• Fiscal policy: Use of borrowing, government spending and taxation to manipulate the level of AD
• Interest rates: Price of borrowing money. The MPC (Monetary policy committee) can alter it as part of monetary policy
• Rising interest rates cause reduce AD because:

  They increase cost of borrowing, leading to fall in investment and consumption

  They incentivise saving as reward for saving increases, therefore demand for shares and stocks decreases and their price falls

  Confidence about spending/borrowing decreases, and mortgages cost more to repay, reducing AD
• Issues with using interest rates

  Time lag of up to 2 years when using interest rates

  Sometimes interests rates are so low that they cannot be decreased further

  Low confidence may mean that no matter the interest rate consumers and firms do not want to borrow or banks do not want to lend

  High interest rates for a long time discourages investment and decreases LRAS
• Quantitative Easing: When the bank of England buys assets (usually government bonds) for money to increase money supply and get money moving around the economy. Quantitative easing refers to the set amount of money being created
• Effects of quantitative easing

  Increases AD, so asset prices rise which causes wealth effect, increasing consumption and investment

  Money supply increases, which increases consumption and investment

  Lower interest rates as banks are receiving more money from selling assets, which encourages borrowing and increases consumption and investment
• Problems with Quantitative easing

  If uncontrolled, could cause very high inflation

  If confidence remains low, consumption and investment may not increase

  it leads to rising share prices, which means the rich get richer while the poor get no gains
• The Bank of England controls monetary policy rather than the government. The Monetary Policy Committee, which is made up of 9 people: 5 from the BoE and 4 independent experts, makes the most important decisions including base interest rate and actions over Quantitative easing
• The main goal of the BoE is to keep inflation at 2%. If it goes below 1% or above 3% the governor of the BoE must write a letter to the chancellor of the exchequer explaining why this has happened and what the BoE is doing to bring it back to target. CPI is used to see if the target has been met
• The government can increase AD using Fiscal policy by decreasing income tax, which increases disposable income and therefore increasing consumption and AD
• The government could also increase AD by increasing government spending as it is a component of AD
• Government budget: A statement given by the government which outlines their plans for spending on fiscal policy (spending, borrowing and taxation)
• A government budget deficit is where the government spend more than they receive, and a budget surplus is where they receive more than they spend
• Direct tax: A tax paid directly to the government by an individual taxpayer
• Indirect tax: A tax where the person charged with paying the money to the government is able to pass the cost on to someone else e.g supplier can pass on the burden of indirect tax to consumers
• The 4 highest revenue raising taxes are: Income tax, national insurance, VAT, and corporation tax
• Problems with fiscal policy:

  Decreasing Government spending and AD may reduce other areas like education quality

  Taxes and spending have an impact on inequality and incentives, e.g high taxes reduce incentives

  Political issues e.g government may be voted out if they increase taxes

  The bigger the multiplier, the bigger the effect fiscal policy has
• Monetary policy is useful as the government is able to increase demand without having to increase spending
• Fiscal policy can be used to target the supply side of the economy. For example if the government increases spending on education, both AD and LRAS will increase