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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
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

Md = k PY where:

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
Individuals Loans Interest Rates Borrowing Firms Existing Loans New Loans Consumption

Investment

Margins

Costs

Employment

Consumption

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The Interest Rate Transmission Mechanism 2


Disposable Income

Existing Property Equity Demand for New Housing Consumption

Consumption

Interest Rates

Mortgages New

Investment

Savings

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The Interest Rate Transmission Mechanism 3


Mp
Appreciation

Dm

Xp
Interest Rates Exchange Rates

Dx

Balance of Payments
Mp
Depreciation

Dm

Xp

Dx

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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 side Increases in policies can help long-term to push the AS capacity can help 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


700 600 500 400

41 40 39 38 37

300

36
200 100 0

35 34 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

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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%GDP

bn

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Government Income ( billion)


Inland Revenue Income Tax (gross of tax credits) Income Tax Credits Corporation Tax Windfall Tax Petroleum Revenue Tax Capital Gains Tax Inheritance Tax Stamp Duties NICs Total Inland Revenue 1998 -99 88.4 -1.9 30.0 2.6 0.5 2.0 1.8 4.6 55.1 183.2 1999 -00 95.7 -1.8 34.3 0.0 0.9 2.1 2.1 6.9 56.4 196.5 2000 -01 106.1 -1.0 32.4 0.0 1.5 3.2 2.2 8.2 60.6 213.4 2001 -02 110.3 -2.3 32.0 0.0 1.3 3.0 2.4 7.0 63.2 216.8 2002 -03 112.6 -3.4 29.5 0.0 1.0 1.6 2.4 7.5 64.6 215.8 2003 -04 118.3 -4.3 28.1 0.0 1.2 2.2 2.5 7.5 72.5 228.0

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 VAT Fuel Duties Tobacco Duty Spirits Duties Wine Duties 199899 52.3 21.6 8.2 1.6 1.5 199900 56.4 22.5 5.7 1.8 1.7 200001 58.5 22.6 7.6 1.8 1.8 200102 61.0 21.9 7.8 1.9 2.0 200203 63.5 22.1 8.1 2.3 1.9 200304 69.1 22.8 8.1 2.4 2.0

Beer and Cider Duties


Betting and Gaming Duties Air Passenger Duty Insurance Premium Tax Land Fill Tax Climate Change Levy Aggregates Levy Customs Duties and Levies Total Customs and Excise

2.7
1.5 0.8 1.2 0.3 0.0 0.0 2.1 94.0

3.0
1.5 0.9 1.4 0.4 0.0 0.0 2.0 97.3

3.0
1.5 1.0 1.7 0.5 0.0 0.0 2.1 102.2

3.1
1.4 0.8 1.9 0.5 0.6 0.0 2.0 104.9

3.1
1.3 0.8 2.1 0.5 0.8 0.2 1.9 108.7

3.2
1.3 0.8 2.3 0.6 0.8 0.3 1.9 115.7

Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls

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Government Income ( billion)


1998 -99 VED Oil Royalties Business Rates Council Tax Other Taxes and Royalties Net Taxes and NICs conts 4.6 0.3 14.7 12.2 7.5 316.6 1999 -00 4.9 0.4 15.4 13.1 7.9 335.4 2000 -01 4.3 0.6 16.3 14.1 8.5 359.3 2001 -02 4.3 0.5 17.9 15.2 9.4 369.1 2002 -03 4.3 0.4 18.5 16.9 10.2 374.9 2003 -04 4.8 0.0 18.4 18.8 11.2 196.7

Interest and Dividends


Gross Operating Surplus and Rent Other Receipts and Accounting Adjustments Current Receipts

5.0
18.2 -5.3 334.5

4.3
18.1 -0.7 357.2

6.0
18.8 -3.8 380.4

4.7
19.9 -5.7 387.9

4.5
19.0 -5.2 393.2

4.4
19.4 -1.8 418.7

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

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

Cash (bn) Real Terms (bn) per cent of GDP

Year

Source: http://www.hm-treasury.gov.uk

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Public Sector Net Cash Requirement (PSNCR)


53 Central government Local authority General government 43 Public corporations Public sector 33

23

bn
13

-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


Inflation

AS
TheAD=C+I+G+(X-M) If rise Assume government in AD an leads to AD therefore an increase reduces initial in taxes real Apart from G, C national (remember equilibrium income, the shifts to also the and I are ceteris subtleties) position paribuswith ,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%) AD 1

2.5% 2.0%

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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