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MACROECONOMICS, MONETARY POLICY, REGULATION OF THE FINANCIAL SYSTEM AND…
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MONETARY POLICY
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TRANSMISSION MECHANISM - how a change in policy actually works its way through the economy to affect macroeconomic indicators
CONTRACTIONARY
Expect inflation to rise
Raise the bank rate and therefore interest rates
- increased savings and fall in consumption
- reduction in borrowing reducing consumption and investment
- change in asset pricing due to wealth effect (a fall in bond prices)
- increase repayments in variable rate mortgages
- less investment
- increase exchange rate
- affects other macroeconomic objectives
- reduce price level
- reduce economic growth
- limited supply-side growth
- increase unemployment
- decrease tax revenues
- exports fall and imports rise
EXPANSIONARY
Expect inflation to fall
Reduce the bank rate and therefore interest rates
- reduction in savings and increase in consumption
- increase in borrowing and increasing consumption and investment
- change in asset pricing due to wealth effect (a rise in bond prices)
- reduced repayments on variable rate mortgages
- increase investemnt
- reduce exchange rate
- affects other macroeconomic objectives
- increase price level
- increase economic growthh
- lots of supply-side growth
- reduce unemployment
- increase tax revenues
- exports rise and imports fall
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OBJECTIVES
MONETARY POLICY - the manipulation of the price and availability of money within an economy to achieve economic policy objectives and in the UK it is the job of of the BofE. The main focus is interest rates but it also considers the size of the money supply, availability of credit, exchange rates and quantitative easing
The key aim is to achieve the government's inflation target of 2%(+/-1%) achieved through changes to the:
BANK RATE - the interest rate set by the Bank of England that affects interest rates set by banks and other financial institutions, such as building societies across the economy
Decisions about the bank rate are made by the MPC
MPC - MONETARY POLICY COMMITTEE
This currently consists of 9 members and meets monthly to consider rent developments and likely future development of aspects of UK economic performance such as:
- consumer spending and consumer confidence
- business investment
- fiscal policy - government expenditure and taxation
- the exchange rate
commodity prices
- unemployment and labour market conditions
The MPC considers current and possible future positions of the economy and whether they are likely to either increase of decrease the inflation rate over the next two years
If there is a chance inflations rate will rise, then it is likely there will be contractionary monetary policy, easing interest rates to lower AD. If there is downwards pressure on prices, there will likely be expansionary monetary policy, decreasing interest rates and increasing AD.
A rise in the bank rate will most likely:
- reduce levels of consumer spending
- increase monthly repayments for those with variable rate mortages
- increase incentives to save
- lower investment by buisnesses
- increase exchange rate
LIMITATIONS OF MONETARY POLICY
- the effects on aggregate supply are less significant and less certain in terms of the size of their impact. this means interest rates are less iseful as a mean of controlling rises in cost-push inflation - though it can help through their effect on the exchange rate
- in 2012, UK inflation rose well above its target, reaching over 5%, almost entirely due to cost-push factors and the MPC did not raise interest rates as it was felt it would have little effect on the inflation rate
- time lags in their effectivness
- uncertain effects
- when interest rates are low, further cuts may not be possible
- changes may have to be large to have any significant effect and most changes are in steps of +/- 0.25%
BANK OF ENGLAND AND THE MONEY SUPPLY
- growth of the money supply and of credit are both important macroeconomic indicators - rapid increases in the often indicate inflationary pressures and possible asset price bubbles
- falling money supply and sharp reductions in credit may indicate a slowdown in economic growth or even a recession. neither of these indicators is directly targeted by the BodE but will be carefully observed
- changes in interest rates affect most people's willingness to borrow which affects the rate of monetary growth and the amount of credit within an economy
- in addition to the interest rate, the BofE has other policies it can use to affect the rate of growth of both he money supply and the amount of credit
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SUPPLY-SIDE POLICY
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Supply-Side policy:
Deliberate actions taken by the government to improve the LRAS of the economy. If successful, supply-side policies should increase the productive capacity without inflationary pressures emerging
Supply-Side Improvement:
General increases productive capacity resulting from business acting out of their interest in improving efficient and quantity of output
Innovation - the development and application of ideas and technologies which improve goods na service or make their production more efficient
Investment - use of profits to improve capacity through increased output and sales. In the short-run, It may be expensive but in th long-run will prove beneficial
FREE-MARKET
Policies designed to improve AS in a market involving the removal of barriers that prevent the market reaching the most effective equilibrium and allowing the market to work as 'freely' as possible
- tax cuts
- cutting red tape (the laws and regulations surrounding business)
- privatisation (the transfer of the ownership of a business form the public/state sector, to the private sector
- e.g. British telecom, British Gas, British airways (1987)
- deregulation
- e.g. opening up a market to new customers
- flexible working
- free trade
- reduction in trade union power
- reduction in unemployment benefits
INTERVENTIONIST
Increasing AS by intervening more in markets - often accompanied by jjigher targeted government expenditure so often also boosts AD
- intervene to reduce poverty
- universal basic incomes
-provison of public goods
- active regional policy
- building more social housing
- policies to lift human capital
- state ownership of buisness
- Nationalisation e.g. rail privatised in the 1990s
- minimum wage
- infrastructure spending
- research and development spending
- entrepreneurship
- industrial policy
Evaluation of supply-side policy:
- the impact depends on the initial state of the economy and the extent of spare capacity
- depends on whether the supply-side policy shifts the AD as well as the LRAS. If its does the final impact on the economy will depend on the relative size of those shifts and the time lag
- supply-side policy's can improve or worsen inequality such as cutting benefits and raising tax compared to increased education and employment
- can be very expensive
- do not always take a long time, particularly in they involve government spending and therefore create immediate actual growth through an outwards shift of AD
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GLOBALISATION
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MNCS
PROS
- increased employment in LICS
- efficiency gain e.g EOS and low costs due to lower standards for labour and the environment in LIC and the potential for dynamic efficiency and growth
- may increase the standards in LICS
- investments in infrastructure and training
- diversify the economy
- tax revenues
CONS
- potential for exploitation through wages and codnitions
- low skilled in LICS, preventing development
- loss of sovereignty in host country
- monopoly power
- environmental damage
- structural unemployment in home country
- although HICS are already post-industrial
- tax avoidance
CONSEQUENCES
HICS
PROS
- job opportunities which are higher paid and skilled
- lower prices of goods and services
- efficiency
- immigration and lower labour costs, increases demand and therefore employment and its derived demand
- cultural sharing or food, music, clothes
- economic growth
CONS
- immigration crowd labour market
- uncertainty around tax
- structural unemployment
- increases susceptibility to shocks
- commodity price bubbles
LICS
PROS
- job opportunities and increase employment, increasing growth
- increased access to global markets
- improves living and working and environmental standards
- infrastructure improvements
- efficiency
CONS
- brain-drain
- inequality
- environmental damage
- slows economic growth
- commodity price bubbles
- coco-colonisation
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WHAT IS IS
The Increasing interconnectedness of regional national and global economies, cultures, politics and societies
Comparitive advantage - the ability of an individual or group to carry out a particular economic activity (such as making a specific product) more efficiently than another activity, with a lower opportunity cost
Absolute advantage - the ability of an individual or group to carry out a particular economic activity more efficiently than another individual or group at a lower actual cost altogether
FISCAL POLICY
TAXATION
Types of Taxation
national insurance - similar to an additional income tax, used to raise finance for health and welfare expenditure
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VAT - a tax of 20% placed on spending on most goods and services. It is an ad valorem tax and a main source of gov. tax revenue
Advantages
- does not affect work incentives
- hard to avoid
Disadvantages
- regressive in many cases
- changes can be inflationary
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Stamp duty - based on a % of the purchase price of a property which rises with the value of the property
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Hypothecated tax - dedication of the revenue form a specific tax for a particular expenditure purpose
council tax - local taxation system on domestic property and is applied to all homeowners and renters
Advantages
- seen as fair as based on wealth of household
- raise monet for local services
Disadvantages
- poverty values used to set bands are very out of date
- those who are asset rich and cash poor may find it difficult to pay
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Progressive tax - where those on higher incomes, pay a higher proportion of their income on tax compared to those on lower incomes
Regressive tax - taxes that increase in relative size on lower income earners. Individual's taxes rise as income falls
Proportional tax - taxes that are paid in equal proportions by everyone, one rate, 'flat taxes'
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GOVERNMNET SPENDING
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Types of budgets
Cyclical budget deficit/surplus - where the balance on the government's finances moves into deficit/surplus because of effects of the economic cycle on tac and spending plans
Structural budget deficit/surplus - where the governments finances remain in deficit/surplus even if the effects of economic growth are removed
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National Debt
The stock of all outstanding government debt that has yet to be repaid. Anytime the government is in a budget deficit, they have to borrow the short-fall
As debt is repaid during a surplus, more debt is most likely being taken on, meaning that the national debt does not necessarily shrink
Significane of the national debt:
- if the gov. runs a deficit repeatedly, the debt continues to grow meaning more interest is paid on it
- those who buy gov. bonds will demand higher interests on the debt if they feel there is a danger that the size of the debt will get out of control
- 2021 national debt was 100%GDP ratio yet the US was 133,28% of GDP
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By 2020-21, the Uk government will have spent around £900 billion per year, equivalent to over £30, 000 per household or 40% of GDP
Involves deliberate changes in either government spending or taxation intended to influence economic growth
Explansionary - which adds to the level of AD by either increasing gov. spending, or decreasing taxation. Also referred to as an 'easing' policy of 'loose' fiscal stance
Contractionary - changes in fiscal policy to reduce the level of AD also called 'tight' policy. It decreases gov. spending or increases taxation
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