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Ec 111 week 2b bb


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Ec 111 week 2b bb

  1. 1. EC-111 British EconomyRecent UKMacroeconomic TrendsDr Catherine RobinsonF35, Richard Price BuildingOffice Hours: Monday 10:30 to 11:30 and Thursday 9:30 to 10:30Appointments:
  2. 2. Balance of Payments During the 1950s and 1960s there were continualproblems with BofP deficits... Governments therefore Manipulated aggregate demand (stop-go policies) Adopted exchange control measures to keep the externalaccount in balance (devaluation a last resort in 1967 -14%) Other policies such as investment incentives to promotecapital formation and long run economic growth REPRESENTS A NARROW INTERPRETATION OFKEYNESIAN THINKING (MAYNARD, 1989)Week 2:1
  3. 3. DID IT WORK? The post war period was characterised by a shift toKeynesian type policies Full employment was the target policy objective On the whole, it was considered to be a good period ofmacroeconomic stability and growth Unemployment was held at 2% or below for most of the1950s and 1960s Growth was generally steady and although low, this wasthought to be due to sociological characteristics of the UKrather than policy failure Balance of payments were troublesome, but manageableWeek 2:23
  4. 4. Opportunity wasted? Conditions post war were conducive a stable macroeconomy Rebuilding war-torn Europe Fixed exchange rates Inflation tied to global rate, determined by US macropolicy Terms of trade favourable for industrialised countires And so had little to do with Keynes..Week 2:24
  5. 5. Change in circumstances Things started to go wrong at the start of the 1970s The collapse of the IMF monetary system (Bretton Woods) Worldwide burst of inflation Terms of trade worsened Global oil crises 4 fold increase in oil price between 1973-1974 A freely floating exchange rate had implications for policy Fiscal expansion would force up interest rates and therefore exchnangerate, reducing private sector demand. A wage-price spiral was set in motion the breakdown of the Philips Curve Stagflation – high unemployment AND high inflationWeek 2:25
  6. 6. Inflation (MM23 CPI annual%change)Week 2:260123456789101945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969
  7. 7. Inflation in the 1970sWeek 2:270510152025301970 1971 1972 1973 1974 1975 1976 1977 1978 1979Note thechange inscale
  8. 8. Inflation (MM23 CPI annual %change)Week 2:28-505101520
  9. 9. So, what to do? Money was the answer… A number of academic think-tanks were looking at theproblem National Institute of Economic and Social Research The Cambridge Economic Policy Group Did not follow the mainstream Keynesian school of thought Believed that the market was inherently stable and constantfine-tuning approach was inappropriate Thought that a poor Balance of Payments position was nothelped but actively hindered by fiscal policyWeek 2:29
  10. 10. Cambridge Economic Policy Group Simple message based on national income accounting: If I+G+X=S+T+M Then X-M=S-I+T-G That is balance of payments =f(private sector surplus (savings-investment) + public sector surplus (taxes net of governmentexpenditure) Private sector surplus is so small, that it can be virtuallyignored Therefore – its all down to government expenditure andtax receipts Such that: X-M≈T-GWeek 2:210
  11. 11. What does this mean? The policy implication of such a model is that anystimulation policy in fiscal terms must be accompaniedby import controls, otherwise, a balance of paymentsdeficit will ensue. Apply a “Fiscal Rule” within the context of a mediumterm strategy for stability Stick to the rule and only alter the “par” tax rate formajor disturbances in the global economyWeek 2:211
  12. 12. A paradigm shift? Things had changed and the „old‟ model was no longer fit forpurpose In the 1950s and 1960s Rebuilding after the war Exchange rates were pegged to the dollar, giving stability UK inflation was tied to global inflation which was largelydetermined by US macro policy – at the time, very conservative The Korean War had just finished which led to a decline inglobal commodity prices This was partly due to the new floating exchange ratesystem....Week 2:212
  13. 13. (1) Floating exchange rates In effect, it reversed the role of monetary and fiscal policy The government now needed to intervene in currencymarkets...fiscal policy without monetary policy would beineffective because interest rates and exchange rateswould change “It was perhaps as much the transition to floating exchangerates as the blandishments of Milton Friedman that causedgovernments to become monetarists”, Maynard, 1989, p.11 A decline in „money illusion‟ (real versus nominal prices) Inflation changed real relationships...the relationshipbetween real consumption and real income changed inEurope Consumption function shiftWeek 2:213
  14. 14. (1) Floating exchange rates The UK Government probably didn‟t appreciate all thisat the time A reluctance to use interest rates as a policy tool A commitment to full employment There was in part a belief that the Balance of Paymentshad „held Britain back‟ in the 1960s, but when free ofthe international monetary system, the economicgrowth was not unleashed SUPPLY SIDE PROBLEMS??Week 2:214
  15. 15. (2) Relative prices were distorted Yes there had been the oil shock BUT the UK had its own problems For YEARS we had been experiencing a downward trend inthe return on capital employed (ROCE – a measure ofprofitability) Fell by >75% 1960s to 1970s Partly due to oil Not down to competitiveness – Unit labour costs improved by15% 1965-1975... The ratio of capital to labour was increasing faster than therate of productivityWeek 2:215
  16. 16. Why? Labour was becoming a less attractive input In part because of years of capital subsidies, designed tostimulate growth (“Going for Growth” Policy) and create fullemployment In part a function of the incomes policies and theanticipatory wage demands and comparatively strong trade unions It didn‟t really manifest itself through decline in employmentbecause of the absorption of employment by the publicsectorWeek 2:216
  17. 17. UK Productivity growthWeek 2:217Table 1.3 Productivity of labour and capital in the UK (compound annual growth rates)1960s 1969-79 1979-82Labour productivity 5.8 2.2 3.5Capital productivity 1.1 -2.6 -4.4Total Factor Productivity 4.9 1.1 1.6Source: Maynard, from OECD Economic Outlook, May 1986.Q=f(L, K, M)
  18. 18. In summary... The post-war period, though stable, is regarded bymany as a missed opportunity Things changed as a result of the oil crisis and themove to floating exchange rates The UK was also affected by the relative prices ofinputsWeek 2:218
  19. 19. Next week... Friedman and the growth of monetarism The rise of Thatcherism The start of the „Great Moderation‟ The productivity miracleWeek 2:219
  20. 20. ReferencesGriffiths and Wall (2009) Applied Economics 9thEdition, chapter 24 .Maynard, G. (1989) The Economy underThatcher, Blackwell, London Chapter 1.Week 2:220