Policies

http://www.bized.co.
uk
Macroeconomic Policies
Copyright 2007 – Biz/ed

http://www.bized.co.uk
Macroeconomic Policies

Monetary Policy

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

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

Monetary Policy

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

Monetary Policy
• The Classical Quantity Theory
of Money:
• MV = PY
– (where M = the money stock, V =
velocity of circulation, P = price level
and Y = level of national income
• More formally:

Monetary Policy
• Md = k PY where:
– 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
• In equilibrium Md = Ms
– So: P = 1/kY x M
– A rise in Ms will lead to a proportional rise
in P

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)

Monetary Policy
• The Interest Rate Transmission
Mechanism
– The process by which a change in
interest rates feeds through to AD

The Interest Rate Transmission

Mechanism 1
Credit
Individuals Consumption
Loans
Interest Borrowing
Rates
New
Firms Investment
Loans
Existing Loans
Margins Costs Employment Consumption


Mechanism 2
Disposable
Income
Existing Consumption
Property
Interest Equity
Rates Mortgages
Demand Investment
New for New
Housing
Savings Consumption


Mechanism 3
Mp Dm
Appreciation
Xp Dx
Interest Exchange Balance of

Rates Rates Payments
Mp Dm
Depreciation
Xp Dx

Supply Side Policy

Supply Side Policy

• Intention is to shift the aggregate
supply curve to the right, increasing
the long term productive capacity
of the economy
• Tend to be long-term policies
• Arguments about how effective they are
– e.g. lowering taxes increases
incentives, reducing welfare
dependency increases the urge
to find work

Supply Side Policy

Inflation
AS AS1
Increases
Supply sidein
policies can help
long-term
to push the
capacity can AShelp
curve to the right
the economy to
increasing the
grow without
capacity of the
2.3%
undue pressure
economy from Yf
2.0% on inflation.
to Yf2
AD
Yf Yf2
Real National Income

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

Supply Side Policy

• Main areas of policy:
– Labour Market – reduce impediments to free
market, 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, 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

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

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

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,
investment, location, expansion

Fiscal Policy

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:

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:

Fiscal Policy
• Also used to influence non-
economic objectives and provide
framework for supply side policy
• e.g. education and health, poverty
reduction, welfare reform,
investment, regional policies,
promotion of enterprise, etc.

Government Income
• Tax Revenue
• Sale of Government Services –
e.g. prescriptions, passports, etc.
• Borrowing (PSNCR)

Public Sector Income

700 41
600 40
39
500
38
400
%GDP
£bn
37
300
36
200
35
100
34
0 33
20 43
20 053
20 063
20 073
20 083
93
19 91
19 92
19 93
19 4
19 95
19 96
19 97
19 98
19 99
20 00
20 01
20 02
20 -03
-9
-
-0
-0
90
91
92
93
94
95
96
97
98
99
00
01
02
-
03
04
05
06
07
08
19
Public sector total receipts1 £ billion Year

Public sector total receipts1 % GDP
Source: http://www.hm-treasury.gov.uk/media//E3CCB/PublicFinancesDatabank280104.XLS

Government Income (£ billion)

Inland Revenue 1998 1999 2000 2001 2002 2003
-99 -00 -01 -02 -03 -04
Income Tax (gross of tax credits) 88.4 95.7 106.1 110.3 112.6 118.3
Income Tax Credits -1.9 -1.8 -1.0 -2.3 -3.4 -4.3
Corporation Tax 30.0 34.3 32.4 32.0 29.5 28.1
Windfall Tax 2.6 0.0 0.0 0.0 0.0 0.0
Petroleum Revenue Tax 0.5 0.9 1.5 1.3 1.0 1.2
Capital Gains Tax 2.0 2.1 3.2 3.0 1.6 2.2
Inheritance Tax 1.8 2.1 2.2 2.4 2.4 2.5
Stamp Duties 4.6 6.9 8.2 7.0 7.5 7.5
NICs 55.1 56.4 60.6 63.2 64.6 72.5
Total Inland Revenue 183.2 196.5 213.4 216.8 215.8 228.0

Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls


Customs and Excise 1998- 1999- 2000- 2001- 2002- 2003-
99 00 01 02 03 04
VAT 52.3 56.4 58.5 61.0 63.5 69.1
Fuel Duties 21.6 22.5 22.6 21.9 22.1 22.8
Tobacco Duty 8.2 5.7 7.6 7.8 8.1 8.1
Spirits Duties 1.6 1.8 1.8 1.9 2.3 2.4
Wine Duties 1.5 1.7 1.8 2.0 1.9 2.0
Beer and Cider Duties 2.7 3.0 3.0 3.1 3.1 3.2
Betting and Gaming Duties 1.5 1.5 1.5 1.4 1.3 1.3
Air Passenger Duty 0.8 0.9 1.0 0.8 0.8 0.8
Insurance Premium Tax 1.2 1.4 1.7 1.9 2.1 2.3
Land Fill Tax 0.3 0.4 0.5 0.5 0.5 0.6
Climate Change Levy 0.0 0.0 0.0 0.6 0.8 0.8
Aggregates Levy 0.0 0.0 0.0 0.0 0.2 0.3
Customs Duties and Levies 2.1 2.0 2.1 2.0 1.9 1.9
Total Customs and Excise 94.0 97.3 102.2 104.9 108.7 115.7


1998 1999 2000 2001 2002 2003
-99 -00 -01 -02 -03 -04
VED 4.6 4.9 4.3 4.3 4.3 4.8
Oil Royalties 0.3 0.4 0.6 0.5 0.4 0.0
Business Rates 14.7 15.4 16.3 17.9 18.5 18.4
Council Tax 12.2 13.1 14.1 15.2 16.9 18.8
Other Taxes and Royalties 7.5 7.9 8.5 9.4 10.2 11.2
Net Taxes and NICs conts 316.6 335.4 359.3 369.1 374.9 196.7
Interest and Dividends 5.0 4.3 6.0 4.7 4.5 4.4
Gross Operating Surplus and Rent 18.2 18.1 18.8 19.9 19.0 19.4
Other Receipts and Accounting -5.3 -0.7 -3.8 -5.7 -5.2 -1.8
Adjustments
Current Receipts 334.5 357.2 380.4 387.9 393.2 418.7

Government Income – Inland Revenue 2003-04

Government Income – Customs and Excise 2003-04

Other Government Income 2003-04

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, stamp
duties, etc.
– 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 non-
economic (governments these days, for example, rarely
‘increase taxes’ to dampen down the economy)
• Be aware of these subtleties when you are writing!

Government Expenditure
• Social Security • Environment
• Law and Order • Agriculture
• Emergency • Industry
Services • Transport
• Health • Regions
• Education • Culture, Media
• Defence and Sport
• Foreign Aid

Public Spending
500.0
450.0
400.0
350.0
300.0
(£bn) 250.0
200.0
150.0
100.0
50.0
0.0
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.hm-treasury.gov.uk

Public Sector Net Cash Requirement

(PSNCR)
53 Central government
Local authority
General government
43 Public corporations
Public sector
33
23
£bn
13
-7
-17
1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998- 1999- 2000- 2001- 2002-
92 93 94 95 96 97 98 99 00 01 02 03
Source:http://www.hm-treasury.gov.uk/media//E3CCB/PublicFinancesDatabank280104.XLS

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 - transparency,
stability, responsibility, fairness and efficiency.
The Code requires the Government to state both
its objectives and the rules through which
fiscal policy will be operated. The
Government's fiscal policy objectives are:

The Golden Rule!

• over the medium term, to ensure sound
public finances and that spending and
taxation impact fairly within and
between generations; and
• over the short term, to support

monetary policy and, in particular, to
allow the automatic stabilisers to help
smooth the path of the economy.

The Golden Rule!

• These objectives are implemented through two fiscal
rules, against which the performance of fiscal policy can
be judged. The fiscal rules are:
• the golden rule: over the economic cycle, the

Government will borrow only to invest and not to fund
current spending; 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. Other
things being equal, net debt will be maintained below
40 per cent of GDP over the economic cycle.

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. This allows the fiscal
balances to vary between years in line with the cyclical position of
the economy, permitting the automatic stabilisers to operate
freely to help smooth the path of the economy in the face of
variations in demand; and
– the rules work together to promote capital investment while

ensuring sustainable public finances in the long term. The golden
rule requires the current budget to be in balance or surplus over
the cycle, allowing the Government to borrow only to fund capital
spending. The sustainable investment rule ensures that borrowing
is maintained at a prudent level. To meet the sustainable
investment rule with confidence, net debt will be maintained
below 40 per cent of GDP in each and every year of the current
economic cycle.
Source of information about the Golden Rule:
http://www.hm-treasury.gov.uk/budget/bud_bud03/budget_report/bud_bud03_repchap2.cfm
Crown Copyright, reproduced under licence

Fiscal Policy In Action

Inflation AS
TheAD=C+I+G+(X-M)
If
rise
Assume
government
in AD anleads to
AD therefore
an increase
‘reduces
initial intaxes’
real
Apart from G, C
shifts
national to also
(remember the
equilibrium
and I are
income, the
ceterissubtleties)
position
paribus,with
and a
right
likelyto
unemployment
orlevel
AD1
to be
increases
of would
affected directly or
fall tospending,
National
3% but at it will
a cost
indirectly by the
of higher
have
Income
inflation
various
giving
policy change.
effects:
an
2.5% unemployment
rate of 5% (U
= 5%)
2.0%
AD 1
AD
U=5% U=3% Real National Income

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.
• Try your hand at Fiscal Policy by going
to the Virtual Economy
(http://www.bized.ac.uk/virtual/econo
my/policy/advisors/fiscal.htm)

Policies

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Policies

Uploaded by

Copyright:

Available Formats

http://www.bized.co.

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

The Interest Rate Transmission

Margins Costs Employment Consumption

Copyright 2007 – Biz/ed

The Interest Rate Transmission

Copyright 2007 – Biz/ed

The Interest Rate Transmission

Interest Exchange Balance of

Copyright 2007 – Biz/ed

Supply Side Policy

Copyright 2007 – Biz/ed

Supply Side Policy

Copyright 2007 – Biz/ed

Supply Side Policy

Copyright 2007 – Biz/ed

Supply Side Policies

Copyright 2007 – Biz/ed

Supply Side Policy

Copyright 2007 – Biz/ed

Supply Side Policy

Copyright 2007 – Biz/ed

Supply Side Policy

Copyright 2007 – Biz/ed

Supply Side Policy

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Copyright 2007 – Biz/ed

Public Sector Income

Public sector total receipts1 £ billion Year

Copyright 2007 – Biz/ed

Government Income (£ billion)

Income Tax Credits -1.9 -1.8 -1.0 -2.3 -3.4 -4.3

Corporation Tax 30.0 34.3 32.4 32.0 29.5 28.1

Windfall Tax 2.6 0.0 0.0 0.0 0.0 0.0

Petroleum Revenue Tax 0.5 0.9 1.5 1.3 1.0 1.2

Capital Gains Tax 2.0 2.1 3.2 3.0 1.6 2.2

Inheritance Tax 1.8 2.1 2.2 2.4 2.4 2.5

Stamp Duties 4.6 6.9 8.2 7.0 7.5 7.5

NICs 55.1 56.4 60.6 63.2 64.6 72.5

Total Inland Revenue 183.2 196.5 213.4 216.8 215.8 228.0

Copyright 2007 – Biz/ed

Government Income (£ billion)

Copyright 2007 – Biz/ed

Government Income (£ billion)

Copyright 2007 – Biz/ed

Government Income – Inland Revenue 2003-04

Copyright 2007 – Biz/ed

Government Income – Customs and Excise 2003-04

Copyright 2007 – Biz/ed