Week 1:1 1

EC-111: British Economy

Recent Macro Economic Policy and Trends

Dr Catherine RobinsonF35, Richard Price

Office hours: Monday 10.30-11.30 and Thursday 9.30-10.30Appointments: c.robinson@swansea.ac.uk

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IntroductionAim of this section of the course

Outline key texts and structure of the next 5 weeks

Defining the macro-economyWhat variables are we looking at?

Assessment:2 hour written examination at the end of semester 2

(45%) 5 questions in total – split between me and John’s regional topic

I’ll go over some pointers in the last week

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Aim of the courseTo provide an understanding of the

macroeconomic fortunes of the UK in the post war periodDiscuss some policies

ideological influencesIdentifying different schools of economic thought

Bit of economic history, but bringing it up to date with the financial crisis and the ‘great recession’

Show you some data on UK performanceBut not just about the UK – need to look at it in context

Empirically driven – not too much theory, but designed to put your theory into (a UK) context

Attendance1. Click 1 on your keypad and hold it down

until a appears.

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Macro Outline Introduction

What are we looking at? What does Britain look like, in comparison?

Post War British Macro Economic Policy The rise and fall of Keynesianism From the Welfare State to the Winter of discontent

The Thatcher Years Monetarism and miners strike ERM and inflation targeting

Blair Bank of England independence and the birth of the MPC Things can only get better? ICT and the productivity paradox

The Great Recession Causes and consequences Policy solutions? Productivity paradox (II)

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Recommended Reading Griffiths and Wall is a good place to start

Older editions of the book have a chapter on Managing the Economy (Ch24 in 9th edition), available in the library.

For the final part of the course, financial institutions and Ch30 – managing the economy post credit crunch – will be very informative

This will be supplemented with recommended reading each week Need to recommend some articles and alternatives for the

economic history sections of the course The early lectures will be based on BWE Alford’s 1988 book, ‘British

Economic Performance 1945-1975’. Tagged in the library – 4 copies available

If you want some good, up-to-date commentary, take a look at the Green Budget by the IFS

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Definitions: The Macro Economy

Country-level indicators, constructed as part of the National Accounts

Y=C+I+G+(X-M)

But includes things that are left out of NA Price levels (inflation) Employment/labour force participation rates

Indicators of performance and welfare PRODUCTIVITY (rate at which outputs are generated from

inputs)

Longer run indicators of economic footing National debt

What are the policy levers available to governments? Varies over time and across different institutional set-ups

Short termism versus medium and long term strategies Increasingly influenced by the wider global environment (Globalisation)

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Objectives of Policy Full employment

Anything below 3% was seen as acceptable Not been seen as a viable objective since the 1960s

Stable prices In other words, low inflation 2.5% is the MPC’s specific target

Economic Growth Results in higher living standards in most Western Economies RA Butler (1954) suggested a doubling of living standards

every 25 years could be an explicit target Balance of Payments

Aim for equilibrium (although surpluses are always considered positive)

There are others, of a more socio-economic type

Achieving one of these ‘objectives’ might be feasible, but all at once??

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Instruments of policyWhy isn’t this the equilibrium situation?

Market Failure rationale Almost all government subsidies/industrial support have

to reason with the Treasury that the market has in some way ‘failed’ before they can intervene

How do governments go about it?

Policy instruments: Fiscal policy Monetary policy Prices and incomes policy Exchange rate or import controls

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Fiscal PolicyTaxation and government spending

Aim is to affect the composition and the level of Aggregate Demand in the economy Addresses redistribution of wealth – sort of…Higher taxes and lower spending is likely to lower

ADConversely – lower tax and higher spending should

encourage ADConcerns about the Public Sector Borrowing Deficit

(the PSBR) <<more next week>>

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Monetary Policy The interest rate

Affects the cost of borrowing And the returns to lending

both long and short term investment decisions Leads consumers to change their behaviour also

Low rates of interest offer little incentive to save Affects the balance of payments also

Capital flows between countries

Money Supply Monetarists versus Keynesians Monetarists see MS as affecting prices Keynesians see its impact on output and employment

These two are linked, clearly…. expansionary or contractionary strategy will typically use the two

together

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Prices and Incomes PolicyDirect attempts to control inflation

EG public Sector pay freezeRegarded as irrelevant to monetaristsBut an important tool in periods of expansion to

KeynesiansNot been extensively used since 1979 although

limits on public sector spending have in effect constrained wages

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Exchange RateUsed to influence the balance of payments

Isn’t always something the national government can affect Prior to 1972, IMF system was implemented (Bretton Woods) Exchange rates affect the relative prices of domestic and

foreign goodsAppreciation(Ex) => X and MDepreciation(Ex) => X and M

Assuming appropriate elasticities for imports and exports, lower exchange rate improves the balance of payments

But it will also have an adverse effect on costsRising input costs => higher prices=> higher wage demands

==INFLATION

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Import ControlsNot used much in the UK as a policy instrument

In fact, membership of EU (and its commitment to the freedom of movement of goods and services) and long-standing Commonwealth links, trade has been relatively unhindered by government intervention for decades (excluding WWII)

The UK does participate in GATT (general agreement on tariff & trade) reductions for goods that have traditionally carried a levy

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There are trade-offs Between inflation and unemployment

The Phillips Curve (1958)

Curbing government spending lowers earnings for public sector workers or reduce employment

Raising the exchange rate makes exports relatively more expensive and lowers (manufacturing) output

So how do you balance multiple objectives?

Instruments are not independent of one another

AND instruments have in the past become objectives Exchange rate instrument <<more when we

discuss the ERM>>

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The Phillips Curve

Each dot represents a year

1913-1948

As wages increase (inflation) unemployment declines

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Theory of Economic Policy Tinbergen (1952)

Fixed targets Tinbergen’s rule – there should be at least as many instruments as

there are objectives

Flexible targets (Theil, 1956) Pre-supposes that there is welfare loss associated with missing the

fixed targets Implicitly assumes that there is a social welfare function for the

population It then becomes a question of weighting

‘Satisficing’ (Mosley, 1976) Policy makers are satisficing agents, influenced primarily by recent

levels Looking at the 1946-71 period Mosley found that any balance of

payments deficit resulted in policy change – so that only zero or positive BoP was satisfactory.

Benchmark for unemployment was variable over time

18

Which of these definitions best describes the term

‘satisficing’?1. Bureaucratic

organisations maximise profits

2. Bureaucratic organisations continually strive for the best possible outcomes

3. Bureaucratic organisations react only when welfare reaches an unsatisfactory level

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Two instruments, two objective case

O1

O2

Instrument 1 (eg monetary policy)

Instrument 2 (eg fiscal policy)0

I1`

I2`

Source: Griffiths and Wall, 2001

Movement away from the origin is an expansionary path

O1 is objective 1 (internal balance) at a particular target value

O2 is the objective 2 (external balance) at a particular target value

E

Assume O1 is full employment and O2 is balance of payments equilibrium

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Two instruments, 3 objective case

O1

O2

Instrument 1 (eg monetary policy)

Instrument 2 (eg fiscal policy)0

I1`

I2`

Source: Griffiths and Wall, 2001

O3

G

FE

now with O3 – assume it is economic growth (positively sloped)

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So, now you know…What we plan to cover over the next few weeks

What the macro economy is, specifically concerned with

What are the chief objectives of government economic policy

The tools available to governments who wish to influence the economy

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Tomorrow…We will look at Britain in context

Plotting some of these key variables over time and across countries that might reasonably be compared to Britain

Discussing some of the reasons put forward for the UK position

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References used this week:

Griffiths and Wall (2011) 12th Edition – handy for the Tinbergen theory

Mosley (1976) Towards a Satisficing theory of Economic Policy’, The Economic Journal, 86(341), 59-72 (available on JSTOR)