1) Economic Growth (i.e. an increase in the Real GDP of the economy)
There are several ways in which governments can attempt to stimulate growth:
- Decreasing tax rates to increase disposable income, thereby increasing MPC (depending on confidence) shifting AD to the right.
- Decreasing taxes on firms - e.g. corporation tax. In the recent (2011) budget corporation tax was reduced by 2%.
- Increasing spending on supply side policies such as improvements in education and training, as a more skilled workforce is more productive.
- A decrease in unemployment benefits to encourage more people to work (only effective if there is spare capacity in the economy)
- Expanding the size of the labour supply by encouraging migration
- Put money into research and development for technical innovation to improve efficiency
- defined as the ability to meet the needs of the present without compromising the ability of future generations to meet their own needs. It is thought that rapidly growing countries like China and India may not be sustainable due to their huge demand for natural resources.
- When inflation is high, goods become less competitive on the world market, so governments control inflation through macroeconomic policy. In the UK we have an independent Monetary Policy Committee who's main objective is the control of inflation through manipulation of interest rates.
- This objective is most likely to be achieved if there's economic growth. It is impossible to achieve true full employment as there is always frictional unemployment, however we look at this as full employment and it's called the Naturally Occurring Rate of Unemployment. Keynesian economists believe that the aggregate demand and supply can be in long run equilibrium without the economy being at full employment.
- Both the UK and the USA are running large deficits on the current account of their balance of payments. despite being financed by inflows into the financial account this is considered by some to be unsustainable in the long term. China has had a current account surplus for a long time and finances the USA's deficit by buying up US government bonds in order to maintain the low value of the Yuan against the Dollar (a surplus of US dollars on the market would depress its value). If China loses interest in supplying to the US (unlikely in the short term but possible in the long term), or for any reason stops buying US government bonds, the USA could find it very hard to finance their deficit.
Questions:
ReplyDelete1. Why would decreasing unemployment benefits help growth? benefits down, spending down.
2. You say: "Decreasing tax rates to increase disposable income, thereby increasing MPC"
What is the relationship between MPC and income? Are you suggesting those on a higher income have a lower MPC?
"...the USA could find it very hard to finance their deficit."
ReplyDeleteBut surely then the $ would fall and exports would be competitive? Also the unemployment in the US would diminish owing to the high import prices.
So why would there be a problem?
"When inflation is high, goods become less competitive on the world market,..."
ReplyDeleteIn which case demand would fall and so inflation would fall.
So why is this a problem?
Also, under floating exchange rates a high rate of inflation would be masked by a low exchange rate - so why is there a problem?
1. You have to assume there's spare capacity in the economy. Decreasing unemployment benefits should increase incentives to find work therefore increase the workforce which could raise the productivity of a country providing there is spare capacity. Of course what you said could also be the case it depends on how people receive the change.
ReplyDelete2. Decreasing tax rates definitely increases the ability to spend. Whether it affects the propensity to consume depends on confidence. I was assuming that lowering tax rates would increase consumer confidence all other things being equal.
2nd post - Yes in the long run but in the short term the huge decrease in consumption from the USA could have bad consequences for economies around the world.
ReplyDelete3rd - Which demand do you mean? I'm assuming you mean external demand?
ReplyDeleteYou're right, in the long run equilibrium can be found with a depreciation of the exchange rate. But, in the short term price inflation can rise faster than the exchange rate falls (and vice versa) in which you'd have to charge a higher price in order to maintain the same profit which would translate to higher prices to importers of your goods and potentially a decrease in global demand for your goods in favour of a cheaper alternative.
If you decrease unemployment benefits (JSA) then those with a high MPC, reduce their spending. This will reduce demand. Yes, there may be more people trying hard to find work but, as the previous sentence suggests, there is less demand. So where will the work come from? If we follow your assumption there is spare capacity in the economy then you admit demand is at less than full employment. Cut benefits; cut demand.
ReplyDeleteIf you cut tax rates then disposable income rises (ceteris paribus). If your income rises why would MPC (marginal, remember) rise? If we follow that logic then those on the lowest income have a lower MPC which means give money to the poor and they....put it in the bank.
For the second point, US has a floating exchange rate. Thus a fall in confidence has a quick effect. If demand for imports/exports is highly elastic then does this mean there would be no problem owing to the speed of response?
ReplyDeleteYou say:
ReplyDelete"...in the short term price inflation can rise faster than the exchange rate falls (and vice versa) in which you'd have to charge a higher price in order to maintain the same profit which would translate to higher prices to importers of your goods ..."
Why would you have to charge a higher price? If I sell £10 worth of goods at a price of $20 and I sell 15 then I get $300 = £150.
If, owing to the exchange rate, £1 = $1.50 then I sell more (unless demand is perfectly inelastic). Let's say I sell 16 then I get 16 x $15 = $240 = £160 which is a greater amount.
So, what is the problem?
I think she may be asleep....
ReplyDelete