EC-111 British EconomyRecent UK MacroeconomicTrendsDr Catherine RobinsonF35, Richard Price BuildingOffice Hours: Mondays 1...
Introduction Aim of today To consider what happened to macro policy in the 1980sand 1990s The “Great Moderation” The T...
But first…Who listened to the budgetyesterday??Week 3:13
The political landscapeGovernment Prime Minister(s)Conservative (70-74) HeathLabour (74-79) Wilson, CallaghanConservative ...
Chancellors since 1979 Geoffrey Howe (1979-1983) Nigel Lawson (83-89) John Major (89-90) Norman Lamont (90-93) Kennet...
The main playersWeek 3:16
The Economic legacy of 1979 The 1970s were a period of economic turbulenceunprecedented since the 1930s. Persistent US t...
The Economic legacy of 1979 Labour market conditions workers’ increasing aspirations, and a chaotic Trade Union structur...
Key macroeconomic policies Two main ‘themes’ influenced the subsequent (post-1979)development of macroeconomic policy: M...
Monetary policy Monetary policy had been used passively To keep interest rates steady to create a stable climate forinve...
Monetarist policies Pretty simple - the equation of exchange MV=PT Where M=money supply, V=velocity of circulation, P=p...
Traditional monetarism Expected to cause recession in the short-term Workers would continue to push for inflationary pay...
Monetary Policy and Fiscal Policy a relationship exists between the budget deficit and themoney supply. If the governmen...
Types of Money Only 2 figures are published: M0 – narrow money; wide monetary base Cash outside the Bank of England, P...
The Monetarist phase: 1979-1985 The new Government announced a Medium TermFinancial Strategy to eradicate inflation MTFS...
Rational Expectations A more optimistic view arose from the “rational expectations”school of monetarists (notably, in the...
What happened? The exchange rate also rose dramatically, partly dueto North Sea Oil Double squeeze on manufacturing due ...
Exchange Rate movementsSterling effective exchange rate 1975-2005, monthly average020406080100120140160Jan-75Jan-77Jan-79J...
What happened? Unemployment rose sharply, and the economy fell intothe (global) recession Growth in M4 failed to stay wi...
Money SupplyGrowth of M4-5051015202530Jun-63Jun-65Jun-67Jun-69Jun-71Jun-73Jun-75Jun-77Jun-79Jun-81Jun-83Jun-85Jun-87Jun-89...
MTFS 2 Successive conservative governments, led by Thatcher and thenMajor, persisted with the MTFS but by the second phas...
MTFS 3 Exchange rate crisis of 1985 Loss of confidence in sterling (faced with a strong dollar, risinginflation and cont...
MTFS 4 A resurgence in inflation towards the end of phase 3meant government had to deal with the contractionaryphase, 198...
The ERM The 1980s shift of emphasis away from monetary policytowards exchange rate policy, led up to Britain‟s 1990entry ...
Entry to the ERM the UK entered the EU‟s Exchange Rate Mechanism,committing the UK to an exchange rate within a 6%margin ...
Inflation and unemployment againinflation and unemployment 1981-1993024681012140.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0%unemplo...
Lessons from the Monetaristexperiment Tight monetary policy (1979-81) did not achieve controlover the money supply, due t...
Post Monetarist policy Under „pure‟ Monetarism, the exchange rate wasirrelevant for the conduct of macro policy, all that...
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Ec 111 week 3(2)

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Ec 111 week 3(2)

  1. 1. EC-111 British EconomyRecent UK MacroeconomicTrendsDr Catherine RobinsonF35, Richard Price BuildingOffice Hours: Mondays 10:30-11:30 and Thursdays 9.30-10.30Appointments: c.robinson@swansea.ac.uk
  2. 2. Introduction Aim of today To consider what happened to macro policy in the 1980sand 1990s The “Great Moderation” The Thatcher administration What was its impact on macro policy and the wider economic impact? What caused Thatcher‟s departure? The role of EuropeWeek 3:12
  3. 3. But first…Who listened to the budgetyesterday??Week 3:13
  4. 4. The political landscapeGovernment Prime Minister(s)Conservative (70-74) HeathLabour (74-79) Wilson, CallaghanConservative (79-97) Thatcher, MajorLabour (97-2010) Blair, BrownConservative-Liberalcoalition (2010-)CameronWeek 3:14
  5. 5. Chancellors since 1979 Geoffrey Howe (1979-1983) Nigel Lawson (83-89) John Major (89-90) Norman Lamont (90-93) Kenneth Clarke (93-97) Gordon Brown (97- 2007) Alistair Darling (2007-2010) George Osborne (2010 - )Week 3:15
  6. 6. The main playersWeek 3:16
  7. 7. The Economic legacy of 1979 The 1970s were a period of economic turbulenceunprecedented since the 1930s. Persistent US trade deficit (caused partly by spendingon the Vietnam War) led to the breakdown of theBretton Woods fixed exchange rate system between1971 and 1973. The ‘oil price shocks’ of 1973-4 (triggered by the Arab-Israeli War) and again in 1979-80 (triggered by the Iranianrevolution) helped create inflation and recessionsimultaneously.Week 3:17
  8. 8. The Economic legacy of 1979 Labour market conditions workers’ increasing aspirations, and a chaotic Trade Union structurecontributed to industrial unrest and inflationary pressures. IMF loan (Autumn 1976) Labour government committed to deflationary macroeconomicpolicies. By 1979, some success had been achieved in reducinginflation, and re-kindling economic growth. But unemployment remained high. The ‘Winter of Discontent’ (1978-9) paved the way for Torysuccess under Margaret Thatcher in the May 1979 GeneralElection.Week 3:18
  9. 9. Key macroeconomic policies Two main ‘themes’ influenced the subsequent (post-1979)development of macroeconomic policy: Much more prominent role for monetary policy. A shift of emphasis in the 1980s away from monetary policytowards exchange rate policy These were fundamental changes Fiscal policy was out of fashion Any attempt at stimulus was achieved through supply sidepoliciesWeek 3:19
  10. 10. Monetary policy Monetary policy had been used passively To keep interest rates steady to create a stable climate forinvestment After 1976, monetary policy became the main macro policyinstrument in pursuit of inflationary control Fiscal policy played a subservient roleWeek 3:110
  11. 11. Monetarist policies Pretty simple - the equation of exchange MV=PT Where M=money supply, V=velocity of circulation, P=prices andT=transactions If V and T are fixed (or known) ΔM=ΔP Output and employment are determined by microeconomic factors thataffect aggregate supply In the long run they may change, but in the short to medium term, theyhave a ‘natural’ level Controlling the money supply is the key to controlling inflation Controlling inflation would change wage and price expectations andtherefore reduce unemploymentWeek 3:111
  12. 12. Traditional monetarism Expected to cause recession in the short-term Workers would continue to push for inflationary pay increases, and‘price themselves out of jobs’. These are movements along adownward sloping short run Phillips curve. But in the long-term, as people’s inflationary expectationsadjusted downwards, pay claims would moderate andmarket forces would push the economy back to its ‘natural’levels of output and employment there shouldn’t be anysignificant long-term damage. The long run Phillips curve is vertical.Week 3:112
  13. 13. Monetary Policy and Fiscal Policy a relationship exists between the budget deficit and themoney supply. If the government cannot borrow enough money to meetthe deficit it has to increase the money supply.Week 3:113
  14. 14. Types of Money Only 2 figures are published: M0 – narrow money; wide monetary base Cash outside the Bank of England, PLUS banks operational deposits within the Bank of England No longer published M4 Cash outside banks PLUS private sector retail bank and building society deposits PLUS private sector wholesale bank and building society depositsWeek 3:114
  15. 15. The Monetarist phase: 1979-1985 The new Government announced a Medium TermFinancial Strategy to eradicate inflation MTFS-1 (1979-1981) Targets set for M4 as a reliable indicator of spending But, controlling M4 meant that interest rates had to be set at17% And even this didn’t work The 1980s were characterised by high interest rates At the same time, a global recession had set in Manufacturing output fell by 19.6 % in 2 years Manufacturing employment fell by 23%Week 3:115
  16. 16. Rational Expectations A more optimistic view arose from the “rational expectations”school of monetarists (notably, in the UK, Patrick Minford). They argued that expectations were forward looking. there was a unique natural rate of unemployment and hence thatinflation was determined by money supply growth would formtheir expectations on the basis of what was believed to be futuregovernment policy. Provided that the government could persuade people it meantwhat it said about monetary targets, therefore expectations offuture inflation could come down without having to increaseunemployment.Week 3:116
  17. 17. What happened? The exchange rate also rose dramatically, partly dueto North Sea Oil Double squeeze on manufacturing due to highborrowing costs and a loss of competitiveness inexport markets in 1978 unit labour costs in manufacturingmeasured in dollars rose by 26.4%, in 1979 by30.5% and in 1980 by 34.1%, well above theincreases in the UK’s major trading partners.Week 3:117
  18. 18. Exchange Rate movementsSterling effective exchange rate 1975-2005, monthly average020406080100120140160Jan-75Jan-77Jan-79Jan-81Jan-83Jan-85Jan-87Jan-89Jan-91Jan-93Jan-95Jan-97Jan-99Jan-01Jan-03Jan-05monthexchangerateindexWeek 3:118
  19. 19. What happened? Unemployment rose sharply, and the economy fell intothe (global) recession Growth in M4 failed to stay within targets Individuals shifted their money between accounts andwhilst the overall supply of money showed little signs ofchanging, actual spending was falling The monetarist experiment failed as other policieshad, because of conflicting objectives The high interest rates decreased industrial investment whichled to a fall in UK exportsWeek 3:119
  20. 20. Money SupplyGrowth of M4-5051015202530Jun-63Jun-65Jun-67Jun-69Jun-71Jun-73Jun-75Jun-77Jun-79Jun-81Jun-83Jun-85Jun-87Jun-89Jun-91Jun-93Jun-95Jun-97Jun-99Jun-01Jun-03Jun-05dategrwthratepercentWeek 3:120
  21. 21. MTFS 2 Successive conservative governments, led by Thatcher and thenMajor, persisted with the MTFS but by the second phase,abandoned the attempt to control a single definition of themoney supply The doubling of unemployment in the 1979-1982 weakened thegovernments resolve to control inflation Interest rates fell at the beginning of MTFS2 Lawson cut taxes from 1983 onwards (stimulating AD) Expenditure and earnings rose faster than inflation In part funded through a credit boom… By 1984, zero inflation was perceived as unattainable, 5%becoming an accepted targetWeek 3:121
  22. 22. MTFS 3 Exchange rate crisis of 1985 Loss of confidence in sterling (faced with a strong dollar, risinginflation and continued unemployment) Exchange rate need to be „pegged‟ to a strong currency – theDM A global phenomenon – the Plaza Accord (1985) and theLouvre Accord (1987) saw major trading nations coordinatingtheir economic policies to achieve stability PRIMARY FOCUS NOW THE EXCHANGE RATEWeek 3:122
  23. 23. MTFS 4 A resurgence in inflation towards the end of phase 3meant government had to deal with the contractionaryphase, 1988-1992 Caused by low interest rates Financial liberalisation Mortgage leak Interest rates rose sharply Affected consumer spending and house prices dramatically Necessary for ERM entry in October 1990Week 3:123
  24. 24. The ERM The 1980s shift of emphasis away from monetary policytowards exchange rate policy, led up to Britain‟s 1990entry into the EU‟s Exchange Rate Mechanism (ERM) To keep import costs low Thus easing inflationary pressure An attempt to go back to a fixed exchange rate system like the failed Bretton Woods systemWeek 3:124
  25. 25. Entry to the ERM the UK entered the EU‟s Exchange Rate Mechanism,committing the UK to an exchange rate within a 6%margin on either side of £1=DM2.95. Exchange rate management was now the centrepieceof macroeconomic policyWeek 3:125
  26. 26. Inflation and unemployment againinflation and unemployment 1981-1993024681012140.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0%unemploymentinflationWeek 3:126
  27. 27. Lessons from the Monetaristexperiment Tight monetary policy (1979-81) did not achieve controlover the money supply, due to: distress borrowing by ailing firms financial deregulation erratic behaviour of M3 target But the Monetarist squeeze did achieve a permanentdampening of the inflationary psychology of the 1970s the cost was the most severe recession since the 1930s with a particularly damaging effect on UK manufacturingWeek 3:127
  28. 28. Post Monetarist policy Under „pure‟ Monetarism, the exchange rate wasirrelevant for the conduct of macro policy, all thatmattered were money supply targets. After 1985 this view was untenable; Monetarism was„dead‟ Alternative ideas about the control of inflation centredon the role of the exchange rateWeek 3:128

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