as macro: managing the economy
DESCRIPTION
One of the most significant roles of a modern government is to ensure that the economy performs to its full capacity. The government has to consider the performance indicators like inflation, unemployment and economic growth and devise policies to achieve their aims. In this session we will consider the options that fall into the fiscal and monetary policy portfolio.TRANSCRIPT
MANAGING THE ECONOMY
GEOFF RILEYETON COLLEGE
Session 324
10:06:11 PM
12/04/2023
Define Fiscal and Monetary Policy
You have 1 minute
Changes in taxation, government spending and
borrowing to achieve macroeconomic objectives
The manipulation of interest rates, money supply and
exchange rates to achieve macroeconomic objectives.
Fiscal Policy Monetary Policy
10:06:15 PM
AD = C + I + G + X - M
24
Building levels of response
• Knowledge and understanding – what are fiscal and monetary policy?
• Application – how and when might active use of these policies be helpful?
• Analysis – how do the policies work? How do changes to policy lead to effects?
• Evaluation – do the policies always work well? What might undermine their effectiveness?
10:06:19 PM
Application: Engine Failure
The UK economy is recovering from a deep recession, mainly caused by falling aggregate demand
10:10:45 PM
12/04/2023
Identify 2 reasons for falling AD from the graph on the right
Investment
Private Consumption
25
10:10:55 PM
Can you be an analysis machine?
Clearly show the examiner
how causes can lead to effects
25
10:11:09 PM
Explain how expansionary fiscal policy affects aggregate demand
You have 3 minutes
10:11:22 PM
26
Increase in Consumption
• A reduction in direct or indirect taxation can leave households with higher levels of disposable income. This could translate into additional purchases.
• Lower taxation could also generate additional employment opportunities.
10:11:44 PM
26
Increase in Investment• Lower taxation might
prompt firms to invest in expansion
• Lower taxation can reduce leakages from the circular flow of income, increasing the size of investment multiplier effects
10:12:02 PM
26
UK corporation tax cut from 23% to 21% in April 2014
Increase in Government Spending
• Higher government spending directly contributes to AD
• Government spending also has supply-side effects!
2610:12:21 PM
Increase in Net Trade• Government
support for exporters might help boost their performance
• Lower corporation tax might attract FDI from businesses who then export from the UK
26
10:12:24 PM
Building up to a strong finish
• Knowledge and understanding – what is fiscal policy?
• Application – how and when might active use of fiscal policy be helpful?
• Analysis – how does the policy work? How do causes (changes to policy) lead to effects?
• Evaluation – does the policy always work well? What might undermine its effectiveness?
26
10:12:35 PM
To what extent is fiscal policy always effective at achieving improved macroeconomic performance?
You have 3 minutes
26
10:15:21 PM
Limits to the government’s fiscal choices
26
10:15:24 PM
12/04/2023
Government debt measured as a % of GDP, Source OECD
The Scale of UK Government Debt
Gross Government Debt Net Government Debt
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
20
30
40
50
60
70
80
90
100
110
120
Pe
rce
nt
of
GD
P
20
30
40
50
60
70
80
90
100
110
120 Net Govt debt expected to peak at more than 80% of GDP in 2016-17
Government spends more than £1bn per week in debt interest
Time Lags
26
10:15:27 PM
Increased inequality
26
10:15:29 PM
Impact on Confidence and
Expectations
26
10:15:31 PM
Policy can be affected by external events26
10:15:33 PM
12/04/2023
Since 1923, no country has lost as much wealth as Greece has during last five years: - 27% of GDP has been lost
Evaluation: Taxation and Aggregate Supply
Work incentives / active labour supply
Inward migration of key workers
Capital investment e.g. FDI projects
Enterprise / Entrepreneurship
Human capital spending
Tariffs affect import costs
Evaluation: Taxation and Aggregate Supply
Work incentives / active labour supply
Inward migration of key workers
Capital investment e.g. FDI projects
Enterprise / Entrepreneurship
Human capital spending
Tariffs affect import costs
Evaluation: Taxation and Aggregate Supply
Work incentives / active labour supply
Inward migration of key workers
Capital investment e.g. FDI projects
Enterprise / Entrepreneurship
Human capital spending
Tariffs affect import costs
Evaluation: Taxation and Aggregate Supply
Work incentives / active labour supply
Inward migration of key workers
Capital investment e.g. FDI projects
Enterprise / Entrepreneurship
Human capital spending
Tariffs affect import costs
Evaluation: Taxation and Aggregate Supply
Work incentives / active labour supply
Inward migration of key workers
Capital investment e.g. FDI projects
Enterprise / Entrepreneurship
Human capital spending
Tariffs affect import costs
Evaluation: Taxation and Aggregate Supply
Work incentives / active labour supply
Inward migration of key workers
Capital investment e.g. FDI projects
Enterprise / Entrepreneurship
Human capital spending
Tariffs affect import costs
Monetary Policy27
10:16:14 PM
12/04/2023
Policy Interest Rates in the UK
Interest Rates on Loans
A rise in interest rates increases the cost of paying back loans taken out by consumers and businesses
In recent years the average mortgage interest rate on home loans has fallen, but the interest rate on overdrafts and credit cards has actually increased towards 20%
Analyse the effects of tighter monetary policy
You have 3 minutes
2710:16:34 PM
Impact on Consumption and Investment
• Higher interest rates are likely to increase saving and reduce borrowing, leading to lower levels of consumption overall.
• Higher rates of saving might reduce multiplier effects from injections elsewhere – like business investment.
• Higher interest rates are a disincentive to invest, since much investment is financed through borrowing.
2710:16:55 PM
Impact on Net Trade
• The tightening effect of higher interest rates tends to reduce import demand.
• ‘Tighter’ money (less QE, higher interest rates) might increase demand for the £££. If the value of the £££ rises, that should mean lower exports and more imports, reducing AD.
27
10:16:57 PM
Building up to a strong finish
• Knowledge and understanding – what is monetary policy?
• Application – how and when might active use of monetary policy be helpful?
• Analysis – how does the policy work? How do causes (changes to policy) lead to effects?
• Evaluation – does the policy always work well? What might undermine its effectiveness?
27
10:17:59 PM
To what extent is monetary policy always effective at achieving
improved performance in the UK economy?
You have 3 minutes
27
10:18:17 PM
What really determines the level of saving?
27
10:18:18 PM
Do interest rates strongly influence business investment?
27
10:18:30 PM
Are higher interest rates enough to slow
house price increases, and higher levels of
consumption?
27
10:18:38 PM
12/04/2023
House Prices
House prices in London have risen by 18% in the last year
Do interest rate changes have a significant effect on the value of the £££?
Furthermore, do changes in the £££ significantly influence net trade?
27
10:19:03 PM
12/04/2023
Sterling Exchange Rate
And what impact do changes to AD have on the economy anyway?
There’s a balancing act here: does the economy want, or need more AD?What impact will more or less AD have on the broader economy?
The effect depends on the supply side
27
10:19:03 PM
Interest Rates and the Distribution of Income
Incomes of savers• If the interest on savings is less than inflation,
savers will see a reduction in their real incomes
Incomes of home-owners with mortgages• If interest rates fall, the income of home-owners
who have variable-rate mortgages will increase
Interest rates on unsecured debt• Lower interest rates on loans such as credit cards
and bank loans will fall
When interest rates fall, there is a re-distribution of income away from lenders and savers towards borrowers with loans / debt
Some of the Recent Changes to UK Monetary Policy
• Quantitative Easing (QE) 2009 – buying bonds to increase deposits and lending by the banking industry – worth £375bn
• Funding for Lending Scheme (2012) – joint policy between Treasury and the BoE which provides cheaper funding to banks that increase their loans to households and businesses
• Forward Guidance (2013-14) - under forward guidance, the Bank’s policy rate will remain at 0.5% at least until unemployment falls to 7% or until there are clear signs that the amount of spare capacity in the economy has reached normal levels
12/04/2023
Show your Awareness in the Exam!
Main BoE policy interest rate 0.5%
Quantitative easing £375bn
Household debt 155% of GDP
House prices rose 8% in 2013
Govt borrowing £108bn in 2014-15
VAT remains at 20%
Corporation tax cut to 21%
Lower employment taxes for businesses
12/04/2023
Twitter: @tutor2u_econ