Demand Side Policies

Demand-side Policies

Kristen L. Stack

American Military University

Demand-side Policies

Every few years, countries experience some economic downturns, also known as a recession. Companies begin to lay off workers, consumers stop spending money, and the average person is put into a financial bind. A recession is defined as a significant decline in activity across the economy, lasting longer than a few months. (Investopedia) More easily put, it’s a big drop in consumer spending that results in loss of jobs, income and business profits. Which results in more bankruptcies, both personal and business, and higher unemployment rates because there are too many people chasing the few jobs that are available. A recession generally lasts about 6 to 18 months, and interest rates usually fall during these months to stimulate the economy. In general, a recession will end when the economy starts to grow usually for 2 or more business quarters. This means that companies are hiring again, consumers are spending and businesses are investing. That doesn’t mean everyone has gotten their jobs back or businesses are back to where they were prior to the recession. It just means the overall economy is expanding or growing on a somewhat consistent basis. Fiscal policy is the means by which a government adjusts its level of spending in order to monitor and influence a nation’s economy. It is the “sister strategy” to monetary policy with which a central bank (i.e. the Federal Reserve) influences a nation’s money supply. (Investopedia) The two policies together are used in an effort to direct a country’s economic goals. Fiscal policy is based on the theories of British economist John Maynard Keynes. It basically states that governments can influence productivity levels by increasing or decreasing tax levels and public spending. In turn, this curbs inflation, increases employment and maintains the value of money. Although, tuning the economy through fiscal policy alone can be a difficult means to reach economic goals. The line between an economy that is productive and one that is infected by inflation can easily be blurred. In the United States, the Federal Reserve is in charge of monetary policy. Like fiscal policy, monetary policy is another one of the ways the U.S. government attempts to control the economy. The goals of monetary policy are to promote maximum employment, stable prices and moderate long-term interest rates. (FederalReserve) To do this the Federal Reserve uses three things: open market operations, the discount rate and reserve requirements. Open market operations involve the buying and selling or government securities. The discount rate is the interest rate charge in the Federal Reserve Banks to institutions on short-term loans, and reserve requirements are the portions of deposits that banks must maintain in their vaults or on deposit at a Federal Reserve Bank. Open market operations are the primary and most commonly used tool. When the Fed wants to increase reserves, it buys securities and pays for them by making a deposit to the primary dealer’s bank. When the Fed wants to reduce reserves, it sells securities and collects from those same accounts. The vast majority of these transactions are not intended to make changes to monetary policy, but rather to prevent forces from pushing the federal funds rate too far from the target. The global recession of 2008-2009 resulted in a significant loss of output gross domestic product (GDP), a large increase in unemployment, and a deflationary scare in many other countries. (NewYorkFed) The recession triggered fiscal and monetary policy responses by many banks and government authorities. Many central banks with policy rates at or near zero percent turned to other stabilization tools. The Federal Reserve for example, implemented a large-scale asset purchasing program. By the spring of 2009, inflation and output growth expectations stabilized and stocks rebounded. The role of monetary and fiscal policies in stabilizing the economy during this time is largely debated. We do know that forecasters began raising their expectations of inflation and GDP growth following the implementation of these policies. Monetary expansions affected inflation forecasts while fiscal policies influenced expectations of economic growth. From this perspective, the policies were effective at stimulating economic activity and preventing deflation during the recession.

References

Investopedia US, A Division of ValueClick, Inc. (2013)

http://www.investopedia.com/terms/r/recession.asp
Federal Reserve Education. http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/monetary-policy/
Federal Reserve Bank of New York, Current Issues In Economics and Finance. Vol 18. Number 2. (2012) http://www.newyorkfed.org/research/current_issues/ci18-2.pdf

References: Investopedia US, A Division of ValueClick, Inc. (2013) http://www.investopedia.com/terms/r/recession.asp Federal Reserve Education. http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/monetary-policy/ Federal Reserve Bank of New York, Current Issues In Economics and Finance. Vol 18. Number 2. (2012) http://www.newyorkfed.org/research/current_issues/ci18-2.pdf