Demand-side economics stimulates demand to promote economic growth in times of economic downturn. Key features of demand-side economics include monetary policy and government spending on infrastructure or wage-based tax cuts to promote spending. This type of economics is also referred to as Keynesianism or New Keynesian economics after the economist John Maynard Keynes, who popularised the theory.
Lowered Nominal Interest Rates
Keynesian economics advocates lowering the nominal interest rate to spur investment. Commercial banks pay the nominal interest rates when borrowing from the central bank. When the rate is lowered, commercial banks borrow more money to lend to investors. Likewise, investors are more willing to borrow from commercial banks when the cost of investment, represented by the interest rate, is lowered. Investors use the borrowed funds to start new businesses, expand existing businesses or finance personal spending. It is believed that the resulting spending by borrowers directly contributes to the renewed growth of the economy.
Government spending on infrastructure is a hallmark of demand-side economic policies. Infrastructure improvements provide the nation with updated bridges, expanded highways and repaired roads. During the Great Depression of the 1930s, government spending on infrastructure provided new public works, such as Hoover Dam. Improved and expanded infrastructure paves the way for new businesses and expansion of existing business for the anticipated economic rebound.
Job creation is a primary motivation for lowering interest rates and spending money on public works. Demand-side economics regards the earning and spending of paychecks as necessary to fuel economic growth. Keynes advised the U.S. government to hire non-skilled people to dig holes and refill them, just to get them working and paid, during the Great Depression. Landlords, restaurants, clothiers and food producers directly benefit from spent paychecks.
Addresses Needs of the Economy
Targeted tax cuts work to spur investment to meet unmet demand in the economy. The government offers these tax cuts to encourage innovations in technology, such as green energy technology, to sharpen the country's competitive edge and to encourage economic growth. Entrepreneurs and existing businesses may increase spending or shift spending to related areas of demand to qualify for the tax cuts.