Theme 2 Flashcards
Economy
The state of a country/region in terms of the production and consumption of goods and services.
Gross Domestic Product
Total value of national output of goods and services produced in a given time period
Expenditure
Gross domestic product (aggregate demand) = consumption + investment + government spending + net exports
AD=C+I+G+NIX
Factor incomes
Incomes from wages and salaries
Profits of private and public sector businesses
Rental income from land ownership
Value of output
Value of output added from four main sectors - primary, secondary, tertiary, quarternary
GDP per capita
GDP/Population
GNI (Gross national income)
GDP + net primary income + net secondary income
Net Primary Income
Income earned by a country’s residents working abroad as well as foreign investments
Net Secondary Income
Transfers of money between countries such as remittances from foreign workers to their families back home or international aid
Purchasing Power Parity (PPP)
PPP measures how many units of one country’s currency are needed to buy the same goods that can be bought with a given amount of another country
In countries where the relative cost of living is high, there will be a downward adjustment to a nation’s PPP - adjusted GNI per capita.
Big Mac Index
Measures each currency against a common standard - the Big Mac. This can tell us whether a currency is under or over valued.
Easterlin Paradox
Concerns whether we are happier and more contented as our real living standards improve
Within society, rich people tend to be happier than poor people.
Easterlin argued that life satisfaction does rise with average income but only up to a certain point.
Beyond that the marginal gain in happiness declines (diminishing returns)
Happy Planet Index
Measures life expectancy, experienced well-being, inequality of outcomes and ecological footprint
The index works to measure efficiency by ranking countries relative to how they offer their people long and happy lives
Economic Well-Being
Refers to overall quality of life and material prosperity it encompasses income, consumption, access to basic needs and services, wealth accumulation, job security.
How is economic well-being measured
Median income, income inequality, wealth and assets, unemployment, life expectancy, literacy rates
Subjective happiness
Self-reported levels of happiness determined using questionnaires, involves rather than material well-being
Factors that influence it include:
- Personality + genetics
- Social influences
- Income and wealth
- Health
Drawbacks of using GDP per capita
Could perhaps be more beneficial to look at disposable income not gross income
Doesn’t show inequality
Median income be a better measure of living standards
Income per capita isn’t always a reliable indicator of well-being
Ignores distribution of income
Doesn’t consider unpaid work
May not capture value of free services
Limitations of data for GDP
Changes in distribution of income
Official data can be inaccurate (e.g. China)
Regional and local variations
Changes in working hours and job conditions
Problems in accurately measuring GDP and inflation
Inflation
A sustained rise in an economy’s general price level - the prices of goods and services are going up over time
Deflation
Sustained period when the general price level for goods and services is falling, usually associated with falling level of AD
Disinflation
Slowdown or fall in the annual rate of price inflation. Consumer prices are increasing but more slowly
Consumer Price Index (CPI)
Price index that measures the price changes in a basket of goods that a consumer faces
Retail Price Index (RPI)
Same concept as CPI but uses a different basket of goods
Demand-pull inflation
Occurs when aggregate demand exceeds aggregate supply
Factors like increased consumer spending, business investment or government expenditure can contribute to demand-pull inflation
Consumers are willing to pay more for what they want, this may be down to economic growth, low interest rates, and an increase in the money supply
Businesses can take advantage of high demand by raising their prices to widen their profit margins.
Cost-push inflation
Arises when production costs increase, causing firms to raise prices. Factors like rising raw material prices, higher prices, or supply chain disruptions can lead to cost-push inflation. When businesses respond to rising unit costs by increasing prices to protect their profit margins. It can come about from both domestic and external.
Growth of Money Supply
Increase in money supply, not matched by a corresponding increase in economic output, can lead to excess demand for goods + services, leading to inflation.
e.g. central banks printing excessive amounts of money
Effects of inflation on consumers
Inflation erodes the purchasing power of money, reducing the real value of savings
Fixed-incomes earners will experience reduced real incomes
People on fixed pensions may find it challenging to maintain their standard of living
Effects of inflation on firms
Firms may face rising production costs, reducing profit margins
May increase prices to maintain profitablity
Effects of inflation on government
Inflation can increase the cost of servicing government debt
Tax brackets may not be adjusted for inflation
Effects of inflation on workers
While workers may see nominal wages increase, their real wages may decline due to deflation
Labour unions may negotiate for higher
Inflation expectations
What people and businesses expect to happen to consumer price in the future. If people expect higher prices, this can feed through to higher wage claims.
Monetarism
Milton Friedman was a leading advocate
Suggests the the amount of money in an economy plays a crucial role in determining the overall price level
If the centra bank increases the money supply too rapidly, it can lead to inflation because there is too much money chasing too few goods
Often critical of using fiscal policy
Consequences of inflation
Inequality - has a regressive effect on lower-income families in developed countries - most of their wealth is held in cash
Falling real income - if wages rises lag price increases each year
Negative real interest rates - if the interest rate on savings is lower than inflation
Cost of borrowing - high inflation may lead to higher interest rates for businesses and consumers with debts
Who is affected positively by inflation
Workers with strong wage bargaining power (e.g. some trade unions)
Debtors if real interest rates on loans become negative
Producers if their prices continue to rise faster than costs
Who is affected negatively by inflation
Retired people relying on fixed pensions
Lenders if real interest rates on loans are negative
Savers if real returns on their savings are negative
Workers in low-paid jobs with little or no bargaining power
UK Inflation - 2022-23 - causes
Pandemic-related supply shortages - supply couldn’t keep up with demand
Conflict in Ukraine leading to a surge in energy prices
Labour shortages
Greedflation/price gouging
Charging excessive or unreasonable prices for goods in response to a situation of increased demand or limited supply. Sellers take advantage of this situation by charging prices that are much higher than what would be considered under normal market conditions.
Effects of growth of money supply
The growth of the money supply can be a cause of inflation when it outpaces the growth of real economic output
As money supply grows, people have more to spend. If the supply does not increase at the same rate, there will be excess demand. This means suppliers can increase their prices. Expectations of future inflation can further exacerbate the problem. If people anticipate prices to rise further, they may make purchases sooner which will increase excess demand.
Relative inflation rate
How high the rate of inflation is in one country compared to another. This is important as it could affect the balance of trade.
Countries with high inflation will see exports decline and vice versa. This can lead to imbalances in the balance of trade and countries with high inflation will become less competitive in the global marketplace
Capital Flight
When a country experiences high inflation, investors may start to worry about the stability of the economy. They may fear that the high inflation will lead to a decline in the value of the country’s currency. To protect their assets, investors may decide to move their money out of the country.
Government bonds in inflation
If inflation is high, the government will have to offer a higher yield (or interest rate) to entice investors to lend it money. This is because investors will want to be compensated for the inflation eroding the value of their investment. This then means government must pay off their bonds at a higher rate.
Deflation
Deflation is a sustained period when the general price level goods and services is falling. This means that a weighted basket of goods and services is becoming less expensive over time.
Opportunities due to deflation
Increased real income of families
Rise in demand for ‘luxury products’
Asset prices falling can improve housing affordability (asset price deflation)
Consequences of deflation
Holding back on spending if consumer expect prices to keep falling
Debt increase - real value of debt rises with deflation
Lower profit margins due to reduced prices
Real cost of borrowing increases - interest rates will rise if nominal rates of interest do not fall in line with prices
Costs of high inflation for government
Pressure on the gov. to raise the value of state welfare benefits
High inflation can cause real GDP growth to slow down
High inflation can make gov. borrowing more expensive when they issue new bonds
Can lead to a worsening of international competitiveness causing a fall in exports
Benefits of high inflation for government
Can lead to fiscal drag - this happens when people’s wages/incomes are rising in nominal terms which causes them to pay more in direct and indirect taxation
Can cause a reduction in the real value of the governments existing debt
Wage-Price Spiral
A wage-price spiral is a situation where workers bid for higher wages because they have seen the real incomes eroded by fast-rising prices
This can lead to a further burst of cost-push inflation
Rising inflation → falling real incomes → workers bid for improved wages → leads to high labour costs → firms raise they’re price
Stagflation
Refers to a combination of stagnant economic growth, rising unemployment and high and rising inflation
Consumer Price Index
A measure that tracks changes in the average price level of a basket of goods and services purchased by a typical household over time. Used to assess inflation.
It is weighted so different components account for different proportions of the basket
Limitations of the UK CPI
Not fully representative of all consumers - inaccurate for non-typical households
Errors or inaccuracies in data
Many services in the digital economy do not have a price
Time lags
Challenges in measuring inflation
Basket of goods and services may not be accurately reflected
Substitution bias - consumers tend to adjust their spending patterns in response to price changes
Quality adjustments - CPI must make quality adjustments to account for quality changes, which can be challenging to quantify accurately
Geographic variation - May not capture regional variance
Subgroups and demographics - CPI represents an average consumer, and the inflation experience can vary among groups
Unemployment
Refers to individuals who are not currently employed but are actively seeking and are available for work
Under-employment
When individuals are employed but their job does not fully utilise their skills and qualifications
Measures of unemployment
Claimant Count - measure of unemployment based on the number of people who are claiming unemployment benefits - provides a narrow definition of unemployment
International Labour Organisation (ILO) and UK Labour Force Survey - defines unemployment as individuals of working age who are without work, actively seeking work, and available for work
Reasons for high levels of job vacancies in the UK
Brexit has made it harder for businesses to recruit migrants from the EU
Skill gaps and low pay cause problems in recruitment and retention
1.3 million unemployed in UK -2023
25% of working population or 8.7 million people economically inactive - 2023
Structural unemployment
Occurs when there is a mismatch between the skills of the workforce and requirements of available jobs
Frictional unemployment
Temporary unemployment when individuals are between jobs or have entered the workforce
Seasonal unemployment
Linked to seasonal variations in demand e.g. tourism or agriculture
Cyclical/Demand deficiency unemployment
Arises from a lack of aggregate demand during economic downturns
Real Wage Unemployment
Real wage unemployment is a situation in which wages are set above the equilibrium level, resulting in an excess supply of labor or unemployment.
E.g. minimum wage
Effects of unemployment on consumers
Reduced income can lead to lower consumer spending, impacting businesses
Effects of unemployment on firms
High unemployment can lead to a larger labour pool, potentially reducing wage pressures
Effects of unemployment on workers
Lost income, reduced job prospects, psychological stress
Effects of unemployment on government
Increased spending on unemployment benefits and lost tax revenue
Effects of unemployment on society
Social unrest, reduced well-being, inequality
Long-term unemployment
People who have been unemployed for 12 months or more. Structural supply-side problem
Mass unemployment
When one person in ten in the labour force is out of work. In practice, the true level of unemployment may be higher than this
Youth unemployment
Unemployment rate for 16-24 year olds
Reasons for youth unemployment
Lack of experience - weak human capital
Lack of education/training
Age discrimination
Economic downturns - often young people are the first yo be laid off
Automation and technological advancements
Frictional after entering workforce
Discouraged Workers
Inactive work seekers. These are people who have ceased to seek work because they believe there are no suitable jobs
Hidden unemployment
People who don’t have work but aren’t counted in government reports, for example, people who have stopped looking for a job
Causes of hidden unemployment
Large amount of people on disability benefits with chronic illnesses
Having to care for elderly relatives
Rise in self-employment, zero-hours contracts and agency work
The Gig Economy
Work arrangement where people perform short-term, flexible, and often freelance work e.g. Uber or food delivery
Economic Inactivity
People who are of working age not in employment and who have not been actively seeking work
Reasons for economic inactivity
Students remaining in full-time education
Caring for family members
Long-term sickness
Early retirements
Ways to reduce economic inactivity
Improving financial incentives - make work pay and lower some barriers for people seeking jobs. e.g. tax-free childcare, increase minimum wage, reforms to rented housing
Investment in human capital and labour market flexibility - employer or government funded programmes such as degree apprenticeships, T-Levels, STEM education
Balance of Payments
A record of all economic transactions between a country and the rest of the world. It is divided into two main components - current account and capital and financial accounts
Current Account
Balance of trade in goods - difference in value of exports and imports of tangible goods
Balance of trade in services - difference in value of exports and imports of services traded
Income balance (primary income) - earnings from abroad (dividends, interest, wages) and payments made to foreign investors
Current transfers (secondary income) - transactions of money without counterpart item of economic value - foreign aid, remittances
Net primary income
Monetary flows generated from owning of cross-border financial assets. It represents the yield of UK investments abroad and that of foreign-owned investment in the UK
Net secondary income
Current transfers between residents and non-residents - no counterpart item of value traded back - e.g. foreign aid, remittances, diaspora contributes
Aggregate demand
The total demand for goods and services within a country. It measures spending by consumers, firms, government and overseas consumers and firms
AD = C + I + G + NX
Disposable income
The amount consumers have left over after taxes; they can choose to spend or save this money
Marginal propensity to consume
Refers to how much a consumer changes their spending following a change in income
MPC = change in consumption / change in income
Marginal propensity to save
How much consumers change their saving following a change in income MPC + MPS = 1
Average propensity to consume equation
Consumption / income
Factors affecting consumption
Availability and cost of credit
Expectations
Confidence - animal spirits
Asset prices
Time Lags
Factors affecting planned business investment
Actual and expected demand
Expected profits and business taxes
I/R and availability of business finance
Business confidence - animal spirits
Animal spirits
Keynes coined the notion of animal spirits which refers to a mix of confidence, trust, mood and expectations
When confidence is low, MPS is increased for individuals and businesses
Significance of investment
Injection of demand for capital goods industries
Can lift productivity/incomes
Economies of scale and increased competitiveness
Investment helps to sustain export - led growth
The Accelerator Effect
Positive relationship between planned capital investment and the rate of change of national income. If an industry is experiencing a surge in demand, businesses may respond by using existing capacity more intensively. If they expect demand to stay high, they may increase spending on capital investment.
Therefore, a rise in demand for consumer goods and services will cause a bigger percentage change in demand for capital goods, the accelerator effect
Net Investment
Gross investment - capital depreciation
If gross investment > depreciation, net investment will be positive and businesses will have higher productive capacity
Gross investment
The total amount the economy spends on new capital
Government Spends on
Welfare spending - transfer payments
Public services - current spending
State investment - capital spending
Government money comes from
Income tax
National insurance
Corporation tax
Inheritance tax
VAT
Assets
Current Spending - examples
Salary of NHS employees
NHS drugs
Road maintenance
Army logistics supplies
Exports
The act of selling goods and services to another country. Income from exports count as an injection into the circular flow of income and exports to the AD
Trade Balance
Difference between the value of exports and imports. When the value of exports and imports. When value of exports > imports, there is a trade surplus
Factors impacting net trade
Relative prices of exports in world markets - e.g. inflation
Exchange rate - stronger currency makes exports more expensive
Non-price demand factors e.g. demand and branding
Strength of AD in key export markets
Wealth Effect
The wealth effect is the idea that an increase in an individual’s wealth will lead to an increase in their consumption. The concept is based on the idea that when people feel wealthier, they are more likely to feel confident in their financial situation and therefore more willing to spend money on goods and services.
Aggregate Supply
The total amount that producers in an economy are willing and able to produce at a given price level in a given time
Factors impacting AS
Increased cost of labour - wages, employment taxes
Increased cost of raw materials/commodities - energy costs, war, weather events
Exchange rates and imports
Changes in productivity
Taxation/regulation
Technological advancements (SR+LR) - leads to more efficient production
Labour productivity
A measure of efficiency indicated by output per person employed or value of output per hour worked
Infrastructure
Physical capital such as transport networks, energy, power and water supplies and telecommunications
Key factors influencing long run aggregate supply
Q2CELL + productivity
Changes in labour supply available for production
Changes in the stock of capital inputs including infrastructure
Changes to the stock of natural resources
Changes in the efficiency of allocation of factor inputs
Improvements in the quality of inputs / productivity
Advances in the state of technology
Improvements in institutions such as banking/legal system
Circular flow of income
A model of the economy which shows the movement of goods + services between households and firms, and their corresponding payments in money terms.
National Output
The value of the flow of goods and services from firms to households
National Expenditure
The value of spending by households on goods and service
National Income
The value of income paid by firms to households in return for land, labour and capital
Positive multiplier effect
When an initial increase in an injection or decrease in a leakage leads to a greater final increase in the level of real GDP or the final change in equilibrium national output from an initial change in AD
Negative multiplier effect
When an initial decrease in an injection or increase in leakage leads to a lower level of real GDP
Multiplier Effect in a closed system
1/MPS or 1/(1-MPC)
Multiplier Effect in a closed system
1/(MPS+MPM+MRT)
M = import
T = taxation
Economic growth
The increase in the real value of goods and services produced as measured by the annual percentage change in real GDP. It is also defined as a long-run increase in a country’s productive capacity.
Short-term growth causes
Expansionary monetary policy - decrease in interest rates
Expansionary fiscal policy
Depreciating exchange rate helps to boost exports
Strong growth of asset prices
Improved business confidence
Long-term growth causes
Sustained increase in a country’s productive capacity
Improvements in productivity - a growing labour supply and technological change
Shifts in the composition of industries
Increased human capital
Advancements in a country’s essential infrastructure
Increase in entrepeneurship
New resource discoveries
Output Gap
Difference between the actual level of GDP and its estimated potential level
Negative output gap
An economy’s actual output is below potential output
Positive output gap
Where an economy’s actual output exceeds its potential output
Potential output represents the level of production an economy can sustainably achieve when all its available resources are fully utilized without causing inflationary effects. Positive output gap can lead to rising demand-pull and cost-push inflationary effects
Economic cycles
Refers to the fluctuations of economic activity in an economy over time. It involves alternating periods of peaks and troughs
Characteristics of a recession
Falling real GDP
Rising unemployment
Disinflation
Reduced business investment
Effects of a recession
Fall in confidence
Rising cyclical unemployment
Lower rate of inflation
Rising fiscal deficit
Economic recovery
Follows a recession, can come from:
Cuts in interest rates
One or more types of fiscal stimulus
Rebound in business and consumer confidence
Economic Scarring
Refers to medium-long term damage done to the economies of one or more countries following a severe economic shock which then leads to a recession. e.g. fall in investment leading to an ageing of existing capital stock, or rise in long-term unemployment and economic inactivity
Boom
Period where the percentage rate of growth of GDP is fast and higher than the long-term trend
Slowdown
Weakening of the rate of growth, GDP is still rising but at a slower rate
Recession
Period of at least six months where an economy experiences negative growth
Recovery
Increase in GDP after a recession
Depression
Prolonged downturn where a nation’s GDP falls by at least 10%
Sustainable growth
Seeks to achieve long-term prosperity while also considering the well-being of current and future generations, as well as the health of the environment
Threats to sustainable growth
Waste from production and consumption
Pollution and increasing climate change risks
Depletion of natural capital
Loss of biodiversity
Key principles of the circular economy
Design for longevity
Closed-loop systems - recycling and repurposing instead of disposal
Renewable energy
Sharing and collaborative consumption - reduces demand for new products, minimising waste
Regeneration of ecosystems
Policies to promote sustainable growth
Carbon taxes
Carbon trading schemes - permits
Tougher environmental regulations
Spending to protect biodiversity
Investment in sustainable technologies
Tax relief on R&D initiatives
Export-led growth
A development strategy where a country focusses on increasing exports as a driver of expansion.
e.g. China, South Korea, Taiwan, Vietnam
Key features of export-led growth
Specialisation - comparative advantage
Foreign exchange earnings - can be used to import, service external debt, and fund development projects
Economies of scale - link to specification
Technology transfer and innovation as firms are introduced to international markets
Job creation - positive multiplier effect
Risk from dependency on export-led growth
Vulnerability to external shocks
Dependence on commodity prices for countries exporting them
Currency appreciation - makes exports less competitive
Lack of diversification - overreliance on a few key industries
Environmental concerns - may prioritise production over environmental sustainability
Benefits of economic growth
Increased SoL
Job creation
Reduced poverty
Increased government revenue
Investment opportunities - growth attracts domestic and foreign investment
Drawbacks of economic growth
Inflation if AS can’t keep up with demand
Resource depletion
Income inequality
Financial instability if growth is fuelled by excessive spending and speculative investment
Gross National Income
Alternative to GDP, GNI = GDP + Net Primary Income + Net Secondary Income
Macroeconomic objectives
Economic growth - strong, sustained, sustainable
Low and stable inflation
Balance the budget - no debt
Sustainability
Low unemployment
Fair distribution of income
Balanced trade - CA
Demand-side policies
Policies which can impact the level of demand in the economy
Expansionary fiscal policy and uses
Use of government spending and taxation to increase the level of AD in the economy. Used to:
Used to stimulate economic in a recession
Stabilise economic growth
Reduce rate of inflation - 2% UK target
Redistributed income (↓ tax on poor)
Reduce unemployment
Contractionary fiscal policy and uses
Changes to government spending and taxation to decrease AD
Used to:
Reduce inflation (mainly monetary policy)
Reduce budget deficit + debt
Redistribute income (↑ tax on rich)
↓ CA deficit
Fiscal policy - Government spending
Increase in government spending on healthcare, infrastructure, public sector wages can directly ↑ AD
Fiscal Policy - Taxation
↓ income tax - ↑ disposable income - ↑ MPC
- higher impact if reduction in a regressive tax as this will benefit the poor which will have a large impact due to high MPC
↓ corporation tax - ↑ retained profits - ↑ MPI
Cons of expansionary fiscal policy
Trade-offs - demand-pull inflation/CA deficit
Worsening government finances - cost and O/C of funding
Crowding out effect
Time lags
Evaluation of expansionary fiscal policy
Size of output gap
Size of multiplier
Consumer/business confidence
Original state of government finances - affordable?
Laffer curve
LR returns to government through tax revenue
Automatic stabilisers reduce need for fiscal policy
Crowding in vs crowding out
LR benefits to LRAS (T+G)
Automatic stabilisers and fiscal policy
Government spending/taxation vary without direct government decision-making
If an economy has progressive income tax system and welfare system:
In a boom, ↑ incomes will push workers into higher tax bands and ↑average rate of tax (tax paid as proportion of total income) and slow down rising consumption
Lower unemployment means government spending on benefits reduce which reduces G
Vice versa for a recession
This will dampen fluctuations in the economic cycle
Crowding out effect
Classical view
Government borrowing through issuing bonds, people buy with savings
G increases demand for loanable funds (↑ yield)
↑ in I/R is likely to be transferred to loans in general
Consumer/business borrowing will ↓ as IR/ ↑
Crowding in effect
Keynesian view
G leads to ↑ I
This improves economic environment and increases opportunities for businesses (↑I) through the stimulation of economic activity, boosting demand for products, improved productivity and improved confidence
Four principles of taxation - Adam Smith
Fairness
Certainty
Convenience
Efficiency
Equity
Taxation should be fair and equitable - can be achieved through progressive, proportional, or regressive taxation systems
Efficiency in taxation
Taxation should minimise economic distortions and deadweight losses.
Economic neutrality
Taxes should not distort economic decision-making.
Horizontal equity
Similar taxpayers in similar circumstances should be treated equally in terms of their tax liabilities
Vertical equity
Tax burdens should be distributed in a way that is fair and reflects differences in the ability to pay.
Progressive tax
Marginal and average tax rate increases as the amount of taxable income increases - e.g. UK tax system
Regressive tax
Where the average tax rate as a % decreases as the amount of taxable income increases, low-income taxpayers pay a higher percentage of their income in taxes than higher-income taxpayers
Proportional taxes
Marginal and average tax rate remains constant regardless of an individual’s income or wealth
Budget balance
Fiscal balance = tax revenue - expenditure
Surplus - T>G
Deficit- G>T
Cyclical and structural budget deficit
Structural - deficit at FE
Cyclical - deficit in a recession
Pros of running a budget deficit
Higher growth, lower employment in a recession
Benefits of ↑G and incentives of tax cuts (LR implications may cancel out deficit)
Redistribution of income (e.g. ↑ benefits)
Crowding in
Cons of running a budget deficit
Deterioration of government finances - unsustainable ( ↓ FDI due to loss of confidence)
↓ in demand for government bonds meaning government has to increase yield which makes borrowing more expensive - cost and O/C of debt repayments
Conflict of CA deficit + inflation targets
Crowding out effect
Evaluation of budget deficit
What is original state of government finances
SR/LR impacts
Stage of economic growth - more useful in recession?
Specific policy used
Consumer / business confidence may reduce impact of ↓T
Automatic stabilisers may reduce need
Pros of budget surplus
Confidence in government finances - cheaper borrowing and ↑FDI
Flexibility with fiscal policy
Less crowding out
↓ Inflation and CA deficit
Cons of budget surplus
Demand-side shock - ↓ growth ↑ U
Implications of ↓ G
Incentives distortion of ↑ T - ↓ to work and entrepreneurship
Risk of income inequality
Evaluation of budget surplus
Is it necessary
Could make debt worse if ↓ GDP because debt is measured compared to GDP
Policy used? - don’t have to use both at the same time
Stage of the economic cycle
National debt
Accumulation over time - result of a country consistently running budget deficits
Purpose - use to debt to finance critical infrastructure projects, public service, and other expenditures
Debt servicing - servicing the national debt involves paying interest on the outstanding debt
Automatic stabilisers
Are automatic fiscal changes as an economy moves through different stages of the business cycle
Impact depends on whether a government allows the automatic stabilisers to operate fully, and marginal propensity to save or consume
Fiscal multiplier
Estimates the final change in real national income that results from an initial change in government spending
Monetary policy
Involves changes in the base rate of interest and the money supply to influence the rate of growth of AD
Advantages of using monetary policy
It has short term action and implementation
It is flexible (can change 0.1% at a time)
UK central bank is independent - political neutrality
Cons of expansionary monetary policy
Excessive inflation as a trade off for growth
Widen CA deficit - ↑ M
I/R after a certain point will lose effect
Negative impact on savers
Time lags - BofE says I/R cuts take up to 2 years to have full impact on AD
Evaluation of expansionary monetary policy
Size of output gap
Consumer/ business confidence
Banks willingness to lend
Size of the rate cut
Advantages of contractionary monetary policy
↓ demand-pull inflation
Discourage debt which can lead to banking failure
Sustainable borrowing + lending, less chance of asset-price bubbles
Encourage saving- benefits pensioners
Reduce CA deficit
Cons of contractionary monetary policy
Lower growth and higher unemployment
Impact on the indebted
↓ I - ↓ LRAS
Worsening CA deficit through E/R appreciating
Quantitative Easing
Used if traditional monetary policy fails due to low availability of credit, low consumer confidence, low willingness of banks to lend
- Central bank creates money electronically
- Buys government bonds from commercial banks and financial institution
- This injects liquidity into the financial system, effectively increasing the money supply
- Bonds yields are reduced as the central bank purchasing increases demand
- Borrowing is cheaper for firms and individuals which boosts economic activity
Impact of monetary policy on firms
Demand for products are likely to alter depending on the change in I/R
Cost of borrowing is likely to change with changes in I/R
Company share prices may fall as interest rates rise. This may mean investors look elsewhere to invest - increase of shares on the market means fall in price
Great Depression
1930s
Greatest and longest economic recession in modern history
Caused by the stock market crash of 1929
Increase animal spirits following WWI led many people to invest in stocks
Keynesian demand-side policies aided in recovery
Global Financial Crisis
2008-09
Worst economic disaster since stock market. Started with subprime mortgage lending crisis in 2007 and resulted in the failure of investment bank in 2008
Demand-side economies
Belief that the primary factor driving economic activity and short-term fluctuations is demand
Also called Keynesian economics, who advocated that government intervention to help overcome low AD in the short-run
Supply-side policies
Set of economic measures and strategies that aim to improve the long-run productive capacity and efficiency of an economy
Primary goal to supply-side policies is to stimulate long-term economic growth, increase productivity, and create a more favourable environment for businesses to operate
Achieve all four main macro objectives
Interventionist vs market based
Interventionist - promote more of a role for government to influence LRAS
Market based - take away role of government in economy, let markets be freer
Weaknesses of UK supply-side
R&D spending is only 1.74% of GDP
Regional economic imbalances
400,000 rise in economic inactivity since 2020
Market-based supply side policies
Tax cuts - income and corporation (↑ Quantity of labour and Q2 of capital)
Labour market reform - ↓ benefits (↑ Quantity of labour) - ↓ minimum wage and trade union power (↓ costs for businesses)
Competition policy - privatisation, deregulation, trade liberalisation
Examples of recent UK supply-side policies
Privatisation of Royal Mail
Deregulation of the UK retail energy market
Tax free childcare
Creating 20 institutes of technology
Reforms to the UK immigration system
Super-deduction tax incentive for business capital investment
Interventionist supply-side policies
Government spending on education/healthcare - ↑ quality of labour
Government spending on infrastructure - transport ↓ LR costs of production
Subsidies - promote investment
Evaluation of supply-side policies
No guarantee for success
Costly to government (esp. interventionist) - SR CA implications
Time lags
Negative stakeholder impacts (i.e. impact on people on benefits, what is being deregulated?
Output gap - more effective when economy is booming and at FE, Keynesian argue demand-side policies in recession
Policies to reduce unemployment
Cyclical unemployment in a recession can be reduced by demand-side policies boosting AD
Real-wage unemployment can be reduced through decreasing min wage or trade union power
Structural unemployment (NRU) - occupational and geographical immobility and frictional unemployment (NRU) can be helped by supply-side policies to improve mobility of labour, force people to get jobs instead of waiting for a better one (↓ benefits).
Policies to ↓ inflation
Type of inflation
Reducing demand-pull inflation through contractionary demand-side policy
Cost-push inflation is hard to control as usually short-term uncontrollable shocks such as global commodity prices.
Long-term inflation can be tackled with supply-side policies, ↑ productive capacity
Conflicts and trade-offs - macroeconomic objectives
Economic growth vs inflation
Economic growth vs CA deficit - growing economy means growing MPC which in the UK, leads to a high MCM
Economic growth vs budget deficit - reducing a budget deficit may be due to increase in tax which would reduce AD
Economic growth vs sustainability - Kuznets curve
Unemployment vs inflation - Phillips curve
