Download Demand-side and Supply

Demand-side and
Supply-side Policies
Different policies used by
government to achieve
macroeconomic stability
Demand-side Policies
• Focus on changing AD to achieve price
stability, full employment and economic
growth. These policies are put into effect
to counter the short-term fluctuations in
real GDP due to the actions of…….
The Animal Spirits!
Behavior of consumers and businesses are responsible
for the ups and downs of the business cycle.
Goals of Demand-side
policies
To bring AD to potential GDP or create economic
growth by increasing potential GDP
Discretionary Fiscal Policy
• Fiscal Policy
• Monetary Policy
Stabilization Policies
• Fiscal and monetary policies are designed to stabilize the
fluctuations of the business cycle. Remember, economists
(but not economics) are boring and like predictability!
Government Finance
• Balanced budget, Budget deficit,
Budget surplus and debt………
• What’s the difference?
Fiscal Policy
• Fiscal policy are the decisions made by
government concerning its taxes and
expenditures in order to influence the
level of AD. Fiscal policy can affect three
of the four components of AD, those
three are……..
Components of AD influenced by fiscal Policy
Right you are! Fiscal policy can influence the level of
spending by consumers, businesses and the government
itself
How can fiscal policy be so powerful?
• The government can increase or decrease the
tax rate on consumers
• The government can increase or decrease the
tax rate on businesses
• The government can increase or decrease its
own spending levels
Suffering from a recessionary gap?
Fiscal policy remedy!
• Expansionary fiscal policy to the
rescue…….Uhmmmm, what’s that again?
Expansionary Fiscal Policy
• If we are experiencing a recessionary gap due to insufficient
AD, the following will help!
• Increase government spending
• Reduce taxes on consumers
• Reduce taxes on businesses or
• A combination of the above
Expansionary fiscal policy = more AD!
Different results at Different Stages
• If we are in a deep recession (at the horizontal part
of the Keynesian AS curve) expansionary fiscal policy
will increase GDP without increasing the average
price level
• At other points of the Keynesian AS curve
expansionary fiscal policy may or may not increase
GDP but will increase the average price level
Suffering from an inflationary gap?
Fiscal policy remedy!
• Contractionary fiscal policy to the
rescue…….Uhmmmm, what’s that again?
Contractionary Fiscal Policy
• If we are experiencing an inflationary gap due to excessive
AD, the following will help!
• Decrease government spending
• Increase taxes on consumers
• Increase taxes on businesses or
• A combination of the above
Contractionary fiscal policy = less AD!
Halftime! Time for some review
questions
Questions
• What’s the difference between budget deficit
and government debt?
• What are the objectives of fiscal policy?
• What’s the difference between expansionary
and contractionary fiscal policy?
• What will fix an inflationary gap?
• What will fix a recessionary gap?
Monetary Policy
• Monetary policy is carried out by the
central bank of each country. Central
banks also control the money supply,
determine interest rates and oversee the
banking system
Interest Rates
• So what’s the relationship between interest
rates and the demand for money?
When interest rates are high, people hold less cash,
when interest rates are low, people hold more cash.
Comprende? Or is it Entiende?
Changes to the money supply
• So what happens to interest rates if the central bank increase
the money supply? Interest rates increase, decrease or stay
the same?
• And if the central bank decreases the money supply? Interest
rates increase, decrease or stay the same?
Interest Rates and AD
Why change the money supply?
• As you have already seen, when the
central bank increases the money supply,
interest rates fall, and when interest
rates fall, what happens to AD?
Easy Money!
Expansionary Monetary Policy
• When the central bank increases the money
supply, interest rates fall, and consumers and
businesses are more likely to borrow.
Increased borrowing means increased
spending, which means increased AD which is
the perfect medicine to fight a recessionary
gap!
Tight Money!
Contractionary Monetary Policy
• When the central bank decreases the money
supply, interest rates rise, and consumers and
businesses are less likely to borrow.
Decreased borrowing means decreased
spending, which means decreased AD which is
the perfect medicine to fight an inflationary
gap!
So to summarize…..
• During a deflationary gap, to increase AD the
government may choose to increase spending or cut
taxes (fiscal policy) or increase the money supply/lower
interest rates (monetary policy)
• During inflationary gap, to decrease AD the government
may choose to decrease spending or raise taxes (fiscal
policy) or decrease the money supply/raise interest rates
(monetary policy)
So which is better?
Fiscal or Monetary?
Strengths of fiscal policy
In case of emergency…
• Fiscal policy can be extremely effective
during times of economic emergency,
whether that is during a deep
recessionary gap (see 1930s) or times of
escalating inflation
Fiscal Policy and long-term
economic growth
• Expansionary fiscal policy leads to investment and
gains in research and development/new technology
as well as infrastructure improvement and
training/education. All of these can have the effect
of shifting the AS curve to the right and create
economic growth in the future.
The many weaknesses of fiscal
policy
Timing
• Fiscal policy comes with delays. Delays in
recognizing the problem, delays in making the
appropriate decision and delays until the
policy has taken effect. By the time these
“lags” are overcome, the problem could be
worse, maybe been solved already…..
The many weaknesses of fiscal
policy
Information
• Fiscal policy decisions are based on
statistical information compiled by
government workers. Can these workers
be trusted? Your teacher used to be one,
so what do you think?
The many weaknesses of fiscal
policy
Politics
• Taxes are unpopular. Government might want to
raise taxes to slow AD, but that is not going to be a
popular move with voters
• Government might want to cut spending, but many
programs are protected by law, so this may not be
easy to do either
The many weaknesses of fiscal
policy
Crowding Out?
• If the government begins to borrow more
money, what will happen to interest
rates? What effect will that have on
private investment? Might that be a
problem?
The many weaknesses of fiscal
policy
Tax cuts don’t always lead to
increased AD
• Government may think reducing taxes
will lead to increased spending, but if
consumer confidence is low, people may
just take that money and put it in the
bank, rather than spend it…..government
spending is more effective…
The many weaknesses of fiscal
policy
Inability to “fine-tune” the
economy
• Fiscal policy can guide the economy to a
certain point, but it is not very effective
in reaching precise targets in terms of
output, employment, or price levels.
Strengths of Monetary Policy
Strengths of Monetary Policy
• Quick implementation
• No political constraints
• No crowding out effect
• Better able to fine-tune the economy
Weaknesses of Monetary Policy
• Lags can exist due to problem recognition, and time for policy
to take effect
• Reliance on statistics compiled by government bureaucrats
• May not be effective during severe recession (banks may not
want to lend money, consumers and businesses may not want
to take loans)
What about stagflation?
• Fiscal and monetary policy can correct
economic problems that arise from a problem
with AD, but what about a negative supply
shock? Fiscal policy is unable to deal with
instability arising from a leftward shift of the
aggregate supply curve 
Pick one!!!
• Keynesians believe most strongly in fiscal
policy while other economists are wishywashy and prefer a combination of fiscal and
monetary policy. Utilizing the strengths of
each policy together is probably the wisest
strategy.
Opponents of Fiscal and Monetary
Policy
• Monetarists argue that demand-side policies only
make matters worse. They believe government
should focus on social priorities and change the
money supply to match the rate at which economic
growth is occurring. They also argue for policies that
increase wage and price flexibility to allow the
markets to more easily adapt to changing conditions.