Macroeconomic Policies IGCSE Economics

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 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:

Monetary Policy

     

M d = k PY

P is the price level where: Y is the level of real national income M d is demand for money for transactions purposes K = proportion of national income held as transactions balances In equilibrium M d  So: P = 1/kY x M  = M s A rise in Ms will lead to a proportional rise in P

Monetary Policy

 

Supply of Money:

 Narrow Money circulation (M0) – notes and coins in  Broad Money money held in bank and building society accounts (M4) – Notes and coins plus A rise in either (ceteris paribus) might signal a rise in aggregate demand (AD)

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

Credit Individuals

Consumption

Loans Interest Rates Borrowing Firms New Loans

Investment

Existing Loans Margins Costs Employment

Consumption

The Interest Rate Transmission Mechanism 2

Disposable Income Existing

Consumption

Interest Rates Mortgages Property Equity New Demand for New Housing

Investment

Savings

Consumption

The Interest Rate Transmission Mechanism 3

Mp Dm Appreciation Xp Dx Interest Rates Exchange Rates

Balance of Payments

Mp Dm Depreciation Xp Dx

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 AS 2.3% 2.0% AS1 AD Increases in long-term capacity can help the economy to grow without undue pressure on inflation.

Yf Yf2 Real National Income

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 policies continued

 Privatisation.

The privatisation of state enterprises to raise money and efficiency BCA and perhaps some of Pertamina and Garuda

Supply Side Policy

 Tax Reform: Tax reform to encourage people to work  Improving access to training and education

Supply Side Policy

 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 Acts as an ‘automatic stabiliser’ 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

700 600 500 400 300 200 100 0 19 90 -9 1 19 91 -9 2 19 92 -9 3 19 93 -9 4 19 94 -9 5 19 95 -9 6 19 96 -9 7 19 97 -9 8 19 98 -9 9 19 99 -0 0 20 00 -0 1 20 01 -0 2 20 02 -0 3 20 03 -0 43 20 04 -0 53 20 05 -0 63 20 06 -0 73 20 07 -0 83 20 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

41 40 39 38 37 36 35 34 33

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

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

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

2003 04

118.3

-4.3

29.5

0.0

1.0

1.6

2.4

7.5

64.6

215.8

28.1

0.0

1.2

2.2

2.5

7.5

72.5

228.0

Government Income (£ billion)

Customs and Excise

VAT Fuel Duties Tobacco Duty Spirits Duties Wine Duties 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

1998 99

52.3

21.6

8.2

1.6

1.5

2.1

94.0

3.0

1.5

0.9

1.4

0.4

0.0

0.0

1999 00

56.4

22.5

5.7

1.8

1.7

2.0

97.3

3.0

1.5

1.0

1.7

0.5

0.0

0.0

2000 01

58.5

22.6

7.6

1.8

1.8

2.1

102.2

3.1

1.4

0.8

1.9

0.5

0.6

0.0

2001 02

61.0

21.9

7.8

1.9

2.0

2.0

104.9

3.1

1.3

0.8

2.1

0.5

0.8

0.2

2002 03

63.5

22.1

8.1

2.3

1.9

1.9

108.7

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

3.2

1.3

0.8

2.3

0.6

0.8

0.3

2003 04

69.1

22.8

8.1

2.4

2.0

1.9

115.7

Government Income (£ billion)

VED Oil Royalties Business Rates Council Tax Other Taxes and Royalties

Net Taxes and NICs conts

Interest and Dividends Gross Operating Surplus and Rent Other Receipts and Accounting Adjustments

Current Receipts 1998 99

4.6

0.3

14.7

12.2

7.5

316.6

5.0

18.2

-5.3

334.5

1999 00

4.9

0.4

15.4

13.1

7.9

335.4

4.3

18.1

-0.7

357.2

2000 01

4.3

0.6

16.3

14.1

8.5

359.3

6.0

18.8

-3.8

380.4

2001 02

4.3

0.5

17.9

15.2

9.4

369.1

4.7

19.9

-5.7

387.9

2002 03

4.3

0.4

18.5

16.9

10.2

374.9

4.5

19.0

-5.2

393.2

2003 04

4.8

0.0

18.4

18.8

11.2

196.7

4.4

19.4

-1.8

418.7

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

Government Income – Inland Revenue 2003-04 Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls

Government Income – Customs and Excise 2003-04 Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls

Other Government Income 2003-04 Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls

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

Public Spending

500.0

450.0

400.0

350.0

300.0

(£bn)

250.0

200.0

150.0

100.0

50.0

Cas h (£bn) 0.0

Real Term s (£bn) per cent of GDP Source: http://www.hm-treasury.gov.uk

Ye ar

Public Sector Net Cash Requirement (PSNCR) 53 43 33

£bn

23 13 3 -7 -17 1991 92 1992 93 1993 94 1994 95 1995 96 1996 97 1997 98 1998 99 1999 00 2000 01 2001 02 2002 03 Source:http://www.hm-treasury.gov.uk/media//E3CCB/PublicFinancesDatabank280104.XLS

Central government Local authority General government Public corporations Public sector

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:

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

and : over the economic cycle, the Government will borrow only to invest and not to fund current spending; 

the sustainable investment rule

economic cycle.

: 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

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

Fiscal Policy In Action

Inflation AS 2.5% 2.0% AD 1 AD therefore shifts to the right to AD1 fall to 3% but at a cost of higher inflation unemployment rate of 5% (U = 5%) AD Real National Income U=5% U=3%

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/p olicy/advisors/fiscal.htm)