A Level Economics Revision Workshop Fiscal Monetary Policies

A Level Economics – Year 1 (AS) Revision Workshop
Session 4
Demand Side policies
(Fiscal and Monetary)
34
In this session we will consider how the Government of the UK uses
fiscal and monetary policy to impact on their targets for the economy.
We will look at the relative impact of some of the policies and discuss if
any policies have conflicting outcomes.

Your download link:
www.tutor2u.net/asecon2016.pdf

Ever used a Magic 8 Ball to answer your questions?
One of our Magic 8 Balls has the correct answer to the questions you
are about to be asked.
Which Magic 8 Ball is correct? Be quick, you have only a few seconds!

'Magic 8 Ball, is the Bank of England still going to
create money using Quantitative Easing as a policy
tool in 2016?'
1
A B C

2
A B C
'Magic 8 Ball, will government spending on pensions
be their single largest area of spending in 2016?'

3
A B C
'Magic 8 Ball, is ‘household consumption’ likely to
be the largest element of aggregate demand in the
UK in 2016?'

4
A B C
'Magic 8 Ball, what will be the National Living Wage
rate per hour for anyone over 25 years old by 2020?

Quick definition time!
34
The use of government spending,
direct and indirect taxation and
government borrowing to affect the
level and growth of aggregate
demand, output and jobs
Corporation tax
Changes in interest rates, the
supply of money & credit and
exchange rates to influence
the economy
Tightening of credit
supply
You have 1 minute to define
fiscal and monetary policies
and give one example of each

Examples from the Spending Review in
November 2015
34
Reduce costs to
stimulate
growth
Reduce
dependency on
state – improve
employment
Improve labour
efficiency within
the economy to
promote growth

Source: International Monetary Fund, data from 2015 onwards is a forecast
500
550
600
650
700
750
800
850
2010 2011 2012 2013 2014 2015* 2016* 2017* 2018* 2019* 2020*
Revenue/Spendinginbillionpounds
Revenue Spending
Total UK Government Spending and Tax Revenue
34

Fiscal Policy can either be contractionary or expansionary:
AD
Expansionary
• Decrease Direct tax
• Decrease Indirect
Tax
• Increase
Government
borrowing
Contractionary
• Increase Direct tax
• Increase Indirect
Tax
• Decrease
Government
borrowing
AD
35

Fiscal Policy Suggestion ‘Depends on’ factor
Reduce
Unemployment
Reduce Inflation
Sustainable
increase in
economic growth
Reduce Current
Account Deficit
Choose an appropriate fiscal policy needed for each objective and suggest
a ‘depends on’ factor that can influence the success of the policy:
Increase spending on basic
skill training
Increase income tax to
reduce spending
Use taxation to
redistribute income
Having knowledge of skills
needs of employers in the near
future
How concerning is current
rate of unemployment?
Ensuring redistribution does
not reduce enterprise incentive
35
Reduce indirect taxation to
make UK products more
competitive
Changes in exchange rate

Income plus cash benefits by quintile groups
for ALL households, 2000 and 2014
35
Calculate the missing numbers in the yellow boxes above. In each case, you are attempting to find a percentage figure
which shows what proportion of total income is represented by cash benefits.
68%
57%
2%
4%

Evaluation: Will the change in the way that income is distributed between
2000 and 2014 lead to an increase in aggregate demand?
Argument for
Point
Explanation
Evidence
Evaluation
Link back
Lower income groups relying less on benefits
If relying less on benefits, yet overall income is rising, suggests that
people are working more and could be spending more
Lowest quintile has 57% of income in benefits in 2014 compared to
68% in 2000.
This depends on whether the total income in 2014 reflects a real
increase in income
Reduced dependency on benefits and higher proportion of employed
hours suggests higher incomes and therefore higher AD due to more
consumption spending
36

Evaluation: Will the change in the way that income is distributed between
2000 and 2014 lead to an increase in aggregate demand?
Argument against
Point
Explanation
Evidence
Evaluation
Link back
Data suggests only a marginal change in the re-distribution of income
With marginal changes in re-distribution there is no evidence that AD
will alter
When calculating averages compared to ‘overall’ the lowest fifth only
increased by 4 % points (29% of avg in 2000, 33% of avg in 2014)
This data could indicate that the lowest quintiles have a slightly higher income which is
more likely to be spent than saved compared to higher quintiles
The data illustrates a small +‘ve change in benefits but a greater –’ve
change in income distribution so may not show much change in AD.
36

The Impact of Quantitative Easing
Quantitative Easing (QE), as Monetary Policy,
was tried in 2009, 2011 and 2012. We can
now start to evaluate the impact it had on
the economy.
36

£
assets
assets
assets
assets
assets
%
BoE
‘creates’
money
This is used
to purchase
assets –
mainly
government
bonds
Lower yields
on assets
leads to
lower
interest
rates
yield
yield
yield
yield
yield
Increased
demand
increases
price of
bonds and
lowers their
yield

Lower
interest
rates
encourages
greater
borrowing

This should
stimulate
the
economy
Bond costs
£100, with a
yield of 10%
10% of £100
= £10
Bond
increases in
value to
£110
£10 as
percentage
of £110 =
9.1%
Why?
If yield
percentage
is lower,
financial
institutions
less likely to
buy bonds
They can
make more
money from
loaning out
their funds
But will
have to
reduce
interest rate
to attract
custom
How does QE work?

Evaluation
The impact is meant to be both
short and longer term.
There are what are called an
‘impact phase’ (the phase when
the QE process is in place) and
then the ‘adjustment’ phase –
where the impact of QE continues
to influence aspects of economic
performance.
37

What impact has QE actually had?
• Between March 2009 and March
2013, the CPI increased from 109.8 to
125.6, suggesting that QE had a
positive impact on increasing prices
during a period of economic
difficulties
• However, during the same 4 year
period, economic growth was only
3.7%.
• During this period, real wages also
decreased by an average of 8%
• Many pensions, relying on the interest
payments on investments such as
bonds also saw reduced yields.
37

Evaluate the view that Quantitative Easing, as a Monetary Policy, has had
no positive impact on the UK economy between 2009 and 2015.
Argument for
Point
Explanation
Evidence
Evaluation
Link back
QE has led to worse inequality in UK
QE has only helped to prop up the stock markets, which only benefits
owners of assets who are mainly in the higher income groups
Standard and Poor report in Feb 2016 suggests value of financial
assets has risen by £600bn whilst average real wage fell by 8%
However, without the introduction of QE growth could have been
worse during the period with a negative impact on all income groups
QE does not appear to have had a positive impact on the economy as
it has contributed to increasing inequality.
37

Evaluate the view that Quantitative Easing, as a Monetary Policy, has had
no positive impact on the UK economy between 2009 and 2015.
Argument against
Point
Explanation
Evidence
Evaluation
Link back
QE had higher impact compared to a further change in interest rates
As a monetary policy, QE had more influence on the economy than a
change in what was already an historically low level of interest rates
Interest rates have remained at 0.5% since March 2009 giving little
scope to reduce them further
Whilst QE has more impact than interest rate changes, it is difficult to
measure the extent of it’s impact – we do no know what would have
happened without it
The economy has grown over the period of 2009 to 2012, so QE
appears to have more impact than a further change in interest rates
37

An alternative?
Professor Steve Keen (from
Kingston University) argues that
the single biggest issue that
causes deflation and depression in
the economy is the overly-large
debt to GDP level.
He argues for a different kind of
QE that he calls ’The People’s QE’
37

37

Whatever happened to ‘Forward Guidance’?
Introduced by Mark
Carney when he was
first appointed as
Governor of the Bank of
England in 2013
‘Pre-warn’ people
about possible
interest changes
Individuals and firms
could plan to adjust
when changes were
made.
Carney said that there
would be no changes to
interest rates whilst
unemployment
remained above 7%.
Unemployment
dropped to this level
within 6 months of
his appointment.
Strategy altered -there
would be no change to
interest rates whilst a
range of measures (such
as the output gap) were
above set levels.
38

Whatever happened to ‘Forward Guidance’?
38
Advantages of Forward Guidance Impact of changes to
Forward Guidance
If banks can see BoE forward policy
they are more likely to alter their own
interest rates in short run to match
base rate.
It gives guidance about expected
inflation levels so can influence short
term spending.
Policy has less
credibility as it
changed
Has more credibility (!)
– now a more
sophisticated guidance
tool

Balance of UK trade, October 2013 to October 2015
39

Evaluate the view that Monetary Policy in the UK has had a positive impact
on the Balance of Trade in the UK since 2013.
Argument for
Point
Explanation
Evidence
Evaluation
Link back
During the period the balance of trade in services has increased
Expansionary monetary policies have supported exports from UK’s
most successful sectors of finance and insurance
During the period balance of trade in services increased from between
approximately £6.5bn to around £7bn
However, overall trade in goods fluctuated much more, and has not
improved
Monetary policy may have had a positive impact on the balance of
trade in services, but not on the overall balance of trade.
39

Evaluate the view that Monetary Policy in the UK has had a positive impact
on the Balance of Trade in the UK since 2013.
Argument against
Point
Explanation
Evidence
Evaluation
Link back
There is no evidence that monetary policy has improved the balance
of trade
Balance of trade has remained consistent over the period, with a
surplus for services and a deficit for goods
Between 2013 and 2015, services remained a positive number (between approx. £6.5
and £7bn) and goods a negative number (between approx. £12 and £13bn)
However, as Sterling has strengthened due to the Euro’s weakness, consistent
policies may at least have prevented a level of deficit that could have been worse.
The Balance of Trade has remained steadfastly negative, suggesting
that any monetary policy has had little impact.
39

Extension
activities
41

A Level Economics Revision Workshop Fiscal Monetary Policies

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