Demand-Side

policies
 Monetary policies

Monetary policy is a demand-side policy that is conducted by the central bank of a country. Monetary policy
refers to changes in the money supply, and so interest rates, in order to affect aggregate demand.

The goals of monetary policy are to:

• achieve and maintain price stability

• achieve high levels of employment

• stabilize economic activity

• promote a stable economic environment favourable

to investment

• influence the exchange rate and achieve external

balance.
 Tools of monetary policy

Tools of monetary policy include:

• changes in the required reserve ratio (the

proportion of deposits that cannot be lent out)

• changes in the discount rate (the interest rate

central banks charge commercial banks in need
of reserves)

• open market operations (purchases or sales of

short-term government bonds that alter the
reserves banks have)

• quantitative easing: purchases of long-term

bonds and other assets by the central bank.

These actions are taken by the central banks

 Advantages and disadvantages of monetary policy

Advantages
Disadvantages
• Monetary policy is flexible.
• If confidence levels are low, monetary
• It is incremental. policy may prove ineffective.

• It is reversible. • When nominal interest rates are close to

zero there is not much room to lower them
• It is independent (typically) of the government. more (the ZLB problem).

• It has shorter time lags than fiscal policy.

 Fiscal policies

Fiscal policy refers to changes in the level of government expenditures (G) and/or in (direct)
taxes (T) in order to affect aggregate demand and so real output (growth), the level of employment and inflation.
This is done by the use of taxes, government spending, and government transfers to stabilize an economy; the
word “fiscal” refers to tax revenue and government spending.

• lift an economy from recession

• lower (cyclical) unemployment

• decrease inflation

• promote a stable macroeconomic environment that accelerates growth

• reduce business cycle fluctuations

• decrease income inequality

• decrease trade imbalances.

 Advantages and disadvantages of Fiscal policy

Disadvantages
Advantages • Politicians are responsible for fiscal
• Fiscal policy affects aggregate demand directly. policy.
• Fiscal policy can be targeted. • Fiscal policy is characterized by long time
• Certain expenditures may also increase potential output. lags.
• Under certain conditions fiscal policy can be scaled up • It may lead to unsustainable debt.
significantly. • It may lead to inflation.
• (HL) The multiplier renders fiscal policy powerful to • It may widen a trade deficit.
fight a recession.
• Tax cuts may not induce more spending.
• (HL) Automatic stabilizers can be quick and sizable.
• (HL) Fiscal policy may crowd out private
investment.