Definition

Demand management is about controlling aggregate demand to avoid a recession.

Recession

  • A recession is a general and significant decline in economic activity that lasts more than a few months.
  • A recession usually occurs when there is a general decline in spending.
  • A recession usually leads to higher unemployment and lower inflation.

Remark: there is a situation called “stagflation” when there is both high unemployment and high inflation in an economy.

Reminder: Aggregate demand

Aggregate demand, also known as domestic final demand, is the total demand for final goods and services in an economy at any given time.

$$\rm Y = C + I + G + (X – M)$$

Where:

$\rm Y =$ aggregate demand

$\rm C =$ household spending

$\rm I =$ Investment

$\rm G =$ government spending

$\rm X =$ exports

$\rm M =$ imports

In other words:

$\scriptstyle\text{Aggregate demand = Household spending } + \text{ Investment}$ $\scriptstyle + \text{ Government spending } + \text{ (Exports – Imports)}$

Monetary policy

  • Role: adjusting money supply and interest rate
  • Consequences of lower interest rates:
  • Reduce willingness to save
  • Borrow money cheaper
  • Lower mortgage interest payment
  • Exchange rate depreciation
  • Raise asset prices
  • Objectives of monetary policy:
  • Low inflation
  • Stable economic growth and keeping unemployment low

Fiscal policy

  • Role: regulating government spending and taxation
  • Objectives of fiscal policy:
  • Stimulate economic growth in times of recession
  • Keep inflation low
  • Expansionary fiscal policy
  • Increase in aggregate demand
  • Tax reduction
  • Increase in consumers spending
  • The government will increase its borrowing
  • Deflationary fiscal policy
  • Decrease in aggregate demand
  • Tax augmentation
  • Decrease in consumers spending
  • The government will decrease its borrowing