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Macroeconomic Policies

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Macroeconomic Policies

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Monetary Policy

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Monetary Policy
• Attempts to influence the level of economic activity (the amount of buying and selling in the economy) through changes to the amount of money in circulation and the price of money – short-term interest rates. • Interest rates the key area of Monetary Policy

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uk Monetary Policy • Short-term interest rates set by the Monetary Policy Committee (MPC) of the Bank of England • Meets for 2 days each month to decide on rates • The ‘official rate’ is the rate at which the Bank of England will lend to the financial system and influences the structure of all other interest rates Copyright 2007 – Biz/ed .http://www.bized.co.

bized.uk Monetary Policy Copyright 2007 – Biz/ed .co.http://www.

uk Monetary Policy • Basis of Monetary Policy is that there is a long run relationship between the amount of money and inflation • Demand for Money – the amount people wish to hold as cash as opposed to other assets • The Supply of Money – the amount of money in circulation in the economy Copyright 2007 – Biz/ed .http://www.co.bized.

V = velocity of circulation.http://www.uk Monetary Policy • The Classical Quantity Theory of Money: • MV = PY – (where M = the money stock.bized. P = price level and Y = level of national income • More formally: Copyright 2007 – Biz/ed .co.

uk Monetary Policy – P is the price level – Y is the level of real national income – Md is demand for money for transactions purposes – K = proportion of national income held as transactions balances • Md = k PY where: • In equilibrium Md = Ms – So: P = 1/kY x M – A rise in Ms will lead to a proportional rise in P Copyright 2007 – Biz/ed .http://www.bized.co.

http://www.uk Monetary Policy • Supply of Money: –Narrow Money – notes and coins in circulation (M0) –Broad Money – Notes and coins plus money held in bank and building society accounts (M4) • A rise in either (ceteris paribus) might signal a rise in aggregate demand (AD) Copyright 2007 – Biz/ed .co.bized.

http://www.co.bized.uk Monetary Policy • The Interest Rate Transmission Mechanism – The process by which a change in interest rates feeds through to AD Copyright 2007 – Biz/ed .

bized.uk The Interest Rate Transmission Mechanism 1 Credit Individuals Loans Interest Rates Borrowing Firms Existing Loans New Loans Consumption Investment Margins Costs Employment Consumption Copyright 2007 – Biz/ed .http://www.co.

bized.co.uk The Interest Rate Transmission Mechanism 2 Disposable Income Existing Property Equity Demand for New Housing Consumption Consumption Interest Rates Mortgages New Investment Savings Copyright 2007 – Biz/ed .http://www.

co.http://www.uk The Interest Rate Transmission Mechanism 3 Mp Appreciation Dm Xp Interest Rates Exchange Rates Dx Balance of Payments Mp Depreciation Dm Xp Dx Copyright 2007 – Biz/ed .bized.

bized.co.http://www.uk Supply Side Policy Copyright 2007 – Biz/ed .

http://www.g.bized.uk Supply Side Policy • Intention is to shift the aggregate supply curve to the right. lowering taxes increases incentives. increasing the long term productive capacity of the economy • Tend to be long-term policies • Arguments about how effective they are – e. reducing welfare dependency increases the urge to find work Copyright 2007 – Biz/ed .co.

to Yf2 2.uk Inflation Supply Side Policy AS AS1 Supply side Increases in policies can help long-term to push the AS capacity can help curve to the right the economy to increasing the grow without capacity of the undue pressure economy from Yf on inflation.co.bized.http://www.3% 2.0% AD Yf Yf2 Real National Income Copyright 2007 – Biz/ed .

co.bized.uk Supply Side Policies • Policies aim to influence productivity and efficiency of the economy • Key feature – open up markets and de-regulate to improve efficiency in the working of markets and the allocation of resources Copyright 2007 – Biz/ed .http://www.

uk Supply Side Policy • Main areas of policy: – Labour Market – reduce impediments to free market.bized. terms and conditions. pay – Criticism of such policies is that they put the needs of employers above those of workers which can lead to exploitation Copyright 2007 – Biz/ed .http://www.co. reduce bureaucracy and ‘red tape’ – flexible labour markets – Reduce power of trade unions – legislation of the eighties still has an impact in this respect – Short term contracts – Flexible working arrangements – Hiring and firing – Contracts.

http://www.uk Supply Side Policy • Tax and Welfare Reform: – More stringent benefit regime – Tax reform to encourage people to work – Improving access to training and education – ‘New Deal’ scheme Copyright 2007 – Biz/ed .co.bized.

uk Supply Side Policy • Education and Training: – Reform of 14 – 19 education – Modern Apprenticeships – National Qualifications framework – coherent set of qualifications – Expansion of vocational qualifications – Expansion of university access Copyright 2007 – Biz/ed .co.http://www.bized.

expansion Copyright 2007 – Biz/ed .bized. investment.uk Supply Side Policy • Incentives and technology: – Tax reform to encourage incentives and entrepreneurial spirit – Incentives to develop new technology – investment – Drive to embracing ‘knowledge driven economy’ – Regional policies to encourage enterprise. location.co.http://www.

co.uk Fiscal Policy Copyright 2007 – Biz/ed .http://www.bized.

bized.co.uk Fiscal Policy • Influencing the level of economic activity though manipulation of government income and expenditure • Associated with Keynesian Demand Management Policies • Now seen in wider terms: Copyright 2007 – Biz/ed .http://www.

http://www.bized.uk Fiscal Policy • Influence Aggregate Demand – – Tax regime influences consumption (C) and investment (I) – Government Spending (G) • Influences key economic objectives • Acts as an ‘automatic stabiliser’ • BUT: Copyright 2007 – Biz/ed .co.

poverty reduction. etc. investment. Copyright 2007 – Biz/ed .http://www.co. regional policies.g.uk Fiscal Policy • Also used to influence noneconomic objectives and provide framework for supply side policy • e. promotion of enterprise. welfare reform.bized. education and health.

• Borrowing (PSNCR) Copyright 2007 – Biz/ed .co.g. passports.bized.uk Government Income • Tax Revenue • Sale of Government Services – e. etc.http://www. prescriptions.

http://www.XLS Copyright 2007 – Biz/ed %GDP £bn .uk/media//E3CCB/PublicFinancesDatabank280104.gov.co.hm-treasury.uk Public Sector Income 700 600 500 400 41 40 39 38 37 300 36 200 100 0 35 34 33 19 90 19 91 91 19 92 92 19 93 93 -9 19 4 94 19 95 95 19 96 96 19 97 97 19 98 98 19 99 99 20 00 00 20 01 01 20 02 02 20 -03 03 -0 20 43 04 20 053 05 20 063 06 20 073 07 20 083 08 -0 93 Public sector total receipts1 £ billion Public sector total receipts1 % GDP Year Source: http://www.bized.

4 29.0 2.8 34.1 0.1 -1.4 2001 -02 110.3 3.5 72.6 215.2 2.3 32.5 3.3 -2.3 28.5 64.9 2.2 60.3 -4.hm-treasury.2 2.0 1.xls Copyright 2007 – Biz/ed .5 0.6 213.0 1.5 7.3 0.5 2000 -01 106.4 7.bized.6 -3.0 1.2 8.gov.9 56.4 196.2 1999 -00 95.4 0.0 32.0 0.8 4.0 1.uk/media/F6C/7E/public_fin_databank_211204.2 2.4 -1.0 1.1 6.8 2002 -03 112.co.0 2.http://www.6 2.0 Source: http://www.8 2003 -04 118.6 55.9 30.5 2.7 -1.uk Government Income (£ billion) Inland Revenue Income Tax (gross of tax credits) Income Tax Credits Corporation Tax Windfall Tax Petroleum Revenue Tax Capital Gains Tax Inheritance Tax Stamp Duties NICs Total Inland Revenue 1998 -99 88.5 228.2 216.0 63.4 7.1 183.0 1.1 2.0 0.6 0.

9 200304 69.5 0.9 115.8 1.7 1.5 1.8 2.3 0.7 1.5 0.8 1.1 2.1 94.3 0.9 3.3 21.http://www.0 97.6 0.0 1.4 2.0 200203 63.5 0.5 0.3 0.0 104.9 2.1 0.bized.1 1.9 1.3 0.2 1.2 0.0 3.8 2.4 0.0 2.8 200102 61.4 22.4 0.xls Copyright 2007 – Biz/ed .3 1.8 1.0 21.0 0.uk Government Income (£ billion) Customs and Excise VAT Fuel Duties Tobacco Duty Spirits Duties Wine Duties 199899 52.hm-treasury.5 5.9 7.2 3.7 0.1 1.8 8.9 108.1 102.6 1.8 0.5 0.1 22.9 0.7 3.0 2.6 7.6 0.co.1 2.7 Source: http://www.8 0.0 0.0 Beer and Cider Duties Betting and Gaming Duties Air Passenger Duty Insurance Premium Tax Land Fill Tax Climate Change Levy Aggregates Levy Customs Duties and Levies Total Customs and Excise 2.2 1.0 2.5 22.1 8.8 1.6 8.3 1.2 1.gov.7 200001 58.4 0.5 199900 56.0 1.5 22.uk/media/F6C/7E/public_fin_databank_211204.8 1.0 2.0 1.0 0.3 3.6 1.

4 19.3 14.uk Government Income (£ billion) 1998 -99 VED Oil Royalties Business Rates Council Tax Other Taxes and Royalties Net Taxes and NICs conts 4.9 2003 -04 4.7 19.6 16.9 10.8 11.1 7.4 18.2 393.4 2000 -01 4.2 -5.7 Source: http://www.gov.3 14.3 334.9 0.7 Interest and Dividends Gross Operating Surplus and Rent Other Receipts and Accounting Adjustments Current Receipts 5.7 12.hm-treasury.0 18.4 18.0 18.http://www.5 19.5 17.2 7.2 4.5 4.2 6.0 -5.5 359.2 374.9 335.9 4.4 369.1 2002 -03 4.1 8.1 -0.8 0.3 0.2 9.uk/media/F6C/7E/public_fin_databank_211204.co.0 18.bized.8 418.4 13.3 0.7 357.5 16.7 387.5 316.xls Copyright 2007 – Biz/ed .8 380.3 0.9 -5.6 1999 -00 4.3 2001 -02 4.4 -1.4 15.6 0.3 18.4 4.8 -3.2 196.9 15.

http://www.gov.bized.hm-treasury.uk Government Income – Inland Revenue 2003-04 Source: http://www.xls Copyright 2007 – Biz/ed .co.uk/media/F6C/7E/public_fin_databank_211204.

http://www.bized.uk Government Income – Customs and Excise 2003-04 Source: http://www.gov.xls Copyright 2007 – Biz/ed .co.hm-treasury.uk/media/F6C/7E/public_fin_databank_211204.

hm-treasury.xls Copyright 2007 – Biz/ed .bized.uk Other Government Income 2003-04 Source: http://www.gov.co.uk/media/F6C/7E/public_fin_databank_211204.http://www.

http://www. for example.uk Fiscal Policy • Need to remember subtleties in use of fiscal policy – Adjustment of income tax allowances rather than rates of income tax – Extending or amending range of goods covered by VAT – Changing the rules under which tax has to be paid – married persons allowances. inheritance taxes. – Abolishment of certain tax allowances – MIRAS (Mortgage Income Relief At Source) – Accusations of ‘stealth taxes’ – much of it is a ‘tinkering’ with the tax system to achieve certain aims – mostly noneconomic (governments these days.bized.co. rarely ‘increase taxes’ to dampen down the economy) • Be aware of these subtleties when you are writing! Copyright 2007 – Biz/ed . stamp duties. etc.

bized.http://www. Media and Sport Copyright 2007 – Biz/ed .uk Government Expenditure • Social Security • Law and Order • Emergency Services • Health • Education • Defence • Foreign Aid • • • • • • Environment Agriculture Industry Transport Regions Culture.co.

0 200.hm-treasury.0 0.0 400.0 100.0 450.0 350.uk Public Spending 500.0 300.0 50.0 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 Cash (£bn) Real Terms (£bn) per cent of GDP Year Source: http://www.0 150.uk Copyright 2007 – Biz/ed .co.0 (£bn) 250.gov.http://www.bized.

200096 97 98 99 00 01 2001.http://www.1993.199492 93 94 95 1995.co.XLS Copyright 2007 – Biz/ed .1998.gov.uk/media//E3CCB/PublicFinancesDatabank280104.1992.1997.1999.hm-treasury.bized.uk Public Sector Net Cash Requirement (PSNCR) 53 Central government Local authority General government 43 Public corporations Public sector 33 23 £bn 13 3 -7 -17 1991.200202 03 Source:http://www.1996.

responsibility.uk The Golden Rule! • Fiscal policy framework The Government's fiscal policy framework is based on the five key principles set out in the Code for fiscal stability . The Code requires the Government to state both its objectives and the rules through which fiscal policy will be operated. fairness and efficiency. The Government's fiscal policy objectives are: Copyright 2007 – Biz/ed . stability.co.http://www.bized.transparency.

uk The Golden Rule! • over the medium term.co. to support monetary policy and. to ensure sound public finances and that spending and taxation impact fairly within and between generations. Copyright 2007 – Biz/ed . and • over the short term. to allow the automatic stabilisers to help smooth the path of the economy.http://www. in particular.bized.

http://www. against which the performance of fiscal policy can be judged. Copyright 2007 – Biz/ed . and • the sustainable investment rule: public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level.bized.uk The Golden Rule! • These objectives are implemented through two fiscal rules. net debt will be maintained below 40 per cent of GDP over the economic cycle. Other things being equal. The fiscal rules are: • the golden rule: over the economic cycle. the Government will borrow only to invest and not to fund current spending.co.

permitting the automatic stabilisers to operate freely to help smooth the path of the economy in the face of variations in demand. reproduced under licence Copyright 2007 – Biz/ed . and – the rules work together to promote capital investment while ensuring sustainable public finances in the long term. net debt will be maintained below 40 per cent of GDP in each and every year of the current economic cycle.co.cfm Crown Copyright.uk/budget/bud_bud03/budget_report/bud_bud03_repchap2. To meet the sustainable investment rule with confidence. The sustainable investment rule ensures that borrowing is maintained at a prudent level. This allows the fiscal balances to vary between years in line with the cyclical position of the economy. The golden rule requires the current budget to be in balance or surplus over the cycle.bized. Source of information about the Golden Rule: http://www.http://www. allowing the Government to borrow only to fund capital spending.hm-treasury.uk The Golden Rule! • The fiscal rules ensure sound public finances in the medium term while allowing flexibility in two key respects: – the rules are set over the economic cycle.gov.

effects: an unemployment rate of 5% (U = 5%) AD 1 2.0% AD U=5% U=3% Real National Income Copyright 2007 – Biz/ed .uk Fiscal Policy In Action Inflation AS TheAD=C+I+G+(X-M) If rise Assume government in AD an leads to AD therefore an increase ‘reduces initial in taxes’ real Apart from G. National 3% but at it will a cost indirectly by the of higher have Income inflation various giving policy change.co.http://www. the shifts to also the and I are ceteris subtleties) position paribuswith .5% 2.bized.and a likelyto to be right AD1 unemployment orlevel increases of would affected directly or fall to spending. C national (remember equilibrium income.

uk/virtual/econo my/policy/advisors/fiscal.co.bized.ac.http://www.htm) Copyright 2007 – Biz/ed .bized. • Try your hand at Fiscal Policy by going to the Virtual Economy (http://www.uk Fiscal Policy In Action • Fiscal Policy influences AD in the short term but can be used to affect AS in the long run – depending on the nature of the policy.