as macro: managing the economy

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