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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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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
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Monetary Policy
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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
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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:
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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
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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)
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Monetary Policy
• The Interest Rate Transmission
Mechanism
– The process by which a change in
interest rates feeds through to AD
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The Interest Rate Transmission
Mechanism 1
Credit
Consumption
Individuals
Loans
Interest
Rates
Borrowing
Firms
New
Loans
Investment
Existing Loans
Margins
Costs
Employment
Consumption
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The Interest Rate Transmission
Mechanism 2
Disposable
Income
Existing
Interest
Rates
Property
Equity
Mortgages
New
Savings
Consumption
Demand
for New
Housing
Investment
Consumption
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The Interest Rate Transmission
Mechanism 3
Mp
Dm
Xp
Dx
Appreciation
Interest
Rates
Balance of
Payments
Exchange
Rates
Mp
Dm
Xp
Dx
Depreciation
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Supply Side Policy
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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
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Inflation
Supply Side Policy
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
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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
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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
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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
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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
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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
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Fiscal Policy
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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:
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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:
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Fiscal Policy
• Also used to influence noneconomic objectives and provide
framework for supply side policy
• e.g. education and health, poverty
reduction, welfare reform,
investment, regional policies,
promotion of enterprise, etc.
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Government Income
• Tax Revenue
• Sale of Government Services –
e.g. prescriptions, passports, etc.
• Borrowing (PSNCR)
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Public Sector Income
700
41
600
40
39
500
£bn
37
300
%GDP
38
400
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
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Government Income (£ billion)
Inland Revenue
1998
-99
1999
-00
2000
-01
2001
-02
2002
-03
2003
-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
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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
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Government Income (£ billion)
1998
-99
1999
-00
2000
-01
2001
-02
2002
-03
2003
-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
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
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Government Income – Inland Revenue 2003-04
Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls
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Government Income – Customs and Excise 2003-04
Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls
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Other Government Income 2003-04
Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls
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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 noneconomic (governments these days, for example, rarely
‘increase taxes’ to dampen down the economy)
• Be aware of these subtleties when you are writing!
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Government Expenditure
• Social Security
• Law and Order
• Emergency
Services
• Health
• Education
• Defence
• Foreign Aid
•
•
•
•
•
•
Environment
Agriculture
Industry
Transport
Regions
Culture, Media
and Sport
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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
2001-02
2000-01
1999-00
1998-99
1997-98
1996-97
1995-96
1994-95
1993-94
1992-93
1991-92
1990-91
Real Terms
(£bn)
per cent of GDP
1989-90
Cash (£bn)
Year
Source: http://www.hm-treasury.gov.uk
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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
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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:
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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.
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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.
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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
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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
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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)
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