Chapter 6: The application of macroeconomic policy instruments and the international economy

The government use three main economic policies:

• Fiscal policy: the taxation and spending decisions of a governments

• Monetary policy: central bank, and/or government decisions on the rate of interest, the money supply and the exchange rate.

• Supply-side policies: policies designed to increase AS by improving the efficiency of labour and product markets.

To influence economic activity and to achieve their macroeconomic policy objectives.

Fiscal policy(supply side policies)

The government affecting AD.

Eg:Rise AD by increasing its own spending/reducing taxes= Reflationary: :of policy measures designed to increase aggregate demand. Deflationary(det motsatte) of policy measures designed to reduce aggregate demand) & Multiply effect.

The nature of fiscal policy

government try to stabilise and make AD match AS, this is called “acting counter-cyclically. The G is seeking this, by offsetting changes in private sector spending by:

• Discretionary fiscal policy: deliberate changes in government spending and taxation designed to influence AD

• Automatic stabilisers: forms of government spending and taxation that change automatically to offset fluctuations in economic activity

Economic cycle: the tendency for economic activity to fluctuate outside its trend growth rate, moving from a high level of economic activity(boom) to negative economic growth(recession)

Types of taxes

• Progressive tax: a tax that takes a higher percentage from the income of the rich

• Regressive tax: a tax that takes a greater percentage from the income of the poor.

Government spending: (divided into:)

• capital expenditure(roads, hospitals, schools etc.)

• current spending(public services)

• transfer payments(money transferred from taxpayers to recipients of benefits)

• debt interest payments (to the holders of government debt)

The budget

Shows the relationship between government spending and tax revenue.

Def: Recession: A fall in real GDP over a period of six months or more.

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Monetary policy: (supply side policies)

The rate of interest, the money supply and the exchange rate.

Eg: A rise in interest rate → decrease AD, by reducing consumption investment and export – imports.

Changes in the money supply and interest rates are inversely related. A rise in money supply, reduces the interest rate.

The monetary policy committee(MPC) of the bank of England sets rates in the UK.

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Trying to increase AS

Supply-side policies

Policies seek to increase or decrease AD depending on the level of economic activity.

Examples:

• Education and training

• Government assistance to new firms

• Reduction in direct taxes

• National minimum wage(NMW)

• Reduction in unemployment benefit

• Reduction in other benefits

• Reduction in trade union power

• Privatisation

• Deregulation

Policies to reduce unemployment

Demand-side policies

Supply-side policies

Policies to promote economy growth

Short run:

• Lower rate of interest is likely to stimulate consumption and investment

• Higher investment will increase AS

• Increase government spending

Long run:

• Quality and or quantity of resources

• Human capital: Education, training and experience that a worker, or a group of workers, possesses.

Stable growth

Actual growth to match trend growth and for that trend growth to rise over time.

Policies to improve the balance of payments

Short run:(concentrated on the demand side)

Government try to raise export revenue/reduce import expenditure to correct a current account deficit: Causing a fall in the exchange rate, reducing demand for all products whatever their source and specifically reducing demand for imports.

• Exchange rate adjustments: Exchange rate to be on a current level with other country's.

• Deflationary demand management: Reduce government spending, higher taxes, etc.

• Import restrictions: Reduce expenditure on imports by composing import restrictions including:
  Tariffs: A tax on imports

  Quota: A limit on imports

Long run(concentrated on the supply side):

Lack of quantity competitiveness, low labour productivity or high inflation, then reducing the value of the currency deflationary demand-side policy instruments and import restrictions

Current account surplus: when more money is leaving the country than entering it, as a result of its exports, income and current transfers from abroad being less than imports,income and current transfers going abroad.

Effectiveness of ficial policy: Drawbacks:

• government spending and tax rates take time to have an effect on the economy, it can also take time to recognise the need for a change in policy and to gether the information on which to base the change.

• Time lag between introducing a fiscal policy instrument and that instrument having an impact on the economy. Eg: Income tax in changes , households take some time to adjust their spending.

• Forms of government spending are inflexible. Difficult to cut spending on health care and pensions.

The effectiveness of monetary policy:

• The effects of monetary policy tend to be more concentrated on certain groups than do changes in income tax for example.

• Limit with using interest rate changes is that when the interest rate falls to very low levels, a further cut is likely to be ineffective in stimulating activity.

• ?: Extend AD → change in response to interest rate changes.

The effectiveness of supply-side policies

• Increasing the productive potential of an economy on its own, will not be sufficient in raising economic performance if there is a lack of AD.

• Eg: Spending on education → long time to have an effect

Possible conflicts between policy objectives:

Economic growth and low unemployment may benefit from expansionary demand-side policy measures, but this will make it more difficult for a government to achieve low inflation and satisfactory balance of payments position.

• Interest rate

Advantages that may be gained from international trade

• Enables the country to specialise as the products it does not produce it can import

• Lower prices and higher quality that results from the higher level of competition that arises from countries trading internationally

• Enjoy a greater variety of products, including a few not made in the country.

Methods of protection:
Def: Protectionism: The protection of domestic industries from foreign competition.

• Tariffs: a tax on import

• Quotas: a limit on imports

• Voluntary export restraint(REV) A limit placed on imports from a country with the agreement of that country's government.

• Foreign exchange restrictions: Seek to reduce imports by limiting the amount of foreign exchange made available to those wishing to buy imported foods and services or invest , travel abroad

• Embargoes: Ban on the export or import of a product and/or a ban on trade with a particular country.

• Redtape: Time-delaying customs procedures may be used to discourage imports

• Etc.....