demand management

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demand management

Demand managementclick for a larger image
Fig. 41 Demand management. The management of aggregate demand in an economy.

demand management


stabilization policy

The control of the level of AGGREGATE DEMAND in an economy, using FISCAL POLICY and MONETARY POLICY to moderate or eliminate fluctuations in the level of economic activity associated with the BUSINESS CYCLE. The general objective of demand management is to ‘fine-tune’ aggregate demand so that it is neither deficient relative to POTENTIAL GROSS NATIONAL PRODUCT (thereby avoiding a loss of output and UNEMPLOYMENT) nor overfull (thereby avoiding INFLATION).

An unregulated economy will tend to go through periods of depression and boom as indicated by the continuous line in Fig. 41. Governments generally try to smooth out such fluctuations by stimulating aggregate demand when the economy is depressed and reducing aggregate demand when the economy is over-heating. Ideally, the government would wish to manage aggregate demand so that it grows exactly in line with the underlying growth of potential GNP, the dashed line in Fig. 41, exactly offsetting the amplitude of troughs and peaks of the business cycle.

Two main problems exist, however:

  1. the establishment of the correct timing of such an INJECTION or WITHDRAWAL;
  2. the establishment of the correct magnitude of an injection or withdrawal into the economy (to counter depressions and booms). With perfect timing and magnitude, the economy would follow the trend line of potential GNP.

A number of stages are involved in applying a stabilization policy as shown in the figure. For example, at time period zero the onset of a recession/depression would be reflected in a downturn in economic activity, although delays in the collection of economic statistics means that it is often time period 1 before data becomes available about unemployment rates, etc. Once sufficient data is to hand, the authorities are able to diagnose the nature of the problem (time period 2) and to plan appropriate intervention, such as tax cuts or increases in government expenditure (time period 3). At time period 4, the agreed measures are then implemented, although it may take some time before these measures have an effect on CONSUMPTION, INVESTMENT, IMPORTS, etc. (see MULTIPLIER). If the timing of these activities is incorrect, then the authorities may find that they have stimulated the economy at a time when it was already beginning to recover from recession/depression, so that their actions have served to exacerbate the original fluctuation (dotted line 1 in Fig. 41). The authorities could also exacerbate the fluctuation (dotted line 1) if they get the magnitudes wrong by injecting too much purchasing power into the economy, creating conditions of excess demand.

If the authorities can get the timing and magnitudes correct, then they should be able to counterbalance the effects of recession/ depression and follow the path indicated as dotted line 2 in Fig. 41. Reducing the intensity of the recession in this way requires the authorities to FORECAST accurately the onset of recession some time ahead, perhaps while the economy is still buoyant (time period 6). On the basis of these forecasts, the authorities can then plan their intervention to stimulate the economy (time period 7), activate these measures (time period 8), so that these measures begin to take effect and stimulate the economy as economic activity levels fall (time period 9).

Much government action is inaccurate in timing because of the institutional and behavioural complexities of the economy. Where the government has not been successful in adequately eradicating such peaks and troughs in the business cycle, it is frequently accused of having stop-go policies (see STOP-GO CYCLE), that is, of making injections into a recovering economy, which then ‘overheats’, and subsequently withdrawing too much at the wrong time, ‘braking’ too hard.

Demand management represents one facet of government macroeconomic policy, other important considerations being SUPPLY-SIDE policies, which affect the rate of growth of potential GNP, and EXCHANGE RATE policies, which affect the competitiveness of internationally traded goods and services. See DEFLATIONARY GAP, INFLATIONARY GAP, EQUILIBRIUM LEVEL OF NATIONAL INCOME, AUTOMATIC ( BUILT-IN) STABILIZERS, INTERNAL-EXTERNAL BALANCE MODEL, PUBLIC FINANCE, BUDGET.

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