4.5 - Macroeconomic policies in a global context Flashcards
Role of the state in the macroeconomy
Why don’t economies operate in isolation and how does this contribute to the effectiveness of any macroeconomic policy?
- Due to globalisation, economies do not operate in isolation but are highly interdependent
- This means that the effectiveness of any of the macroeconomic policies and direct controls used by a government is dependent on the global environment
- The extent to which it is dependent is influenced by the size and development of the economy
Austerity
A contractionary government policy which raises taxes and reduces government spending in order to decrease a deficit or pay off national debt.
The Use of Policy Measures To:
> Reduce fiscal deficits and national debts
- Debt is not necessarily bad as it can be used to leverage growth - but unsustainable debt is bad
- One way to decrease national debt/fiscal deficit is to implement an austerity policy.
> the UK government has been using a policy of
austerity since 2010, where they attempt to decrease spending.
> It would also be
possible to increase taxes. - However, austerity could limit growth, and
reduce living standards and reduce income equality.
● On the other hand, opposition parties offer an alternative in the form of demand stimulus by high spending , which will cause economic growth and therefore bring
about higher tax revenues.
> This will allow for budget surpluses and eventually a
reduction of national debt.
> improve credit worthiness
● Another approach is to simply rely on automatic stabilisers to allow the economy to
grow so national debt/fiscal deficit will reduce as a percentage of GDP.
> This is mainly
the approach that the US took after the Global Financial Crisis and their economy
recovered fairly quickly
> By 2015, the fiscal deficit as a percentage of GDP was similar in the US and UK.
● One way to reduce national debt would be for the government to default on their loans but the economic cost of this is so large that governments only default if it is
the only option. Russia and Argentina have defaulted on their debts in the past.
The Use of Policy Measures To impact:
> Reduce poverty and inequality
Reducing poverty and inequality:
- Free market forces are unlikely to create an equal society, leading to absolute or relative poverty and inequality.
- Most agree that some redistribution from rich to
poor is necessary
- the government can use a progressive tax system which will produce a
more equal distribution of income after tax.
> evaluate using laffer curve - government expenditure in the form of benefits and
transfer payments
> Universal benefits
> Means tested benefits - The government can also provide goods and services which give citizens equal
opportunities and access to services they may not otherwise be able to afford, such
as healthcare, education and housing.
> This helps to ensure that everyone is given an
equal start in life - government can attempt to reduce wage differentials.
○ A national minimum wage and maximum wages or pay ratios
○ Equal pay legislation will prevent inequality between men and women or between different ethnic groups.
○ Trade union friendly legislation will allow the wages of their workers to rise, and those in unions are more likely to be the low paid so this will positively affect equality .
○ Employers could be forced to provide benefits to their workers , such as
sickness benefits, pensions and medical care, which will effectively increase wages. - could introduce price controls on essential goods
> This will increase the spending power of the poor.
> However, this could cause excess supply and may lead to the development of black
markets. - Trickle down theory?
- The measures taken to reduce poverty and inequality are very much influenced by political ideology and normative economics
Trickle down theory
- Free market economists use the concept of trickle down, arguing that increasing the
incomes of the rich will lead to an increase in the income of the poor. - The rich create
jobs by spending their money and employing others and reducing their income would reduce employment and lead to lower living standards.
Law of diminishing marginal utility and redistribution
- The law of diminishing marginal utility suggests that redistribution increases total utility and therefore is a better allocation of resources.
- The higher the spending
of an individual, the less satisfaction they gained from spending an extra pound
Use of policies to impact
> Changes in interest rates and the supply of money
- The central bank has the ability to change interest rates and monetary supply.
Why might they do this?
- domestic reasons, such as to control inflation,
- or due to global issues such as a low exchange rate or a change in world commodity prices.
> the exchange rate may depreciate as other countries raise interest rates.
> They may wish to keep interest rates lower but to stabilise the currency they have to respond by raising interest rates
- No simple relationship between the supply of money and inflation and it
can be argued that central banks don’t have complete control over the money supply
because they cannot control the ability of the financial system to create credit. - The globalisation of the financial market has also made it increasingly harder to control
domestic money supply.
> The consensus is that central banks should allow inflation caused by supply side shocks but manage demand side inflation. - Following the financial crisis of 2007-08, some central banks were concerned with
deflation rather than inflation and this led to the policy of quantitative easing. - For example, the Bank of England and the European Central Bank used this policy.
- This is because interest rates were so low they could not be reduced much further.
Use of policies to:
> Increase international competitiveness
- Supply side measures will improve productivity and flexibility and can involve taxes and deregulation.
-They can encourage competition, forcing firms to be efficient and
thus competitive within the global market. - They can place an emphasis on quality of
products and use tax incentives to encourage incentives. - Education will improve the skills of the workforce and help improve flexibility.
- Exchange rate policies may be used, and they may control inflation and
macroeconomic stability.
> currency depreciation can make exports cheaper - increasing their international competitiveness - protectionism
- They can join the WTO or sign trade agreements
Evaluate the use of policies to increase international competitiveness
- These typically include protectionism, currency depreciation and the use of supply side policies
- The effectiveness of these policies depends on the response of trading partners
- Policies to improve international competitiveness can result in creating internal domestic conflicts which are difficult to resolve
- Policies to improve international competitiveness can result in creating internal domestic conflicts which are difficult to resolve
> give an example (steel industry)
- By protecting the steel manufacturing industry in the UK, the cost of steel as an input for broader industry increases
- Employment gained in steel manufacturing is very likely surpassed by employment lost in steel related industries as a result of the increased costs of production
Examples of external shocks
- The Global Financial Crisis of 2008
- The Arab Spring which started in 2011:
> This was a further development of the Iraq War and the long running war on terror.
> It continued to develop into a major conflict centered in Syria, raising geopolitical tensions.
> Many Western economies benefitted through an increase in gross domestic product as governments increased spending on military hardware - The Asian Tsunami of 2011
> had major impacts on the supply chains of many automotive and electronic industries - The Global Trade War that developed under President Trump and continued from 2016 to 2020
- The Global Pandemic, Covid19, which started in January of 2020
- The Russian War on the Ukraine which started in February 2022.
> The Ukraine is one of the world’s largest producers of grain and Russia is one of the world’s largest exporters of natural gas
- Due to globalisation, the world’s economies are increasingly interdependent.
- Macroeconomic policies can be used to combat the effects of negative shocks to the economy.
> give some examples
- One example could be a commodity price shock , for example where oil prices greatly increase.
> The government could use expansionary policy to reduce the impact of a
fall in GDP
> or they could use deflationary policy to reduce the impact on inflation. - Another example may be a financial crisis, where the government can use expansionary policy to
increase AD.
> It is estimated that shocks in the global economy accounted for about 2/3 of weakness in the UK output after the financial crisis, due to the impact on trade. - Following
Brexit, interest rates were lowered to improve confidence but then raised to deal with
inflation caused by the falling value of the pound.
> Changes in exchange rates can cause inflation within the country or could cause a fall in
growth and a poor balance of payments, both of which the government can attempt to solve
through various methods. - Political instability in the UK or in other countries is likely to impact the economy, and will mean the government needs to take action
Transnational companies (TNCs)
A firm that has production facilities in two or more countries
Behaviour of transnational corporations
- Transnational Corporations are well known for using their power, wealth and access to the world’s best lawyers to secure (and protect) favourable trading conditions that will maximise their profits
- They often engage in monopoly and monopsony behaviour
Positives of transnational corporations
- TNCS can bring huge gains to an economy through their creation of jobs, the tax revenue they raise, the knowledge they bring and the investment they undertake.
Negatives of transnational corporations
- they can have a negative economic and social impact by destroying
local culture, affecting the environment and withdrawing more in profits than they
inject through investment. - They also have a history of influencing politicians to take decisions that will favour their interests and are involved in tax avoidance.
Transfer pricing
- Transfer pricing is one way for firms to engage in tax avoidance.
- This can occur if a
firm produces a good in one country and then transfers it to another to make it into another good which it then sells. - If taxes are higher in the first country than the second country, they can set a low price on the product made in the first country. The overall aim is to increase their
profit made in the low tax country and decrease it in the high tax country and so overall reduce their tax bill.
Problem with transfer pricing for countries
- A corporation will set up multiple sub-corporations which it owns
- The corporation then extracts resources from a country and sells it to their own sub-corporation at a low price
- This results in low taxes or low revenue share in the resource rich country
> If they sell it to their own sub-corporation at a low price, the government receives less revenue
> It is hard for less developed countries to challenge this kind of power and the World Bank is now helping governments to negotiate deals that bring transparency
Other measures to reduce transnational abuse of power
- Setting more rigorous labour protection laws as well as ensuring that transnationals are using local labour and not labour from their own country
- Establishing more rigorous laws around technology transfer between local and transnational firms
- Establishing limitations or targets on the level of exports by the transnational firms
Problems Facing Policymakers When Applying Policies
> Inaccurate information
- Data often lags reality as underlying economic conditions can change quickly
> Short term information - Data on unemployment, inflation, GDP growth etc. is useful for identifying trends, but the reason for the trend may not always be clear and policy decisions may be based on incorrect assumptions
- Trying to cut down on tax
evasion and avoidance is difficult as the government does not have the full picture on
the level of avoidance, who it is that is avoiding the tax and the best way to reduce it. - The Bank of England makes its decisions based on past data but it is possible trends
in the economy may be changing so past data gives an inaccurate picture of where
the economy is currently heading.
> With interest rates so low for such a long period,
past data is unlikely to give an accurate representation of the current economic
climate which makes it difficult for the Bank to know which action to take. - Full cost-benefit analyses can be time consuming and costly and it is impractical for the
government to gain every single bit of information they need
Problems facing policymakers when applying policies:
> Risks and uncertainties
- Identifying risks and establishing the uncertainties contained within any policy decision can be a very difficult task
> The risks may be greater than expected
> The uncertainties may not even be identifiable when the policy is instituted
> The government can’t know the full impact of their decisions as consumers often react unexpectedly/irrationally
and this could undermine government policy.
- Managing risk is an essential part of
good decision making.
Problems facing policymakers when applying policies:
> Inability to control external shocks
- External shocks have a ripple effect on economies around the world and globalisation makes it very difficult to protect against them
> The government is unable to control and prepare for these
external shocks; the best they can hope to do is lessen their impact.
> Since every
situation is different, it may be difficult to know the best method to solve the problem.
> Policies employed by policy makers may not have their intended impacts and it may
undermine current policies in place, for example Brexit has delayed government
plans to balance the budget.
