3.4 Demand And Supply Side Policies
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The document discusses various macroeconomic concepts related to fiscal and monetary policy such as: - Supply side policies can shift the LRAS curve to increase potential output without raising inflation. - Fiscal policy tools like government spending, taxation, and transfers can be used for demand management. - Monetary policy tools like interest rates can influence money supply and demand to impact output and inflation. - Crowding out refers to how increased government spending and borrowing can reduce private investment by raising interest rates.
3.4 Demand And Supply Side Policies
- 2. Privatization Deregulation Budget Deficit Budget Surplus National Debt Monetary Policy Fiscal Policy Demand Side Policies Government Securities Supply Side Policies
- 3. Any supply side policy will shift the LRAS curve to the right Any policy is seen as beneficial because it leads to a higher level of national income Y 2 and a lower price level P 2 Many monetarist governments of the 1980’s used supply side policy initiatives to promote sustainable long-term economic growth which continued till the 1990’s.
- 4. The LRAS curve shifts to the right, but only the vertical portion shifts. A higher national income can be achieved without any increase in price levels. These policies are of no effect during times of severe recession of depression. If economy is at AD 1 then a shift of LRAS to the right will not change Y 1. Shift of LRAS has no effect Shift of LRAS has positive effect
- 5. Deregulation – a reduction in the level of regulations for business such as health and safety will reduce costs of production and improve profitability. Privatization – shifting companies from state/government ownership to private firms will improve competition and efficiency. Promotion of free trade – will boost export receipts and open up new regions for trade Small business grants – can foster business growth in sunrise , infant industries.
- 6. Legislation against trade unions – allows firms to hire and fire workers more easily and control costs of production. Education and Skill training – develops productivity in workers which can boost GDP growth and job satisfaction. Income tax rates – lowering tax rates will offer and incentive for people to worker harder and to work for longer hours. Unemployment benefits – a reduction in unemployment benefits will act as an incentive to move into full time work. The opportunity cost of not working is too high.
- 8. Fiscal Policy Is a tool the government can use to regulate the economy through its expenditure and raising of revenue through taxation. Monetary Policy Is the tool used by the government to control the economy by controlling money and the banking system (interest rates) Legislation (laws) Is a tool the government can use to control the economy by setting limits and expectations on behaviour. Usually to minimise the negative effects of growth.
- 9. Increase in circular flow equals GROWTH / BOOM / RECOVERY Decrease in circular flow equals RECESSION Injections to the circular flow increase rate of growth, withdrawals decrease growth
- 10. Fiscal measures for growth include Specific spending priorities, putting money into areas which the government believes will promote economic growth. Influencing the size of the circular flow with the size of the government budget. Targeting taxation and subsidies. Specific spending priorities are determined by government, in areas where it believes the private sector does not supply adequate quantity or quality of goods or services. Shown as G, T, Tr in the circular flow model to either inject or withdrawal money from the flow.
- 11. What should be government be spending its money on? If you were the President of a country what would be your spending prorities? Rank the following in order of importance and show where you would spend $30 Billion by drawing a percentage bar graph. Eduction National Development Health Spending Environment and Water Resources Defence Spending Foreign Affairs Trade and Industry Development Transport Infrastructure Ministry of ManPower Financial Transfers (Transfer Payments) 0% 100% 0cm 100cm
- 15. Progressive Taxes Act as an automatic economic stabiliser by affecting the government operating balance Taxes increasing Government spending on transfers decreasing Taxes decreasing Government spending on transfers increasing Budget Surplus Budget Deficit
- 16. Progressive Taxes Tax creep occurs when people move into higher tax brackets. Tax creep slows rate of economic growth by reducing discretionary income for high income people. % of income available for discretionary income falls
- 17. Government Budget More spending than taxation Less spending than taxation Budget deficit Operating Deficit Budget surplus Operating Surplus Expansionary Fiscal Policy Contractionary Fiscal Policy More economic growth Less economic growth
- 18. This are the decisions, guided by the government to change interest rates to influence the rate of economic growth. Remember Increase in interest rates , increases savings, withdrawals money from circular flow. Slows economic growth. Also decreases rate of investment in capital assets. Decrease in interest rates , decreases savings, increases consumer spending. Increases economic growth. Also increase rate of investment.
- 19. Monetary policy is controlled by the Central Reserve Bank. It aims to achieve price stability by influencing the interest rate. The government does not control interest rates, as the Reserve Bank is an independent authority. Decreasing interest rates can stimulate spending Increasing interest rates can encourage savings. Monetary Policy has flow on effecs to the Foreign Exchange market, leading to either an appreciation or depreciation of the Domestic Currency Influences either S, C, I in the circular flow model to either inject or withdrawal money from the flow – changes in economic growth.
- 20. Central Bank sets the Base Interest Rate Private Banks can save and borrow money with the Central Bank They can borrow money at 0.25% + Base Interest Rate They can save money at 0.25% - Base Interest Rate The interest rates of borrowing or saving are passed onto customers plus a profit margin
- 21. Central Bank increases the Base Interest Rate From 2 – 3% “ Loosening of Monetary Policy” If Base Interest Rate = 2% If Base Interest Rate increases to = 3% DBS can borrow money at 0.25% + 2% = 2.25% DBS can save money at 0.25% - 2% = 1.75% DBS can borrow money at 0.25% + 3% = 3.25% DBS can save money at 0.25% - 3% = 2.75% Customer can borrow money at = 5.25% Customer used to borrow money = 4.25%
- 22. Customer can now borrow money at = 5.25% Customer used to borrow money = 4.25% Savings Increases Borrowing decreases Consumer Spending decreases Level of Investment decreases Withdrawals > Injections Withdrawals > Injections AD decreases x 2 Shift to the Left Output Decreases, Unemployment Rises, Inflation may fall
- 23. Money Supply The line shows the amount of money available to borrow at any one time. The supply of money will increase when the Central Bank decreases the Base Rate . The money supply will decrease when the Central Bank increases the Base Rate
- 24. Interest rates Quantity of money MD At high interest rates , demand for transaction money M1 decreases. Q low People prefer less cash and more term deposits. At low interest rates people will happily increase transaction demand for money as opportunity cost of deposits is low. Increased willingness to spend. Q high
- 25. Interest rates Quantity of money MD MS shift to the left Increase in Base Rate Interest rate increases MS 1 Ir MS shift to the right Decrease in Base Rate Interest rate decrease
- 28. Budget Deficit: The government sector can borrow, over and above the tax revenue collected, to finance planned government spending in a given year. The National Debt: This is the total amount owed by the government. It is the sum of each annual budget deficit ever borrowed. Its current value is roughly $11 Trillion in USA, or about $35,000 per person. This may sound like a lot of money, but it is only roughly half of GDP (which is currently around £800 billion a year). Budget Surplus: Occasionally, the government does end the year with money left over after all their government spending has been completed. In this case, they are, by definition, paying back some of the huge National Debt that they have accrued. In recent years.
- 29. From the Wall Street Journal
- 32. Thatcher was very keen on reducing government spending and, therefore, the PSNCR. She felt that high PSNCRs were inflationary. To understand why a PSNCR might be inflationary, you need to understand from whom the government borrows. Although governments do sometimes borrow from a third party (from abroad) in the same way as an individual might borrow from a bank, most of the borrowing of the UK government is in the form of selling bonds and Treasury bills to individuals and pension institutions. In other words, the UK government is borrowing from its own citizens. Government borrowing is only inflationary if the money supply increases as a result. Developed countries gave up printing money to finance borrowing (which obviously increases the money supply) years ago. As long as selling these bonds and bills to the non-banking sector finances the borrowing, then the effect on the money supply will be neutral. This is because every £1 borrowed and spent by the government (an injection into the economy) will be matched by £1 less spending by the individual who bought the bond or bill. For the individual concerned, this is a form of saving, which is a leakage from the economy. It is dangerous to sell bonds and bills to the banking sector because they can be treated as relatively liquid assets, so the bank can lend money against them, thus increasing the money supply.
- 34. In economics , crowding out is any reductions in private consumption or investment that occurs because of an increase in government spending. If the increase in government spending is financed by a tax increase, the tax increase would tend to reduce private consumption. If instead the increase in government spending is not accompanied by a tax increase, government borrowing to finance the increased government spending would increase interest rates, leading to a reduction in private investment . There is some controversy in modern macroeconomics on the subject, as different schools of economic thought differ on how households and financial markets would react to more government borrowing.
- 35. The accelerator effect in economics refers to a positive effect on private fixed investment of the growth of the market economy (measured e.g. by Gross Domestic Product). Rising GDP (an economic boom or prosperity) implies that businesses in general see rising profits, increased sales and cash flow, and greater use of existing capacity. This usually implies that profit expectations and business confidence rise, encouraging businesses to build more factories and other buildings and to install more machinery. (This expenditure is called fixed investment.) This may lead to further growth of the economy through the stimulation of consumer incomes and purchases, i.e., via the multiplier effect.
- 37. Inflationary pressure Recession Unemployment Full capacity Real Output Taxation Government Spending Expansionary Fiscal Policy Contractionary Fiscal Policy Interest Rates fall Average Price Level Interest rates increase Circular Flow model Transfer payments Investment Savings Consumer Confidence Business Confidence November Exchange Rates
- 38. Government Operating Surplus Fiscal stance Budget Deficit Budget Surplus Government Securities National Debt Government Operating Deficit Monetary Policy Discretionary Fiscal Policy Fiscal Policy