Basic transmission mechanisms: 1.

Economic growth leads to lower unemployment Growth --> rising income per capita --> greater spending into the economy --> AD for goods and services increase --> more manpower needed lower unemployment 2. Economic growth leads to higher inflation Growth --> increase in wages/ bonuses --> greater spending into the economy --> increase in AD -> price level increases --> demand-pull inflation 3. Economic growth leads to the worsening of current account deficit Growth --> increase in wages/ bonuses --> UK people have high marginal propensity to import --> rise in imports and assume exports unchanged --> worsening of the current account deficit 4. Economic growth leads to income inequality Growth --> wages for low/ middle class earners will usually increase but at a slower rate --> probably worse off after adjustment for inflation, student loan repayments, income tax and NICs (National Insurance Contributions) --> rich people may be subjected to higher income tax BUT there are other non-income gains that are taxed at much lower rate e.g. capital gain and share dividends --> widening income inequality 5. Growth leads to deterioration of environment Growth --> increase in wages --> greater AD for goods and services -->more lands cleared to give way for residential homes, business parks and factories/ more cars on the road --> deforestation and rise in global warming 6. Lower unemployment leads higher growth Low unemployment --> AD for goods and services will increase -->higher real output --> growth 7. Lower unemployment leads to higher inflation Low joblessness --> greater spending into the economy --> AD shifts rightward --> price level increases --> demand-pull inflation 8. Lower unemployment leads to worsening of current account deficit Low joblessness --> unemployed people now have income to spend -->UK people have high marginal propensity to import --> rise in imports and assuming exports unchanged --> current account deficit widens 9. Lower unemployment leads to deteriorating environment Fewer jobless people --> greater spending into the economy --> more lands to be cleared to construct houses, leisure areas and factories/ more cars and busses on the roads --> deforestation and emission of CO2 10. Lower unemployment reduces income inequality Fewer unemployed people --> jobless people now have income and assume that their income is more than their previous benefits and UK government implements progressive taxation --> narrowing the gap between the rich and poor 11. Lower unemployment leads to higher inflation Fewer jobless people --> total expenditure into the economy increases--> AD shifts rightward -> increase in price level --> higher demand-pull inflation 12. High inflation leads to lower growth Supposed that the inflation creeps beyond the targeted level of CPI 2% +/- 1% Bank of England may consider an increase in base rate if this happens, cost of borrowing will increase --> lower consumption and investment fall in AD lower growth

13. High inflation leads to increase in unemployment Increase in inflation falling real income limiting the spending ability of households AD for goods and services will fall fewer workers needed 14. High inflation leads to the worsening of current account deficit Increase in production costs less competitive pricing export prices increase and assuming import prices unchanged fall in demand for British manufactured goods widening current account deficit 15. High inflation leads to widening income inequality Rise in price level wages growth rate is usually lower than the rate of inflation falling real income consumers/ households are priced-out every pound purchases lesser goods and services 17. High inflation leads to less deterioration of environment Increase in price level falling real income limiting the ability of households to spend elsewhere fall in AD for goods and services factories operate shorter hours and economic activities come to a slowdown less severe congestion, deforestation and flights improve the conditions of the environment 18. Large current account deficit leads to lower economic growth Huge current account deficit imports of goods outweigh exports of goods net withdrawal from the UKs circular flow of income falling net exports/ resulting in net imports AD shifts leftward lower real output faltering growth 19. Large current account deficit leads to lower inflation Rising current account deficit imports of goods are greater than exports of goods net withdrawal from the circular flow of income falling (X-M) AD shifts leftward price level falls lower inflation for the UK economy 20. Large current account deficit leads to rising unemployment Huge current account deficit indicator that British people have high marginal propensity to import (M increases) and at the same time UK manufactured goods are losing its price competitiveness (X falling) decline in factory orders both from domestic and international market factories no longer need so many manpower as before retrenchment rising unemployment 21. Large BOP deficit leads to improvement in the environmental condition Large BOP deficit is due to the ongoing current account deficit imports of goods far outweigh exports of goods demand from both domestic and international market falling greater spare capacity e.g. heavy equipments are not in used and factories dispose lesser waste, thrash and smog cleaner environment within UK

22. Large BOP deficit leads to increase in income inequality Huge current account deficit imports greater than exports falling factory orders both from domestic and international market factories will need to get rid of surplus of workers those retrenched will fall into greater poverty More to come, stay tune!! Remember, you don't have to study textbooks. It is incredibly sufficient if you're able to understand transmission mechanisms alone. LOGIC is the word. Please don't rot memorise

Now, let's roll for demand management policies Fiscal policy 1. Increase in government spending leads to economic growth Larger budget e.g. building of new schools and hospitals direct injection into the circular flow of income increase in AD rise in real output economic growth 2. Increase in government spending leads to falling unemployment The UK government spends more money onto public sector e.g. enlargement of existing departments and build more roads and bridges create jobs e.g. teachers, surgeons and nurses in NHS, road builder etc lower unemployment within UK 3. Increase in public sector expenditure leads to rising inflation Direct injection into the circular flow of income government spending is a component of AD AD shifts to the right price level increases demand-pull inflation 4. Increase in budget deficit leads to larger current account deficit Greater budget deficit is an indicator that the UK government has increased its spending AD shifts rightward economic growth rise in income UK people have high marginal propensity to import import of foreign goods increases assuming exports unchanged widening of current account deficit 5. Increase in public sector spending leads to deterioration of environment Larger budget to construct schools, hospitals, roads and bridges, sports complex etc clearing up of lands/ deforestation worsening the environmental condition 6. Increase in public sector spending leads to falling income inequality Larger budget e.g. financial support to help key workers to climb onto the property ladder, Minimum Income Guarantee for pensioners, New Deal programmes for long term unemployed, Jobseekers Allowance etc people who are unemployed have some incomes to sustain themselves while some are moved into labour market narrowing income inequality/ reducing cases of relative poverty 7. Reduction in income tax leads to economic growth Lower income tax higher take-home pay more money to spend into the economy rise in consumption AD shifts rightward rise in real GDP growth 8. Lower income tax leads to falling unemployment rate Lower income tax higher disposable income more money to spend into the economy AD for goods and services will increase more manpower needed lower unemployment 9. Lower business tax leads to higher inflation Slash in corporation tax higher retained profits firms are more likely to increase investment e.g. purchase of capital equipments, build new factories etc injection into the circular flow of income AD increases increase in price level inflation 10. Lower business tax and income tax leads to worsening of current account deficit Lower business tax higher retained profits more likely to invest/ enlarge operations purchase of more raw materials, intermediate goods and capital equipments from abroad assuming exports constant worsening the current account deficit 11. Slash in income tax leads to deterioration of environment Lower income tax higher take-home pay households have more money to splash into the economy AD for goods and services increase More supermarkets, banks, pubs, housing areas, parks etc will be built worsening the environmental condition 12. Cut in income tax leads to falling income inequality

Reduction in income tax for lower/ middle income people allow for higher disposable income reducing the gap between the rich and poor Next comes the monetary policy MONETARY POLICY 1. Lower interest rate leads to higher growth Slash in base rate cheaper cost of borrowing more households will borrow and spend (cars, properties, flat screen TVs etc) while companies seize opportunity to invest due to higher rate of return on capital increase in AD rise in real output growth 2. Lower interest rate leads to lower unemployment Fall in repo rate fall in cost of borrowing people will spend more money (cars, furniture, foods and drinks etc) and companies will increase their investment (new factories, outlet, operation centre etc) more manpower needed to produce goods and services falling unemployment 3. Lower interest rate leads to rising price level Cut in overnight rate cheaper borrowing more people and firms spend into the economy AD shifts rightward price level increases inflation 4. Lower interest rate leads to narrowing of the current account deficit Falling interest rates less attractive to save money in UK due to lower return on savings outflow of hot money e.g. short term funds supply of pound increases in exchange for other currencies value of pound falls exports artificially cheap while imports artificially expensive reduction in the balance of trade cutting down size of current account deficit 5. Lower interest rate leads to worsening of environmental condition Cheap borrowing households splash more money into the economy e.g. buying properties, cars, dine more often outside while companies invest by building new factories clearing up of lands to give ways to development and growth greater air, water, and noise pollution 6. Lower interest rate leads to reduction in income inequality Households increase spending into the economy AD for goods and services increases more manpower needed to produce output job creations people on long term unemployment may return to job markets SUPPLY SIDE POLICIES/ MICROECONOMICS REFORM (some other syllabus) 1. Lower income tax leads to higher economic growth Workers get to keep higher portion of their income create an incentive to work harder/ longer hours/ taking up second piece of job more potential output produced higher economic growth 2. Reform to income tax leads to lower unemployment Unemployed people realise that take-home-pay has increased larger gap between disposable income and benefits from staying unemployed creates incentive to enter into labour market lower unemployment 3. Lower income tax leads to lower inflation Higher take-home-pay creates an incentive to be more productive at work place increase in output high overhead costs are spread over greater output lower unit costs pass on to economy falling price level lower inflation 4. Fall in income tax leads to narrowing of BOP deficit

Higher disposable income creates an incentive to be more productive rise in output lower unit costs competitive pricing assuming other factors constant, exports will increase narrowing the balance of trade/ current account deficit 5. Trade union reform leads to higher economic growth Weaker trade union lesser industrial disputes more productive working days in a month/ year more potential output produced higher growth 6. Labour union reform leads to lower inflation Unions have lesser power to bargain for high wages that are not met by equivalent rise in productivity wages cost kept low prices of goods and services do not increase lower costpush inflation 7. Weaker trade union leads to fall in unemployment Trade unions have less power to bargain for absurd wages wage costs are kept low companies will have greater tendency to demand for more workers job creations lower unemployment 8. Weaker labour union leads to falling BOP deficit Lesser strikes and more productive working days and wage costs are kept low costs are spread over more output lower unit costs competitive pricing assuming other factors constant, exports will rise narrowing BOP deficit 9. Better education and training leads to higher growth UK government increases spending onto education and training professors are financially rewarded, more research grants for universities, improvement in education system, more schools, greater range of vocational programmes introduced like carpentry, IT skills, tailoring and cooking class more productive and skilled workforce increase in potential output growth 10. Better education and training leads to lower inflation UK will have more productive and skilled manpower efficiency at workplace increases increase in potential output costs are spread wider lower unit costs pass on to the economy lower inflation 11. Better education and training leads to lower unemployment UK will have more knowledgeable workers and those that undergone training will have better skills value for money if firms recruit them reduce frictional (time taken to land on new job) and structural unemployment (due to change in structure of economy) 12. Better education and training leads to shrinking BOP deficit UK will have more educated and skilled workers productivity at workplace increases more output produced lower unit costs rise in competitiveness higher exports, assuming imports constant BOP deficit narrows 13. Privatisation leads to economic growth More new private firms are established the spirit of competition has led to more innovation e.g. methods to increase output and employees are more likely to be productive to keep their jobs higher potential output growth 14. Privatisation leads to fall in inflation More new private firms are created fierce competition and assuming other factors constant prices will be kept low and also there will be an incentive to reduce costs so that price reduction will not affect their profit margin lower inflation

15. Privatisation leads to narrowing of current account deficit

More private firms are created and assuming other factors constant more competitive environment have the incentive to keep prices low and at the same time pursue efficiency measures to preserve margins of profit/ incentive to produce quality goods export prices become competitive and assuming imports unchanged BOP deficit shrinks 16. Deregulation leads higher growth Reduction in the barriers to entry more private enterprise set up more potential goods and service produced growth 17. Deregulation leads to lower inflation Government efforts to create a more competitive environment lower barriers to entry more firms competing to enlarge their market share prices of goods and services are kept low falling inflation 18. Deregulation leads to shrinking deficit in the balance of trade Greater competition firms try to hold down prices competitive pricing for exports of goods and services reduction in current account deficit 19. Reducing state welfare benefits lead to higher growth The opportunity cost of staying unemployed has increased greater incentive for jobless people to enter the labour market and assuming other factors constant more output growth is achieved 20. Reducing welfare benefits lead to lower inflation More jobless people will have the incentive to enter the labour market supply of labour increases wages will be suppressed wages cost fall lower prices inflation is reduced 21. Cut in welfare benefits leading lower unemployment Long term unemployed finds that it is more financially rewarding to be in labour market than at home more of them try to look for jobs and assuming other factors constant fall in the number of jobless people 22. Lower benefits lead to falling current account deficit Gap between new benefits and disposable income increases creates an incentive to look for work increase in labour supply into certain industries will keep market wages low low unit costs improve competitiveness exports of goods and services increase reduction in BOP deficit 23. Employment subsidies leading to higher growth Government provide grants e.g. wages and training are paid by the state private firms in theory are encouraged to provide more regular training for their workers rise in productive potential growth 24. Employment subsidies leading to lower unemployment Companies are given financial subsidies creates the incentive/ provided with more budget to enlarge their base of employees new vacancies are created more people are absorbed into labour market lower joblessness 25. Employment subsidies leading to lower inflation Wages are subsidised by government keep operating costs low and assuming other factors constant companies may pass on some of the cost savings in the form of lower price falling inflation 26. Subsidies leading to reduction in size of current account deficit Operations are partially subsidised by government e.g. training, wages, purchase of raw materials etc able to operate in a larger scale leading to various economies of scale cheaper unit costs greater competitiveness falling current account deficit

Some more advanced TRANSMISSION MECHANISMS: 1. Increase in government spending may lead to lower growth (possible? YES, 2 ways) A. Rise in public expenditure --> greater budget deficit --> more borrowing from the private sector by selling gilts --> due to the attractive returns and since they are government-backed --> bought by private companies --> lesser money to invest --> possibility of lower growth and is known as crowing out effect B. Surge in public spending --> the increasing need to borrow for more money --> creates competition with the private sectors for money --> interest rate is bid up --> higher cost of borrowing --> falling in private investment --> economic growth may be muted and is known as crowding out effect 2. Rise in exports which may lead to widening current account deficit (What?? YES, 4 ways) A. Surge in exports --> demand for sterling increases to facilitate transactions --> pound appreciates --> British-made goods become less price competitive --> demand for exports fall --> current account deficit widens B. Rise in exports --> revival in the manufacturing sector --> increasing the need to sustain/ enlarge the operations --> purchase of more capital equipments usually from Germany and Japan --> may worsen current account deficit C. Rise in exports --> revival of the beleaguered manufacturing sector --> more people are absorbed into employment --> total spending onto imported goods may increase since UK people have high marginal propensity to import --> worsening the balance of trade D. A rise in exports, assuming imports are constant --> (X-M) will increase --> AD shifts rightward --> price level increases --> demand-pull inflation --> UK goods less price competitive --> falling demand from major trading partners like USA, France, Germany and Italy --> widening of the current account deficit 3. Collapse in house prices will lead to rising unemployment A Falling house prices --> negative wealth effect/ falling equity --> people reduce their spending into the economy/ build up their savings --> falling AD for goods and services --> less manpower is needed --> rising unemployment --> through negative multiplier effect, unemployment may increase much more B. Tumbling property market --> housing firms have less incentive to increase their portfolio --> reduction in the number of bricklayers needed and workers from construction related industries e.g. machinery, raw materials etc will be retrenched too --> rising unemployment Well candidates, as you can see the list of transmission mechanisms may go on and on and on and that is why I strongly recommend you all to comprehend how the flows work rather than memorising them as there could be easily hundreds of them. Study SMART pays!! :) Cheers