Nathan Millet Theme 4 Macro Economics 2020
The 7 Macro Economics Objectives:
1. Low unemployment
2. Low and stable inflation (the UK target is 2% +/-1% )
3. Sustainable economics growth
4. Balanced currents accounts on the balance of payments
5. Balanced fiscal budget
6. Preservation of the environment
7. Reduction in income equality
Keynesian LRAS curve:
[insert diagram1]
A = spare capacity - This is where there is stagnant economics growth, high
unemployment and idle machinery.
B = bottleneck territory - As the economy approaches full capacity there will be scarcity
in the labour market. As such, workers bargaining power increases which drives up
wages and leads to inflationary pressure.
C = full capacity - This is where the economy is producing the maximum level of output
that it is capable of when all its factors of production are efficiently employed.
Aggregate Demand:
AD = C + I + G + (X-M)
Demand-side policies:
Demand-side policies are those that seek to shift AD inwards or outwards in order to
achieve macro-economic objectives.
There are 2 types of Demand-side policies:
1. Monetary policy
2. Fiscal policy (government taxes and spending)
Monetary Policy:
Evaluate the micro economic effects of the Bank of Englands decision to cut
interest rates to a record low of 0.25% in August 2016 [25 marks]
Monetary policy is the manipulation of interest rates and the money supply in order to
achieve macro-economics objectives such as low and stable inflation.
1
,Nathan Millet Theme 4 Macro Economics 2020
(Consumption paragraph questions to answer)
Q: Are individuals more or less likely to say?
A: When interest rates are low individuals will have less incentive to save as the rate of
return is unattractive. As such, the saving rate in the economy is likely to fall and thus
consumption is likely to rise.
Q: Are individuals more or less likely to borrow money/use their credit cards?
A: Given that the cost of borrowing is low individuals have a greater incentive to take out
more loans and increase the frequency of credit purchases.
Q: Are individuals who are invariable (tracker) mortgages paying more or less each
month?
A: When intense rates are low individuals who are on tracker mortgages will be paying
back less each month. As such, they will have more disposable income left over and thus
consumption is likely to rise.
(Investment paragraph)
Given that the cost of borrowing is low firms are more likely to take out larger loans and
take on more risk. Given this, investment is likely to rise.
{Exports - Imports (X-M) paragraph}
When interest rates are low hot money will flow out of the UK economy, thus is because
international investors want to put their money in back accounts that give then the
highest rate of return. As such, there will be more sellers of pounds in the foreign
exchange market, leading to an outward shift of supply, and thus a depreciation of the
pound.
[insert diagram 2]
As a result, the UK becomes more price competitive. Given this, exports are likely to rise
as international currencies can now buy more pounds. At the same time, imports are
likely to fall as the pound is worth less in the international market. The combination or
rising exports and falling imports helps to reduce the UK’s current account deficit.
Bonus:
Given that investment and exports are injections into the circular flow of income there will
be a positive multiplier effect. This is the number of times the rise in national incomes
exceeds the initial injection that caused it.
[insert diagram 3]
Expansionary Monetary policy causes AD to shift outwards from AD1 to AD2. The positive
multiplayer effect causes a further outwards shift to AD3. As a result, economic growth
rises form Y1 to Y3 and thus living standards will rise. Also unemployment will fall as the
economy moves closer to full capacity. There was also an improvement on the UK’s
current account as he deficit shrank. However, there is demand-pull inflation as the price
level rises from P1 to P3.
2
, Nathan Millet Theme 4 Macro Economics 2020
Evaluation:
1. However there is no guarantee that the commercial banks will pass on the full
benefits of the cuts in the base rates to their customers in the form of lower interest
rates. This occurred in 2009 when the Bank of England cut the base rate from 5% all
the way down to a then record low of 0.5%, but many of the commercial banks did
not significantly alter their interest rates.
2. Also expansionary monetary policy may be offset by contractionary fiscal policy.
Since 2010 the Government had embarked on austerity programme which has led to
significant cuts to Government spending. In addition to this, the UK is in the process
of leaving the EU, and the uncertainly surrounding this process may adversely affect
both consumer and business confidence. If consumption and investment begin to
fall along Government spending it may push the UK economy into a recession and,
in the worst case scenario, deflation. This would be catastrophic as the base rate in
the UK is already nearly 0%, and thus they are likely to suffer from a liquidity trap.
This is where monetary policy becomes ineffective as further cuts to the base rate,
has little or no effect on the economy.
3. The impact on the economy depends on the elasticity of the LRAS curve when AD
initially intersects it. If the economy were initially at spare capacity then an outward
shift of AD would result in economic growth with little or no inflation. On the other
hand, if the economy where initially near full capacity then an outward shift of AD
would result in little or no economic growth but significant inflation.
Given that unemployment in the UK is below 4% which is lowest level for three decades,
this suggests the UK may be operating near full capacity.
Quantitative Easing
This is where the central bank (The Bank of England) buys up large quantities of illiquid
assets such as UK Government bonds (Gilts) off the commercial banks using electronic
money. This increases liquidity in the financial sector and thus incentivises banks to
increase their lending by reducing their interest rates. (use this as first paragraph for QE
question)
Public Finance
A Fiscal Deficit is when government spending exceeds tax revenue in 1 year.
National Debt is the accumulation of all the unpaid fiscal deficits up to that moment in
time.
A Fiscal Deficit is comprised of 2 parts:
1. Cyclical Deficit:
This is where the deficit automatically adjusts based on where the economy is on its
business cycle. For example, if the Uk felling a rescission the gov will automatically
collect less tax revenue and pay out more in unemployment benefits. As such, the
Cyclical Deficit will rise.
3
The 7 Macro Economics Objectives:
1. Low unemployment
2. Low and stable inflation (the UK target is 2% +/-1% )
3. Sustainable economics growth
4. Balanced currents accounts on the balance of payments
5. Balanced fiscal budget
6. Preservation of the environment
7. Reduction in income equality
Keynesian LRAS curve:
[insert diagram1]
A = spare capacity - This is where there is stagnant economics growth, high
unemployment and idle machinery.
B = bottleneck territory - As the economy approaches full capacity there will be scarcity
in the labour market. As such, workers bargaining power increases which drives up
wages and leads to inflationary pressure.
C = full capacity - This is where the economy is producing the maximum level of output
that it is capable of when all its factors of production are efficiently employed.
Aggregate Demand:
AD = C + I + G + (X-M)
Demand-side policies:
Demand-side policies are those that seek to shift AD inwards or outwards in order to
achieve macro-economic objectives.
There are 2 types of Demand-side policies:
1. Monetary policy
2. Fiscal policy (government taxes and spending)
Monetary Policy:
Evaluate the micro economic effects of the Bank of Englands decision to cut
interest rates to a record low of 0.25% in August 2016 [25 marks]
Monetary policy is the manipulation of interest rates and the money supply in order to
achieve macro-economics objectives such as low and stable inflation.
1
,Nathan Millet Theme 4 Macro Economics 2020
(Consumption paragraph questions to answer)
Q: Are individuals more or less likely to say?
A: When interest rates are low individuals will have less incentive to save as the rate of
return is unattractive. As such, the saving rate in the economy is likely to fall and thus
consumption is likely to rise.
Q: Are individuals more or less likely to borrow money/use their credit cards?
A: Given that the cost of borrowing is low individuals have a greater incentive to take out
more loans and increase the frequency of credit purchases.
Q: Are individuals who are invariable (tracker) mortgages paying more or less each
month?
A: When intense rates are low individuals who are on tracker mortgages will be paying
back less each month. As such, they will have more disposable income left over and thus
consumption is likely to rise.
(Investment paragraph)
Given that the cost of borrowing is low firms are more likely to take out larger loans and
take on more risk. Given this, investment is likely to rise.
{Exports - Imports (X-M) paragraph}
When interest rates are low hot money will flow out of the UK economy, thus is because
international investors want to put their money in back accounts that give then the
highest rate of return. As such, there will be more sellers of pounds in the foreign
exchange market, leading to an outward shift of supply, and thus a depreciation of the
pound.
[insert diagram 2]
As a result, the UK becomes more price competitive. Given this, exports are likely to rise
as international currencies can now buy more pounds. At the same time, imports are
likely to fall as the pound is worth less in the international market. The combination or
rising exports and falling imports helps to reduce the UK’s current account deficit.
Bonus:
Given that investment and exports are injections into the circular flow of income there will
be a positive multiplier effect. This is the number of times the rise in national incomes
exceeds the initial injection that caused it.
[insert diagram 3]
Expansionary Monetary policy causes AD to shift outwards from AD1 to AD2. The positive
multiplayer effect causes a further outwards shift to AD3. As a result, economic growth
rises form Y1 to Y3 and thus living standards will rise. Also unemployment will fall as the
economy moves closer to full capacity. There was also an improvement on the UK’s
current account as he deficit shrank. However, there is demand-pull inflation as the price
level rises from P1 to P3.
2
, Nathan Millet Theme 4 Macro Economics 2020
Evaluation:
1. However there is no guarantee that the commercial banks will pass on the full
benefits of the cuts in the base rates to their customers in the form of lower interest
rates. This occurred in 2009 when the Bank of England cut the base rate from 5% all
the way down to a then record low of 0.5%, but many of the commercial banks did
not significantly alter their interest rates.
2. Also expansionary monetary policy may be offset by contractionary fiscal policy.
Since 2010 the Government had embarked on austerity programme which has led to
significant cuts to Government spending. In addition to this, the UK is in the process
of leaving the EU, and the uncertainly surrounding this process may adversely affect
both consumer and business confidence. If consumption and investment begin to
fall along Government spending it may push the UK economy into a recession and,
in the worst case scenario, deflation. This would be catastrophic as the base rate in
the UK is already nearly 0%, and thus they are likely to suffer from a liquidity trap.
This is where monetary policy becomes ineffective as further cuts to the base rate,
has little or no effect on the economy.
3. The impact on the economy depends on the elasticity of the LRAS curve when AD
initially intersects it. If the economy were initially at spare capacity then an outward
shift of AD would result in economic growth with little or no inflation. On the other
hand, if the economy where initially near full capacity then an outward shift of AD
would result in little or no economic growth but significant inflation.
Given that unemployment in the UK is below 4% which is lowest level for three decades,
this suggests the UK may be operating near full capacity.
Quantitative Easing
This is where the central bank (The Bank of England) buys up large quantities of illiquid
assets such as UK Government bonds (Gilts) off the commercial banks using electronic
money. This increases liquidity in the financial sector and thus incentivises banks to
increase their lending by reducing their interest rates. (use this as first paragraph for QE
question)
Public Finance
A Fiscal Deficit is when government spending exceeds tax revenue in 1 year.
National Debt is the accumulation of all the unpaid fiscal deficits up to that moment in
time.
A Fiscal Deficit is comprised of 2 parts:
1. Cyclical Deficit:
This is where the deficit automatically adjusts based on where the economy is on its
business cycle. For example, if the Uk felling a rescission the gov will automatically
collect less tax revenue and pay out more in unemployment benefits. As such, the
Cyclical Deficit will rise.
3
