2. The Macro Economy

3. Economic Objectives Low Unemployment
High but sustainable economic growth
Low and stable inflation (target is 2%)
Balanced balance of payments

4. Government Objectives
The role of the government is to provide a stable environment in which business can flourish. It aims to provide the highest possible trend rate of growth.
Government and the cycle – too high growth rates are rarely sustainable. Current governments have taken to trying to dampen down the extremes of the cycle so that recessions are not as deep or recoveries as sharp as they have been in the past.

5. AD / AS Analysis
This gives us a model of how the economy works and how output and employment is determined.
Demand may not be at an optimum level. Governments may use monetary and fiscal policy to influence the level of AD
Long run growth is determined by AS

6. A combination of policies can be used to achieve objectives
DEMAND SIDE POLICIES – about changing the level of aggregate demand (spending)
Monetary Policy – the use of interest rates and control of the money supply to achieve macroeconomic objectives
Fiscal Policy – the use taxation and government spending to achieve macroeconomic objectives
SUPPLY SIDE POLICIES – about increasing the economies capacity to produce goods and services

7. Tackling Unemployment
Increase aggregate demand in the economy. More demand = more spending = more output = more employment (lower unemployment)
Expansionary fiscal and monetary policy
Supply Side Policies
Eg education and training to help peopl gain employment

8. Economy Overheating – Inflation above target
Contractionary Monetary Policy – increase interest rates – more incentive to save – people pay more back on mortgages – demand in the economy falls – inflationary pressures reduced
Contractionary Fiscal Policy (budget surplus?)– tax up – gov spending down – lower aggregate demand – inflationary pressures reduced
Supply Side Policies – allow demand to grow without increasing prices by increasing economies productive potential

9. Economy in Recession or Slowdown – growth low or negative
Expansionary Monetary Policy
Expansionary Fiscal Policy
Supply Side Policies
HOWEVER – evaluate!!!!
Eg expansionary monetary policy to increase growth may lead to inflation rising above target

10. Macro Economic Policy

11. Fiscal Policy
Is the use of government spending and taxation to achieve economic objectives

12. Fiscal Policy
Expansionary (Reflationary) Fiscal Policy – if the economy is in a slowdown, or recession, the government may cut taxes and increase government spending, in order to increase aggregate demand (spending) in the economy.
Contractionary (Deflationary) Fiscal Policy – If the economy is overheating, with too much inflation, the government may increase taxes and reduce government spending, in order to reduce aggregate demand (spending) in the economy.

13. You need to be able to explain.
Example
A cut in direct taxation such as income tax.
Will increase people’s disposable income.
As a result there will be more aggregate demand and spending in the economy
Therefore businesses will produce more in response to higher demand
As a result GDP will be higher (economic growth)
More people will be needed to produce higher output (lower unemployment)
However there may be an upward pressure on prices (demand pull inflation)

14. Fiscal Policy – Key Concepts
Budget Deficit – is where the government spends more than it takes in revenue from taxation and other sources. An expansionary fiscal policy may involve deliberately running a budget deficit so as to increase total demand in the economy. This may be done if the economy is growing slowly or in a recession
Budget Surplus – is where the government spends less than it takes in revenue from taxation and other sources. A contractionary fiscal policy may involve deliberately running a budget surplus so as to reduce total demand in the economy. This may be done if the economy is overheating and inflation is rising

15. Tax and Spend – Key Terms
Tax – a compulsory payment to the government
Direct Tax – a tax on income and wealth paid directly to the government
Indirect Tax – a tax on spending. Often defined as a tax on goods and services. We pay this indirectly through the price of something
Progressive Tax – Takes a greater proportion of income from higher incomes
Regressive Tax – Takes a greater proportion of incomes from lower incomes
Proportional Tax – Takes the same proportion of income from all income levels

16. Government Spending & Business The impact will depend upon what the government spends its money on
Increases in spending may create more demand in the economy
Spending may be targeted in order to support certain areas – eg car scrappage scheme
Spending on roads, buildings etc may support construction industry
The multiplier effect – this is where an injection of spending creates more spending than the initial amount spent. (can be regional or national)

17. The Multiplier Effect
Where an injection of spending in the economy leads to more spending than the initial amount spend. Eg
Government builds school – incomes of builders etc rises – these people are able to spend more – increased spending represents income for other business – these businesses may increase output and employ more people as their income rises – a lot of this extra income will be spent generating more income for other businesses etc

18. Economic Effects of Changes in Direct Taxation
Direct Taxes such as income tax help to reduce inequalities in income as they are progressive
High Direct Taxes may harm incentives. Income tax may deter workers from working longer, seeking promotion or moving to higher paid jobs.
Unemployment Trap – taxes such as income tax may even deter people from working at all if their income after tax is not much higher than income from benefits when not working
High Direct Taxes may discourage entrepreneurship and even lead to business locating in another country

19. Economic Effects of Changes in Indirect Taxation
Choice – Taxpayers have a choice as they only pay the tax if they purchase the commodity on which the tax is raised
Indirect Taxes affect the pattern of demand – consumers will reduce the consumption of goods and services with the highest taxes on them. This can lead to less output and employment in those industries
Indirect taxes tend to be regressive – poorer people pay a higher proportion of their income in tax
Indirect taxes – can be used to discourage the consumption of demerit goods or goods with high external costs such as cigarettes, alcohol and petrol

20. Tax!
The impact of any tax cut on spending will depend upon the Marginal Propensity to Consume (MPC). This is the proportion of any extra income that will be spent. Mine is likely to be lower than yours!
The government is currently spending more than it takes in taxation – it is borrowing and it can’t do this for ever
Robin Hood Economics – Tax from rich and give to the poor is likely to create the most spending in the short term.

21. Evaluating the Effects of Fiscal Policy
Imprecise Tool - Affects demand and spending BUT – difficult to judge and estimate the impact any decision might have (eg size of multipliers)
Side Effects of Policy – Expansionary may add to inflationary pressures. Contractionary may lead to slower growth and rising unemployment
May Conflict with Other Objectives – eg government would be reluctant to undertake an expansionary fiscal policy at present as it is trying to cut the budget deficit

22. The Importance of the Budget Deficit
In recent years the UK government has faced a difficult trade off in its objectives for demand management:
On the one hand – the economy has been operating at well below full capacity as a result of the recent recession. This would suggest a need for an expansionary fiscal policy to boost aggregate demand in the economy
On the other hand – we have a large budget deficit and national debt as a percentage of GDP has risen to levels not seen since the end of WW2. this would suggest a need for a contractionary fiscal policy
Why does the deficit matter?
A high proportion of government revenue is being used to pay the interest on the national debt
The debt imposes a burden on future generations
If we do not tackle the deficit it could affect the UK’s credit rating. If our credit rating falls we may have to pay higher interest on the debt.

23. Monetary Policy
The use of interest rates and the supply of money to achieve Macro Economic objectives. The Bank of England is responsible for monetary policy in the UK and is tasked with keeping inflation at 2% (+ or – 1%)

24. Interest Rate Policy
Expansionary Monetary Policy – if the economy is in a slowdown, or recession, and inflation is below target the Bank of England may cut interest rates in order to increase total demand and spending in the economy.
Contractionary Monetary Policy – If the economy is overheating, with too much inflation, the Bank of England may increase interest rates in order to reduce total demand and spending in the economy.

26. How does interest rate policy work?
A rise in interest rates
Makes saving more rewarding so consumers may spend less
Makes borrowing more expensive so consumers may spend less on credit
Makes borrowing more expensive for firms so investment expenditure falls
Means many people have higher mortgage repayments so their disposable income falls and they have less to spend

27. Evaluating the Effects of Monetary Policy
Time Lags – The MPC meets monthly so it can react quickly to changes in the economy. It is also quicker to react than fiscal policy BUT – it still takes time for the full impact of interest changes to affect the economy
Exchange Rate Effects – Changes in interest rates can also affect the exchange rate and so can impact upon the Balance of Payments
Policy Conflicts – higher interest rates now to combat inflation could send us back into recession

28. Supply Side Policies
Policies that increase the ability of the economy to supply more goods and services
If successful, this means that when demand rises in the economy, this will lead to a greater GDP (economic growth) without inflation being a problem

29. Supply Side Policies Examples
Education and Training - make workforce more productive and flexible – human capital
Reducing Direct Taxes – on lower income earners increases the incentive to work – on higher income earners may increase incentive to work hard or work in the UK rather than somewhere else
Reducing Benefits – Increases incentive to work
Encouraging Enterprise – through tax relief, grants and subsidies – new business should lead to more output and more growth
Encouraging new technology and innovation – capital allowances to encourage investment and R&D – Helps to increase productive capacity of the economy
Reducing Monopoly Power – monopolies restrict output and increase prices. Reducing monopoly power helps increase total supply in the economy
Reduce Union Power – as these act as monopolies in the labour market

30. Evaluating the Effects of Supply Side Policies
Long Term – often take a long time to put into effect and to have an impact
Controversial – may face resistance from some groups in the economy – eg trade unions will oppose policies to limit their powers. Reducing benefits may hurt vulnerable groups in society.

31. Tradeoffs It is difficult to achieve all objectives all of the time
Eg school core v option results, policies can cancel each other out – eg budget deficit to reduce unemployment and high interest rates to control inflation

32. Comparing Policies Monetary Policy Demand Side Supply Side Fiscal
Eg – changes in education may take years to be effective
Quite Flexible but….
MPC meet monthly
Monetary
Demand can be affected fairly quickly by policy changes
Long Term
Policy
Demand Side
Supply Side
This is evaluation, evaluation, evaluation
Fiscal
Not Flexible enough to react to changes in the economy in the short term
Changes made annually in budget

33. Possible Questions
Assess the likely effects on UK Inflation of rising energy bills (10 marks)
Assess the likely effects of rising energy bills on the UK Economy (12 marks)
To what extent does Britain’s budget deficit make it difficult for the UK government to follow the energy policy it would like (10 marks)
Assess the economic case for subsidising windfarms – evidence D (12 marks)
Assess the extent to which subsidising windfarms creates economic benefits (12 marks)
Assess the case for the UK government paying cold weather payments to vulnerable people (10 marks)
Analyse two reasons why of those in debt on their energy bills, 41% owe more than they did 12 months ago - evidence H (8 marks)
Assess the potential impact of rising levels of energy bill debt on the UK economy (12 marks)
Assess the potential impact of disruptions to Norwegian gas supplies for the UK Economy (10 marks)
Assess the extent to which energy security is important to the UK economy (10 marks)