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Macroeconomic Policies
IGCSE Economics
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 Bank
Indonesia
Senior officials meet to decide on
rates
 The ‘official rate’ is the rate at Bank
Indonesia will lend to the financial
system and influences the structure
of all other interest rates
Monetary Policy
These are UK figures
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
Consumption
Individuals
Loans
Interest
Rates
Borrowing
Firms
New
Loans
Investment
Existing Loans
Margins
Costs
Employment
Consumption
The Interest Rate Transmission
Mechanism 2
Disposable
Income
Existing
Interest
Rates
Property
Equity
Mortgages
New
Savings
Consumption
Demand
for New
Housing
Consumption
Investment
The Interest Rate Transmission
Mechanism 3
Mp
Dm
Xp
Dx
Appreciation
Interest
Rates
Balance of
Payments
Exchange
Rates
Mp
Dm
Xp
Dx
Depreciation
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
Supply sidein
Increases
policies can help
long-term
to push the
AShelp
capacity
can
curve to the right
the
economy to
increasing the
grow
without
capacity
of the
undue
pressure
economy from Yf
on
inflation.
to Yf2
2.3%
2.0%
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 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 particularly where the workers
have few powers
Supply Side policies continued
 Privatisation.
The privatisation of state enterprises to raise
money and efficiency
BCA and perhaps some of Pertamina and
Garuda
Supply Side Policy
 Tax Reform:
Tax reform to encourage people to work
 Improving access to training and
education
Supply Side Policy
 Education and Training:
 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
 Regional policies to encourage enterprise,
investment, location, expansion. Transmigrasi
 These policies take a long time to work
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
£bn
37
300
36
200
35
34
0
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
100
Public sector total receipts1 £ billion
Public sector total receipts1 % GDP
Year
Source: http://www.hm-treasury.gov.uk/media//E3CCB/PublicFinancesDatabank280104.XLS
%GDP
38
400
Government Income (£ billion)
Inland Revenue
199899
199900
200001
200102
200203
200304
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
Government Income (£ billion)
Customs and Excise
199899
199900
200001
200102
200203
200304
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
Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls
Government Income (£ billion)
199899
199900
200001
200102
200203
200304
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 Adjustments
-5.3
-0.7
-3.8
-5.7
-5.2
-1.8
Current Receipts
334.5
357.2
380.4
387.9
393.2
418.7
Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.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
Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls
Other Government Income 2003-04
Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls
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
 Law and Order
 Emergency
Services
 Health
 Education
 Defence
 Foreign Aid






Environment
Agriculture
Industry
Transport
Regions
Culture, Media and
Sport
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
2005-06
2004-05
2003-04
2002-03
Year
2001-02
2000-01
1999-00
1998-99
1997-98
1996-97
1995-96
Source: http://www.hm-treasury.gov.uk
1994-95
1993-94
1992-93
1991-92
1990-91
Real Terms
(£bn)
per cent of GDP
1989-90
Cash (£bn)
Public Sector Net Cash Requirement (PSNCR)
Central government
53
Local authority
General government
43
Public corporations
Public sector
33
23
£bn
13
3
-7
-17
1991- 1992- 1993- 199492
93
94
95
1995- 1996- 1997- 1998- 1999- 200096
97
98
99
00
01
2001- 200202
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
AS
Inflation
TheAD=C+I+G+(X-M)
If
rise
Assume
government
in AD an
leads to
AD
therefore
an increase
‘reduces
initial intaxes’
real
Apart from G, C
national
(remember
equilibrium
income,
the
shifts
to also
the
and I are
ceteris
subtleties)
position
paribus,with
and a
likelyto
to be
right
AD1
unemployment
orlevel
increases
of would
affected directly or
fall to
spending,
National
3% but at
it will
a cost
indirectly by the
of higher
have
Income
inflation
various
giving
policy change.
effects:
an
unemployment
rate of 5% (U
= 5%)
2.5%
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/economy/p
olicy/advisors/fiscal.htm)