Macroeconomic Policies IGCSE Economics...IGCSE Economics - Resources, Past Papers, Notes, Exercises...

Macroeconomic Policies IGCSE Economics

www.igcseeconomics.com - Resources, Past Papers, Notes, Exercises & Quizes

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 Interest Rate Transmission

Mechanism The process by which a change in

interest rates feeds through to AD


The Interest Rate Transmission Mechanism 1

Interest Rates

Borrowing

Individuals

Credit

Loans

Consumption

Firms New

Loans Investment

Existing Loans

Costs Employment Margins Consumption



Interest Rates Mortgages

Existing

New

Consumption

Investment

Disposable Income

Property Equity

Demand for New Housing

Savings Consumption



Interest Rates

Exchange Rates

Appreciation

Mp

Xp

Dm

Dx

Depreciation

Mp

Xp

Dm

Dx

Balance of Payments


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

Real National Income

AS

Yf

AS1

Yf2

AD

2.3% 2.0%

Supply side policies can help to push the AS curve to the right increasing the capacity of the economy from Yf to Yf2

Increases in long-term capacity can help the economy to grow without undue pressure on inflation.


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 Policy Tax Reform:

Tax reform to encourage people to work Improving access to training and education

Privatisation. The privatisation of state enterprises to raise

money and efficiency 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 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

0

100

200

300

400

500

600

700

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

-043

2004

-053

2005

-063

2006

-073

2007

-083

2008

-093

Year

£bn

33

34

35

36

37

38

39

40

41

%GD

P

Public sector total receipts1 £ billionPublic sector total receipts1 % GDP

Source: http://www.hm-treasury.gov.uk/media//E3CCB/PublicFinancesDatabank280104.XLS


Government Income – Inland Revenue UK

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


UK Government Income – Customs and Excise



Other UK Government Income



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


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.


Fiscal Policy In Action Inflation

Real National Income

AS

AD

2.0%

U=5%

Assume an initial equilibrium position with a level of National Income giving an unemployment rate of 5% (U = 5%)

If government ‘reduces taxes’ (remember the subtleties) and or increases spending, it will have various effects:

AD=C+I+G+(X-M)

Apart from G, C and I are also likely to be affected directly or indirectly by the policy change.

AD 1

AD therefore shifts to the right to AD1

2.5%

U=3%

The rise in AD leads to an increase in real national income, ceteris paribus, unemployment would fall to 3% but at a cost of higher inflation


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/policy/advisors/fiscal.htm)


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Macroeconomic Policies IGCSE Economics...IGCSE Economics - Resources, Past Papers, Notes, Exercises...

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