The Macroeconomic Environment of Business

THE MACROECONOMIC ENVIRONMENT

Sloman and Jones, Chapters 10 - 12
 Overview
• Macroecon. environm’t.
• Macroecon. objectives
• The Business Cycle

• Balance of payment
• Exchange Rate
• National macroecon policy
• International trade
 Learning Aims

By the end of this session you will be able to:

• Identify the key macroeconomic objectives
• Understand macroeconomic factors
• Describe National macroeconomic policy in
terms of Fiscal Policy, Monetary Policy, Supply-
side Policy
• Understand Balance of payment; Exchange rate
• Discuss the benefits of international trade
 The Macroeconomic
Environment
Macroeconomics – studies the behaviour and
performance of the economy as whole:
• Economic growth
• Unemployment
• Inflation
• Balance of payment
 Macroeconomic objectives

1. High and stable sustainable economic growth

2. Low unemployment
3. Low and stable inflation
4. Avoid bal of paym’t deficit
5. Avoid excessive exchange
rate fluctuations
The Circular Flow of Income
The Business cycle
 The Balance of Payments
The balance of payments records all the flows of
money between residents of e.g. the UK and the
rest of the world
1. The current account records a country’s
imports and exports of goods and services plus
incomes plus transfers of money to and from
abroad
2. Balance of trade – Exports of goods and
services less imports of goods and services.
3. The capital account – The record of transfers of
capital to and from abroad
The UK Balance of payment
 UK balance of payments (£m)
Current account
Balance on trade in goods and services (exports minus imports) 36 154
Net income flows (wages and investment income) +1 562
Net current transfers (government and private) 23 087
Balance on current account 57 679
Capital account (net capital transfers, etc.) +3 705
Financial account
Direct investment –5 738
Portfolio investment –203 375
Other investment (mainly short term) +265 252
Reserves –7 642
Balance on financial account +48 497
(Net errors and omissions) +5 477
Total 0
 Exchange Rates
• The exchange rate is the rate at which one currency
trades for another on the foreign exchange market.
• In a free foreign exchange market, exchange rate is
determined by demand and supply.
• Supply pounds to buy dollars. The higher the
exchange rate, the more dollars you obtain,
therefore the more pounds you supply, hence an
upward sloping supply curve.
• Demand pounds by selling dollars. The lower the
exchange rate, the cheaper it is to obtain UK
goods and assets, and hence more pounds will be
demanded, hence the demand curve slopes
downwards
 Exchange Rates

• The equilibrium exchange rate is where the demand

for pounds equal the supply of pounds.
• The shifts in currency demand and supply is caused
by:
– changes in relative interest rates, e.g. a fall in the
UK interest rate would lead to a fall in demand for
the pound;
– differences in relative inflation rates, e.g. rise in the
inflation rate would lead to a rise in the supply of
the pound
– differences in relative growth rates, e.g. if income
increases, demand for imports rise and supply of
the pound will rise
 Sterling exchange rates against selected currencies
3.50 115
Japanese yen (100s) Australian dollar

Sterling exchaange rate index (Jan 2005 = 100) .

US dollar euro 110
Index (1/1/05 = 100)
3.00
105
Foreign currency units per £1 ..

100
2.50
95
]
90
2.00
85

80
1.50

75

1.00 70
1985 1990 1995 2000 2005 2010
Note: The euro was introduced in 1999, with notes and coins circulating from 2001.
Source: based on data in Monthly Review of External Statistics (National Statistics)
 National Macroeconomic Policy

Government uses macroeconomic policy to

achieve its economic objectives –Refer to slide 6
Govt. Intervention – in broad terms – 3 forms:
1. Fiscal policy 1 & 2 = Demand side policy
2. Monetary policy
3. Supply-side policy
 Fiscal Policy

• The purpose of fiscal policy are to prevent the

occurrence of fundamental
disequilibrium such as preventing a
recession.
• Fiscal policy is also used to influence aggregate
supply, for example, infrastructure or tax
incentives to promote business and thereby affect
the capacity of the economy
• The budget deficit is when government spending
is greater than taxes
 Fiscal Policy
• The budget surplus is when government taxes is
greater than spending
• The public sector net borrowing is the difference
between the expenditures and taxes, surpluses
and sale of assets by the public sector and public
corporations. If expenditures exceed receipts,
then the government borrows to make up the
difference
• The central government debt is the accumulated
central and local government deficits over the
years
 Monetary Policy

• The policy setting – in framing monetary policy,

the government must decide what the goals of
the policy are : is it inflation, GDP , employment, or
exchange rate?
• Targeting the money supply is difficult because money
supply depends on the amount of credit created by
banks
• Targeting inflation is easier because a high rate of
interest can bring down the inflation rate. Therefore
many central banks target inflation by changing the
interest rate.
 Supply-side Policy (SSP)
Market-oriented SSP
• Government expenditure – reduce
• Tax cuts (for firms + individuals)
• Increased flexibility (in labour markets)
• Encourage competition through privatisation
• Deregulation, Private Finance Initiative
• Free trade, Capital Movements
Interventionist SSP
• Research and Development, assistance to small firms,
information, training, advice and persuasion
 International Trade
Why international trade?
1. Resources are unevenly distributed
2. Limited mobility of production factors
3. Specialisation
4. Globalisation?
 Share of world merchandise exports, by value (2012)

USA
Other Asia 8.4% Canada
(inc. Australasia) and Mexico
19.4% 4.5% Latin
America
3.9% UK
2.6%
France
China
3.1%
11.2% Netherlands
3.6%

Japan Germany
4.4% 7.7%
Middle East
Italy
8.9% 2.7%
Other Europe
Africa Former
12.0%
3.4% Soviet
republics
4.4%

Source: Based on data in WTO Statistics Database

 Takeaways
1. The key macroeconomic indicators are
economic growth, inflation, unemployment
and the balance of payments
2. Macroeconomic policy is implemented
through monetary policy, fiscal policy and
supply side policy
3. International trade allows us to consume
more than we produce