THE EFFECTIVENESS OF UK MACROECONOMIC POLICIES

Session 5

Your exam may feel a bit like a marathon….

Make sure you’re fit enough to finish in style!

TASK: remember the main indicators of macro-economic performance?

How is each measured, and what is the UK’s target for it?

EconomicGrowth

Inflation

Unemployment Balance of Payments (Current

account)

You have 2 minutes

•Measured by: •UK target:

Growth

•Measured by:•UK target:

Inflation •Measured by:•UK target:

Unemployment

•Measured by:•UK target:Balance of

Payments (current account)

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•Measured by: Change in real GDP•UK target: 2-3%

Growth

•Measured by:•UK target:

Inflation •Measured by: •UK target:

Unemployment

•Measured by: •UK target: Balance of

Payments (current account)

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•Measured by: Change in real GDP•UK target: 2-3%

Growth

•Measured by: CPI inflation•UK target: 2% (+/- 1%)

Inflation •Measured by:•UK target:

Unemployment

•Measured by:•UK target:Balance of

Payments (current account)

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•Measured by: Change in real GDP•UK target: 2-3%

Growth

•Measured by: CPI inflation•UK target: 2% (+/- 1%)

Inflation •Measured by: Claimant count/Labour

Force Survey•UK target: Forward Guidance 7%

Unemployment

•Measured by:•UK target:Balance of

Payments (current account)

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•Measured by: Change in real GDP•UK target: 2-3%

Growth

•Measured by: CPI inflation•UK target: 2% (+/- 1%)

Inflation •Measured by: Claimant count/Labour Force Survey•UK target: Forward Guidance 7%

Unemployment

•Measured by: Exports, Imports, Net investment income, Transfers

•UK target: more evenly balanced between imports and exports Balance of

Payments (current account)

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UK economic data – application

Always put your answers in context. In order to gain marks for Good Application, it is essential that you are aware of the current data about the UK’s macroeconomic performance, and of recent trends. Then you can use this throughout your answers.

UK economic data – applicationLook at the data on page 40 of your workbook - what can you say about the trends for consumer spending, government spending, gross investment and the current account balance?

Consumer spending •Gradual recovery over the period apart from a dip

in 2011. Expected to continue to rise in 2014

Government spending •Rose throughout the period. Predicted to fall in

2014

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Gross investment

•Volatile throughout the period; years of positive change have not made up for fall in 2009. Finally predicted to recover in 2014

The current account balance •Remains negative; improvements in 2009 and 2011

have been followed by larger deficits

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Gross investment spending

Look at the extract from the Bank of England Agents’ report – what do they expect to happen to investment in the economy?

Economic terminology – what is the term for the relationship between changes in GDP growth and changes in Business Investment?

The accelerator effect!

Does the data here give any evidence of the accelerator effect?

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How important is Investment?

The chancellor said his Budget would support business investment and exports to lay foundations for "long-term economic security".It would ensure that "around the world, wherever you are, you can't help but see 'Made in Britain'. That's the Budget I'm going to deliver," he said.

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Task 3 - The Answer DoctorHere’s the question: Using the data and your economic knowledge, explain why a sustained recovery in an economy is likely to be accompanied by an increase in investment.

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Investment is part of Aggregate Demand. Businesses invest in order to make more profits, which helps them to export more too. During a downturn businesses willnot have the confidence to invest but when AD starts to recover they will begin to invest again so that they can produce more output.

41Using the data and your economic knowledge, explain why a sustained recovery in an economy is likely to be accompanied by an increase in investment.

You have 2 minutes

Investment is part of Aggregate Demand. Businesses invest in order to make more profits, which helps them to export more too. During a downturn businesses willnot have the confidence to invest but when AD starts to recover they will begin to invest again so that they can produce more output.

No data is given – needs application AO2

Cause and effect – give explanation of how or why investment might lead to

higher exports AO3

RESPONSE TO ‘HOOKS’ IN THE QUESTION – NO REFERENCE HERE TO A ‘SUSTAINED’ RECOVERY AO3

41Terminology – add reference to Accelerator AO1

The Answer Doctor

•Use the data which shows the accelerator effect

•Explain why this will only happen if the businesses believe that the recovery will be sustained in the long run

•Explain why investment will lower costs and make businesses more competitive – and the benefits for exports

How could you improve

the answer?

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Now let’s consider the effectiveness of current UK policy……

with this sample exam question

Assess the importance of both demand-side and supply-side

policies in helping the UK economy to achieve a prolonged period of

economic growth.

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Why look for the hooks in an essay title

Provide the focus for developing analysis

Essential for evaluation

Makes you answer the question!

What are the essay hooks in this title?

Assess the importance of both demand-side and supply-side

policies in helping the UK economy to achieve a prolonged period of

economic growth.

You need to consider the policies currently being implemented in the UK in order to evaluate their effectiveness in meeting macroeconomic

targets.What can you tell me about:

Monetary policy?

Fiscal policy?

Supply side policy?

We have picked four current policies:

Monetary policy

Spending on infrastructure

Spending cuts Fiscal policy to promote productivity and

employment41

Monetary policy

Policy Explanation of desired effect Evaluation

Monetary PolicyAdjustment of interest rates and money supply to control aggregate demand - demand side

The Transmission mechanism – how a reduction in interest rates AND an injection of money supply leads to a rise in spending by consumers and investment by businesses, and therefore in AD – to create growth of GDP

Winners/losers?Good for borrowersBad for savers

Evidence:Since March 2009, 0.5% interest rate and Quantitative Easing

Link back to the question: will only help to create growth if consumers have the confidence to spend and businesses have the confidence to invest

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InfrastructurePolicy Explanation of desired

effect Evaluation

InfrastructureAn injection of government spending to enhance the facilities or systems serving the economy – road, rail, telecoms and so on - supply side

The multiplier effect: How an initial increase in spending can become a greater final increase in ADReduction in business costs and improvement in productivity, efficiency and competitiveness

Time?Long time lag between the spending and the effect being felt

Evidence:Budget 2013: An extra £15bn for new road, rail and construction projects by 2020, starting with £3bn in 2015-16

Link back to the question: supply side policy which, in the long run will create the conditions for growth without inflation, which is sustainable and prolonged

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Spending cutsPolicy Explanation of desired

effect Evaluation

Austerity – cutting government spending in order to reduce the annual deficit, borrow less and eventually to repay government net debt

To enable government to balance their budget without excessive rises in taxation, and to repay debt in the long term

Wider context?Risk that cuts in budgets such as welfare lead to greater inequalityMay also have supply side effects if spending on infrastructure projects falls

Evidence: Departmental budgets will be cut by about £1bn next year and the year after; projected borrowing 2013-14 £111bn, 2014-15 £96bn, 2015-16 £79bn, 2016-17 £51bn

Link back to the question: cuts in government spending reduce AD – Demand side - which makes recovery of growth difficult to achieve

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Productivity and employmentPolicy Explanation of desired

effect Evaluation

Productivity and employment – spending on education and training – supply side

Better qualified workers are more productive; cost per unit of output is lower; prices are more competitive raising demand for goods domestically and in export markets

Priority? Opportunity cost – spending on training either reduces spending in other areas, or requires higher borrowing

Evidence: Autumn Statement 2013 Science, technology and engineering courses will receive increased funding; 20,000 apprenticeships to be funded over the next two years.

Link back to the question: policies which shift LRAS to the right, thus enabling growth without inflation, depends upon demand for the goods produced

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Link back to the question for the final paragraph…

Assess the importance of both demand-side and supply-side policies in helping the UK economy to achieve a

prolonged period of economic growth.

1. Which of the policies you have analysed are demand-side and which are supply-side?

2. Time - Which will have a short term effect and which are long-term?

3. Priority - What mix will give the best chance of prolonged growth?

The big finish – the final judgement

Remember that, to reach the top levels of marks for evaluation, you need to make a balanced judgement between the policy options

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What is the most important question that we face?

“It’s the economy, stupid!”

Evaluate the best macroeconomic policies to restore the performance of the UK

economy to pre-recession levels.42

Pre-recession levels of performance:• Long run average GDP growth of around

2.5%• Inflation at or below target• Low unemployment – approximately 1mn

claimant count, 1.5mn LFS

Evaluate the best macroeconomic policies to restore the performance of the UK economy to pre-recession

levels.

Policy Explanation of desired effect Evaluation

Economic stimulusIncrease ‘G’ in order to stimulate AD

The desired effect:The Multiplier – make sure you can define and explain it properly!

IF spent on supply side, long-run growth in productive potential and capacity

Priority?Debt must be cut in order to reduce opportunity cost of interest payments Inequality vs. other macroeocnomic targets – which is most important at present?

Evidence:Opposition approach – cut less and spend more during recession to create jobs; Labour would borrow for investment spending

Link back to the question - Targets: short run can be used to cut unemployment

Gives the opportunity for long run non-inflationary growth of AD

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Evaluate the best macroeconomic policies to restore the performance of the UK economy to pre-recession

levels.

Policy Explanation of desired effect Evaluation

More progressive taxation increase the proportion of income paid as tax for the higher income brackets

The desired effectReduce inequality; increase tax revenue to repay government debt; more equal redistribution of income

Time?Short-run spending has an opportunity costTakes time for LRAS effect to bring a benefit

Evidence: Ed Balls: "For the next Parliament, we will restore the 50p top rate of tax for those earning over £150,000.“ (Feb 2014)

Link back to the question - Targets: does the higher tax burden bring a risk that entrepreneurs will leave the UK? Impact on growth and jobs if it does….

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Evaluate the best macroeconomic policies to restore the performance of the UK economy to pre-recession levels.

Policy Explanation of desired effect Evaluation

Regulate to solve the ‘cost of living crisis’. Use legislation and regulation to cut energy bills, raise minimum wage

The desired effect:Raise disposable income for poorer households – high marginal propensity to spend means that Consumption will rise which will result in greater AD and therefore growth of GDP and more derived demand for employees

Efficiency?Risk of cutting funds for investment in future power generation

Evidence:Real wages have fallen by between 2.4% and 10% (IFS); plans to freeze energy bills and raise minimum wage to the ‘Living Wage’

Link back to the question - Targets: could give a short-run boost to AD which will improve ability to meet macroeconomic targets

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The balanced judgement

Will short-run policies cause

more problems in

the long run?

How important is repayment

of government

debt?

Which of the macro targets

should be given highest

priority?

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07/04/2023

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