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Macroeconomic Policies
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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 the
Monetary Policy Committee (MPC)
of the Bank of England
Meets for 2 days each month
to decide on rates
The official rate is the rate at which the
Bank of England will lend to the financial
system and influences the structure of
all other interest rates
Monetary Policy
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
Md = k PY where:
P is the price level
Y is the level of real national income
Md is demand for money for transactions
purposes
K = proportion of national income held as
transactions balances
In equilibrium Md = Ms
So: P = 1/kY x M
A rise in Ms will lead to a proportional rise in P
Monetary Policy
Supply of Money:
Narrow Money notes and coins
in circulation (M0)
Broad Money Notes and coins plus
money held in bank and building
society accounts (M4)
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

Mechanism 1
Credit
Consumption
Individuals
Loans
Interest
Rates
Borrowing
Firms
New
Loans
Investment
Existing Loans
Margins
Costs
Employment
Consumption

Mechanism 2
Disposable
Income
Existing
Interest
Rates
Property
Equity
Mortgages
New
Savings
Consumption
Demand
for New
Housing
Investment
Consumption

Mechanism 3
Mp
Dm
Xp
Dx
Appreciation
Interest
Rates
Balance of
Payments
Exchange
Rates
Mp
Dm
Xp
Dx
Depreciation
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
Inflation
Supply Side Policy

AS
AS1
Supply sidein
Increases
policies can help
long-term
to push the
capacity
canAShelp
curve to the right
the
economy to
increasing the
grow
without
capacity
of the
undue
pressure
economy from Yf
on
inflation.
to Yf2
2.3%
2.0%
AD
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 legislation
of the eighties still has an impact in this respect
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
Supply Side Policy

Tax and Welfare Reform:
More stringent benefit regime
Tax reform to encourage people
to work
Improving access to training
and education
New Deal scheme
Supply Side Policy

Education and Training:
Reform of 14 19 education
Modern Apprenticeships
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
Drive to embracing knowledge driven
economy
Regional policies to encourage enterprise,
investment, location, expansion
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 noneconomic 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
41
600
40
bn
38
400
37
300
% GDP
39
500
36
200
35
100
34
33
Public sector total receipts1 billion

Public sector total receipts1 % GDP
Year
Source: http://www.hm-treasury.gov.uk/media//E3CCB/PublicFinancesDatabank280104.XLS
Government Income ( billion)

Inland Revenue
1998
-99
1999
-00
2000
-01
2001
-02
2002
-03
2003
-04
Income Tax (gross of tax credits)
88.4
95.7
106.1
110.3
112.6
118.3
Income Tax Credits
-1.9
-1.8
-1.0
-2.3
-3.4
-4.3
Corporation Tax
30.0
34.3
32.4
32.0
29.5
28.1
Windfall Tax
2.6
0.0
0.0
0.0
0.0
0.0
Petroleum Revenue Tax
0.5
0.9
1.5
1.3
1.0
1.2
Capital Gains Tax
2.0
2.1
3.2
3.0
1.6
2.2
Inheritance Tax
1.8
2.1
2.2
2.4
2.4
2.5
Stamp Duties
4.6
6.9
8.2
7.0
7.5
7.5
NICs
55.1
56.4
60.6
63.2
64.6
72.5
Total Inland Revenue
183.2
196.5
213.4
216.8
215.8
228.0
Source: http://www.hm-treasury.gov.uk/media/F6C/7E/public_fin_databank_211204.xls

Customs and Excise
199899
199900
200001
200102
200203
200304
VAT
52.3
56.4
58.5
61.0
63.5
69.1
Fuel Duties
21.6
22.5
22.6
21.9
22.1
22.8
Tobacco Duty
8.2
5.7
7.6
7.8
8.1
8.1
Spirits Duties
1.6
1.8
1.8
1.9
2.3
2.4
Wine Duties
1.5
1.7
1.8
2.0
1.9
2.0
Beer and Cider Duties
2.7
3.0
3.0
3.1
3.1
3.2
Betting and Gaming Duties
1.5
1.5
1.5
1.4
1.3
1.3
Air Passenger Duty
0.8
0.9
1.0
0.8
0.8
0.8
Insurance Premium Tax
1.2
1.4
1.7
1.9
2.1
2.3
Land Fill Tax
0.3
0.4
0.5
0.5
0.5
0.6
Climate Change Levy
0.0
0.0
0.0
0.6
0.8
0.8
Aggregates Levy
0.0
0.0
0.0
0.0
0.2
0.3
Customs Duties and Levies
2.1
2.0
2.1
2.0
1.9
1.9
Total Customs and Excise
94.0
97.3
102.2
104.9
108.7
115.7

1998
-99
1999
-00
2000
-01
2001
-02
2002
-03
2003
-04
VED
4.6
4.9
4.3
4.3
4.3
4.8
Oil Royalties
0.3
0.4
0.6
0.5
0.4
0.0
Business Rates
14.7
15.4
16.3
17.9
18.5
18.4
Council Tax
12.2
13.1
14.1
15.2
16.9
18.8
Other Taxes and Royalties
7.5
7.9
8.5
9.4
10.2
11.2
Net Taxes and NICs conts
316.6
335.4
359.3
369.1
374.9
196.7
Interest and Dividends
5.0
4.3
6.0
4.7
4.5
4.4
Gross Operating Surplus and Rent
18.2
18.1
18.8
19.9
19.0
19.4
Other Receipts and Accounting

Adjustments
-5.3
-0.7
-3.8
-5.7
-5.2
-1.8
Current Receipts
334.5
357.2
380.4
387.9
393.2
418.7
Government Income Inland Revenue 2003-04
Government Income Customs and Excise 2003-04
Other Government Income 2003-04
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 noneconomic (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
0.0
2 0 0 5 -0 6
2 0 0 4 -0 5
2 0 0 3 -0 4
2 0 0 2 -0 3
2 0 0 1 -0 2
1 9 9 0 -9 1
1 9 9 1 -9 2
1 9 9 2 -9 3
1 9 9 3 -9 4
1 9 9 4 -9 5
1 9 9 5 -9 6
1 9 9 6 -9 7
1 9 9 7 -9 8
1 9 9 8 -9 9
1 9 9 9 -0 0
2 0 0 0 -0 1
Year
Real Terms
(bn)
per cent of GDP
1 9 8 9 -9 0
Cas h (bn)
Source: http://www.hm-treasury.gov.uk
Public Sector Net Cash Requirement

(PSNCR)
Central government
53
Local authority
General government
43
Public corporations
Public sector
33
23
bn
13
-7
-17
1991- 1992- 1993- 199492
93
94
95
1995- 1996- 1997- 1998- 1999- 200096

97
98
99
00
01
2001- 200202
03
Source:http://www.hm-treasury.gov.uk/media//E3CCB/PublicFinancesDatabank280104.XLS
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: over the economic cycle, the
Government will borrow only to invest and not to fund
current spending; and
the sustainable investment rule: 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 economic cycle.
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

AS
Inflation
TheAD=C+I+G+(X-M)
If
rise
Assume
government
in AD an
leads to
AD
therefore
an increase
reduces
initial intaxes
real
Apart from G, C
national
(remember
equilibrium
income,
the
shifts
to also
the
and I are
ceteris
subtleties)
position
paribus,with
and a
likelyto
to be
right
AD1
unemployment
orlevel
increases
of would
affected directly or
fall to
spending,
National
3% but at
it will
a cost
indirectly by the
of higher
have
Income
inflation
various
giving
policy change.
effects:
an
unemployment
rate of 5% (U
= 5%)
2.5%
2.0%
AD 1
AD
U=5%
U=3%
Real National Income
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/econom
y/policy/advisors/fiscal.htm)

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A rise in either (ceteris paribus)

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The Interest Rate Transmission

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The Interest Rate Transmission

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The Interest Rate Transmission

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Supply Side Policy

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Supply Side Policy

Supply Side Policy

Supply Side Policies

Supply Side Policy

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Supply Side Policy

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Supply Side Policy

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Supply Side Policy

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Influences key economic objectives

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Public Sector Income

Public sector total receipts1 billion

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Government Income ( billion)

Income Tax (gross of tax credits)

Income Tax Credits

Petroleum Revenue Tax

Capital Gains Tax

Total Inland Revenue

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Government Income ( billion)

Beer and Cider Duties

Betting and Gaming Duties

Air Passenger Duty

Insurance Premium Tax

Land Fill Tax

Climate Change Levy

Customs Duties and Levies

Total Customs and Excise

Copyright 2007 Biz/ed

Government Income ( billion)

Other Taxes and Royalties

Net Taxes and NICs conts

Interest and Dividends

Gross Operating Surplus and Rent

Other Receipts and Accounting

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Government Income Inland Revenue 2003-04

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