Lesson 37 using macroeconomic policies

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Macroeconomic Policies

Monetary Policy
Attempts to influence the level of
economic activity through changes to
the amount of money in circulation and
short-term interest rates.

Monetary Policy
• Short-term interest rates set by the
Monetary Policy Committee (MPC) of
the central bank
• The ‘official rate’ is the rate at which
the central bank will lend to the
financial system and influences the
structure of all other interest rates

Monetary Policy

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

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

Interest
Rates
Exchange
Rates
Appreciation
Dm
Dx
Depreciation
Dm
Dx
Balance of
Payments

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
• Policies aim to influence productivity and
efficiency of the economy
• Tend to be long-term policies

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

Main areas of supply-side 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

• Tax and Welfare Reform:
– More stringent benefit regime
– Tax reform to encourage people to
work
– Improving access to training and
education
– ‘New Deal’ scheme

• 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

• 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 Side Policies

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

Fiscal Policy
• Influence Aggregate Demand –
– Tax regime influences consumption
(C) and investment (I)
– Government Spending (G)
• Acts as an ‘automatic stabiliser’

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
0
100
200
300
400
500
600
700
1
9
9
0
-
9
1
1
9
9
1
-
9
2
1
9
9
2
-
9
3
1
9
9
3
-
9
4
1
9
9
4
-
9
5
1
9
9
5
-
9
6
1
9
9
6
-
9
7
1
9
9
7
-
9
8
1
9
9
8
-
9
9
1
9
9
9
-
0
0
2
0
0
0
-
0
1
2
0
0
1
-
0
2
2
0
0
2
-
0
3
2
0
0
3
-
0
4
3
2
0
0
4
-
0
5
3
2
0
0
5
-
0
6
3
2
0
0
6
-
0
7
3
2
0
0
7
-
0
8
3
2
0
0
8
-
0
9
3
Year
£bn
33
34
35
36
37
38
39
40
41
%GDP
Public sector total receipts1 £ billion
Public sector total receipts1 % GDP
Source: http://www.hm-treasury.gov.uk/media//E3CCB/PublicFinancesDatabank280104.XLS

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

Government Income – Customs and Excise 2003-04

Other Government Income 2003-04

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

Public Spending
0.0
50.0
100.0
150.0
200.0
250.0
300.0
350.0
400.0
450.0
500.0
(£bn)
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
Year
Cash (£bn)
Real Terms
(£bn)
per cent of GDP
Source: http://www.hm-treasury.gov.uk

Public Sector Net Cash Requirement
(PSNCR)
-17
-7
3
13
23
33
43
53
£bn
1991-
92
1992-
93
1993-
94
1994-
95
1995-
96
1996-
97
1997-
98
1998-
99
1999-
00
2000-
01
2001-
02
2002-
03
Central government
Local authority
General government
Public corporations
Public sector
Source:http://www.hm-treasury.gov.uk/media//E3CCB/PublicFinancesDatabank280104.XLS

Fiscal policy objectives :
• 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.

Fiscal rules:
• the golden rule: over the economic cycle, the
Government will borrow only to invest and not to
fund current spending;
• 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.

Lesson 37 using macroeconomic policies

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