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The continuous increase in real gross domestic product is what is called real economic growth. Economic growth can originate from efficient production levels or from inefficient production levels. Economic growth can happen with decrease, increase or without any change in the price level. There are various factors that are associated with economic growth and they include: capital, economic freedom, natural resources, advancement in technology, labor and freedom of trade.
Demand-side policies are tools that can be used to improve economic growth. Demand-side policies are focused on moving the AD curve towards the right and they are used when the economy drifts away from its optimal continuous growth course (York, & Jermier, 2010, p 78).
In the past few decades, governments have depended on the monetary policy and less importantly on tax rate changes to counteract fluctuations of the business cycles and help the economy to stabilize.
In the great depression, however, government spending plays a significant role in stabilizing the economy. Government spending has been dedicated to spending on infrastructure in order to promote economic growth. Actually, more than half of the products and services in the American Recovery and Reinvestment Act were dedicated to policies that would assist in economic growth and the capability of promoting continuous economic growth was the main aspect in picking projects.
Demand-side policies are divided into fiscal policy, which includes changes in tax collection or government spending and monetary policy, which involve changes in the supply of money by the central bank. Expansionary policies are the policies which are established to stimulate economic growth by causing changes in possible economic output, the real GDP or both (Lenz, 2006, p. 224).
On the demand-side, these policies are applied through one of the following classes that constitute the GDP: government expenditure, consumption expenditure, net export expenditure and investment expenditure (Gupta, 2009, p. 1). Cutting taxes which is a tool of expansionary fiscal policy, leads to an increase in net income and therefore consumption expenditure increases. Lowering of taxation rates contributes to increased investments and venture into profitable projects.
Monetary policy is intended to influence investment expenditure by lowering rates of interest, which are increased in the money supply of a company or may result to total export expenditure. In this case, an expansion in monetary policy leads to an increase in dollars on the foreign exchange markets. Also, lower rates of interest makes America an unattractive place for investment compared to other trading nations (Mankiw, 2009, p. 1).
Therefore, reduction of interest rates leads to expansion of national sales in the exchange market due to increased outflow of capital. This again leads to a weaker currency, which makes American exports somewhat cheaper to overseas customers stimulating demand for goods produced in the United States (Lenz, 2006, p. 212). A weaker dollar makes foreign products more costly to local customers hence leading to a decline in the demand for imported products. The total effect is a raise in net export expenditure.
Demand-side policies are categorized largely as either contractionary or expansionary. Monetary policy is the variation of the rate of interest that central banks charge for lending money to banks in the economy. Contractionary monetary policies are used to decrease inflation of prices by raising the rates of interest. Since banks must pay more in order for the central bank to lend them money, they will in turn increase rates of interest charged on loans to their clients in order to get back the increased cost.
Banks borrow from the central bank because they do not have enough money in form bank deposits from customers (Mankiw, 2009, p. 1). Therefore, in order for the banks to decrease their borrowing from the central bank, they increase interest rates in order to encourage people to increase their personal savings in bank deposit accounts. As the rates of interest go up, customers are likely to save more and borrow less for their expenses.
Companies are also likely to decrease the sum of money they borrow from financial institutions to invest in new machines. The decline in capital investment by companies reduces their ability to increase output in the future. Higher rates of interest therefore may decrease economic growth and lead to a rise in unemployment.
Expansionary monetary policy is used at times of economic recession to stimulate demand and increase employment by reducing rates of interest. Nevertheless, the increase in demand can lead to an increase in prices causing consumer demand for foreign goods to go up. Firms’ demand for labor increases due to the increase in output (Morgan, 2012, p. 462). Investment of firms also goes up.
Fiscal policy entails varying total expenditure of the public sector or the total amount of taxes to affect demand level in the economy. Fiscal policies have a strong influence on the economic activity of any country and it is therefore an influential tool which can be used to stimulate demand generating a multiplier effect on private income.
Fiscal policy is used to move the economy in the direction of full employment because it affects private income directly (Gupta, 2009, p. 1). Keynes therefore advocated for investment and public expenditure owing to its stronger multiplier effect.
Expansionary fiscal policies are designed to encourage more spending in an economy that is facing recession. Expansionary policies stimulate the demand for products and services by cutting taxes and government spending. Companies may react by recruiting more workers leading to an increase in output (Langford, 2000, p. 6).
Increase in demand may however increase market prices of goods and lead to increased spending on goods obtained from other nations. Contradictory policies are designed to diminish spending in an economy facing inflation.
Contractionary fiscal policies involve the reduction of demand by increasing taxes or reduction in government spending (Morgan, 2012, p. 459). Companies may however; react to the decrease in demand by reducing employment and reducing their output. Increased tax rates may lead to a decline in work incentives causing a decline in productivity.
Fiscal policy for economic growth involves government prioritizing its projects and spending money on projects which the government is convinced would promote economic growth. Public investment can form a perfect environment which can stimulate investment on fixed capital (Langford, 2000, p. 3). The pace at which public investments are done should be according to the need of maintaining aggregate demand with the main purpose of counteracting exogenous recurring changes in investment spending.
Monetary policy driven by the management of interest rates has the ability to cause an important effect on the amount of economic activity. Management of interest rates may be used for the purpose of affecting the portfolio of private agents to the benefit of increasing capital goods acquisition and production.
Monetary policy management can stimulate a change in relative prices of various assets from being liquid to becoming illiquid. This means causing changes in investment decisions which are likely to influence real economic variables. Monetary policy operates by anticipating some shift in the interest rates. Monetary policy should provide clear signals regarding the purposes of central bank to private agents. Clear central bank signals make private agents safer and confident to act (York, & Jermier, 2010, p 44).
With the objective of attaining a stable economic growth, governments should implement a policy of exchange rate that aspires to avoid extreme instability in exchange rates. The more stable the exchange rates are, the more entrepreneurs would be encouraged to invest, trade and produce in international trading business.
However, the implementation of demand-side policies is not balanced. Fiscal expansions are popular politically and therefore they are easy to legislate (Langford, 2000, p. 1). Fiscal expansions affect a nation’s deficit in terms of debts in case of a budget deficit. Contractionary policies are not commonly implemented since they are politically dictated.
Gupta, A 2009, ‘The environmental domain’, Organizations external environment. Web.
Langford, B & Hunsicker, F 2000, ‘An integrated view of the relation between the organization and its environment’, Department of business and management systems, West Georgia college. Web.
Lenz, R 2006, ‘Environment, strategy, organization structure and performance: patterns in one industry’, Strategic management journal, vol. 1 no. 3, pp. 209 – 226.
Mankiw, G January 10 2009, ‘Is the government spending too easy an answer’, New York Times, Economy. Web.
Morgan, G 2012, ‘Reflections on images of organizations and its implications for organization and environment’, Journal of organization and environment, vol. 24 no. 4, pp. 459 – 478.
York, R & Jermier, J 2010, ‘Organization and environment’, International journal of Eco social research, vol. 24 no. 4, pp. 44 – 78.