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Discuss the strengths and weaknesses of demand-side policies (fiscal and monetary policy)

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Introduction

Discuss the strengths and weaknesses of demand-side policies (fiscal and monetary policy) [18] Demand-side policies are a government's attempts to influence the level of growth of aggregate demand and hence the levels of employment, real GDP, inflation, growth and balance of payments position. A government will do this by using fiscal and monetary policies. Fiscal policies involve the use of government spending, taxation and borrowing to influence both the pattern of economic activity and also the level and growth of aggregate demand, output and employment. Monetary policies involve the use of interest rates to control the level and rate of growth of aggregate demand in the economy. Different types of demand-side policies can be used depending on the position of inflation in an economy. Reflationary demand-side policies seek to increase aggregate demand and raise the level of planned expenditure at or near the level of potential GDP. ...read more.

Middle

Government spending would decrease due to the nature of fiscal policy. Exports would increase due to an exchange rate that makes goods appear relatively cheaper for foreign countries to import, and imports would decrease as foreign goods appear relatively more expensive than before. A diagram showing the effects of reflationary policy The other type of demand-side policy which may be used is deflationary policy, which is used to decrease the level of aggregate demand, for instance in a situation where aggregate demand is running ahead of aggregate supply and thus causing inflationary pressures. Deflationary policy is very much the opposite of inflationary policy, with increased taxes as part of fiscal policy, leading to decreased consumer demand and decreased investment and thus decreased aggregate demand, with the addition of increased interest rates, further decreasing consumer demand and increasing imports, decreasing exports. All of these factors add up to a total decrease in aggregate demand. ...read more.

Conclusion

an economy with an increase in real GDP, employment and economic growth, and a decrease in unemployment, for a relatively low increase in inflation. However a change from AD2 --> AD3 would not be beneficial for an economy due to the amount of inflation for a relatively small amount of increase in growth, GDP and employment. This leads us onto the strengths and weaknesses of demand-side policies, because the change from AD1 --> AD2 is a great positive to come out of demand-side policy however AD2 --> AD3 is highly negative, which shows the strengths and weaknesses of the Keynesian LRAS curve. However it seems that there are far more weaknesses when referring to demand-side policies than there are strengths. For example, there are significant inaccuracies with regards to economic data. More often than not, data is collected many months before it is available and so it becomes out-of-date and so actions are made on data from months previous. ?? ?? ?? ?? ...read more.

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The writer covers the main points but mixes up fiscal and monetary policy. It would have been better to have dealt with them separately. S/he should also explain the transmission mechanisms, ie how they affect aggregate demand, more clearly.

Marked by teacher Dennis Salter 04/10/2013

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