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A2 Revision – New Classical to Extreme Keynesian

October 27, 2017 Leave a comment

The main competing views of macroeconomics (Keynesian vs Monetarist) is part of Unit 5 in the A2 syllabus and is a popular topic in the essay and multiple-choice papers. Begg covers this area very well in his textbook. In looking at different schools of thought it is important to remember the following:

Aggregate Demand – the demand for domestic output. The sum of consumer spending, investment spending, government purchases, and net exports
Demand Management – Using monetary and fiscal policy to try to stabilise aggregate demand near potential output.
Potential Output – The output firms wish to supply at full employment after all markets clear
Full Employment – The level of employment when all markets, particularly the labour market, are in equilibrium. All unemployment is then voluntary.
Supply-side policies – Policies to raise potential output. These include investment and work incentives, union reform and retraining grants to raise effective labour supply at any real wage; and some deregulation to stimulate effort and enterprise. Lower inflation is also a kind of supply-side policy if high inflation has real economic costs.
Hysteresis – The view that temporary shocks have permanent effects on long-run equilibrium.

There are 4 most prominent schools of macroeconomics thought today.

New Classical – assumes market clearing is almost instant and there is a close to continuous level of full employment. Also they believe in rational expectations which implies predetermined variables reflect the best guess at the time about their required equilibrium value. With the economy constantly near potential output demand management is pointless. Policy should pursue price stability and supply-side policies to raise potential output.

Gradualist Monetarists – believe that restoring potential output will not happen over night but only after a few years. A big rise in interest rates could induce a deep albeit temporary recession and should be avoided. Demand management is not appropriate if the economy is already recovering by the time a recession is diagnosed. The government should not fine-tune aggregate demand but concentrate on long-run policies to keep inflation down and promote supply-side policies to raise potential output.

Moderate Keynesians – believe full employment can take many years but will happen eventually. Although demand management cannot raise output without limit, active stabilisation policy is worth undertaking to prevent booms and slumps that could last several years and therefore are diagnosed relatively easily. In the long run, supply-side policies are still important, but eliminating big slumps is important if hysteresis has permanent effects on long-run equilibrium. New Keynesians provide microeconomics foundations for Keynesian macroeconomics. Menu costs may explain nominal rigidities in the labour market.

Extreme Keynesians – believe that departures from full employment can be long-lasting. Keynesian unemployment does not make real wage fall, and may not even reduce nominal wages and prices. The first responsibility of government is not supply-side policies to raise potential output that is not attained anyway, but restoration of the economy to potential output by expansionary fiscal and monetary policy, especially the former.

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Government debt as % of GDP – New Zealand amongst the lowest in the OECD.

October 8, 2017 Leave a comment

In 2015 New Zealand’s government debt as a % of GDP was amongst the lowest amongst the OECD countries coming in at 35.6% – NZ$86.1bn. This gives the government the ability to borrow billions of dollars to stimulate growth in the economy and fund necessary infrastructure projects. This is important when a recession phase is threatening the economy. In 2015 the median level of debt to GDP was the Netherlands with 77.5% and Australia was 67.7%. The UK and the USA had debt to GDP of 112.6% and 125.9%. The standout countries are Japan with debt of 234% of GDP and Greece at 182%. High amounts of debts are only become a concern when the debt is mainly funded from overseas and issues in non-local currency and the country is unable to alter its exchange rates. For Japan a lot of the debt has been issued internally and been bought by the Bank of Japan (central bank) but this is not the case for Greece as they have had significant help from other countries.

Govt debt as % GDP

Does aggressive or cautious fiscal stimulus lead to higher debt-to-GDP ratio?

With low interest rates globally and liquidity trap conditions a more expansionary fiscal policy has become more prevalent for most governments. However the level of severity of fiscal policy – aggressive fiscal stimulus v cautious fiscal stimulus – is important with regard to a country’s debt-to-GDP ratio as recent experience shows. A paper by Alan Auerbach and Purity Gorodnichenko of University of California Berkeley found that short bursts of expansionary fiscal stimulus doesn’t necessarily lead to higher debt-to-GDP ratios or to higher interest rates. They noted that in some instances markets revised down their worries about creditworthiness in response to large scale stimulus.

Other research by Brad De-Long University of California Berkeley and Larry Summers Harvard University seems to support this view. Their research suggests that long periods of cautious growth eat away at an economy’s productive potential as investments don’t get finished and healthy workers drop out of the labor force.

In future the level of stimulus and its time periods should be automatic and proportionate to the severity of the downturn. Examples could include:

  • Labour tax rates could be linked to unemployment figures so that pay packets jump the moment conditions deteriorate.
  • Funding to local governments could be similarly conditioned, to limit painful cutbacks by municipalities.
  • To prevent a scramble for worthwhile, shovel-ready infrastructure projects, governments could make sure to have a ready queue, so spending could easily scale up in a downturn.

Sources:

  • The Economist – The Borrowers – 9th September 2017
  • BERL: New Zealand among lowest government debts in OECD – 26th September 2017

Types of Macroeconomic Policies

August 30, 2017 Leave a comment

Just been doing some revision with my CIE AS class and discovered this diagram on macro policies. Mind maps like this are very useful ways of revising topics.

Fiscal policy can be distinguished from monetary policy, in that fiscal policy deals with taxation and government spending and is often administered by an executive under laws of a legislature, whereas monetary policy deals with the money supply, lending rates and interest rates and is often administered by a central bank.

Supply-side policies are mainly micro-economic policies aimed at making markets and industries operate more efficiently and contribute to a faster underlying-rate of growth of real national output

Macro Policies.png

A2 Economics – The Laffer Curve

May 24, 2017 Leave a comment

New to the A2 syllabus last year was the Laffer Curve. PBS Economics correspondent Paul Solman explores the question of just how high U.S. tax rates should or shouldn’t be and examines the relationship between economic activity and tax rates. There is a good explanation of the Laffer Curve which is the relationship between economic activity and tax rates.

In between, a smooth curve representing Laffer’s pretty simple idea: Somewhere above zero percent and below 100 percent, there is a tax rate where government will collect the most revenue in any given year. Now, the Laffer Curve applies to everyone, but the top so-called marginal rate is only relevant to the rich. It’s now 35 percent on all taxable income in excess of about $380,000 a year. Does that 35 percent rate maximize total tax revenue for the government?

RIP John Clarke

April 11, 2017 Leave a comment

Sad news yesterday of the passing of John Clarke. As well as his Fred Dagg character he was part of  ‘Clarke and Dawe’ which aired on ABC Australia in which prominent figures speak about matters of public importance. Below is the time they look into what Quantitative Easing actually is. Very amusing and his sense of humour will be missed.

Global Liquidity Trap

April 4, 2017 Leave a comment

The FT had an excellent article back in April last year that covered many concepts which are a part of Unit 4 of the CIE A2 Economics course. It covers the liquidity trap, deflation, MV=PT, circular flow, Monetary Policy, Quantitative Easing etc.

The article focuses on the liquidity trap with Monetary Policy being the favoured policy of central banks. However by pushing rates into negative territory they are actually encouraging a deflationary environment, stronger currencies and slower growth.  The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.

Liquidity Trap

Normally lower interest rates lead to:

  • savers spending more
  • capital being moved into riskier investments
  • cheaper borrowing costs for business and consumers
  • a weaker currency which encourages exports

But when interest rates go negative the speed at which money goes around the circular flow (Velocity of Circulation) slows which adds to deflationary problems. Policymakers pump more money into the circular flow to try to stimulate growth but as price fall consumer delay purchases, reducing consumption and growth.

The article concludes by saying Monetary Policy addresses cyclical economic problems, not structural ones. Click below to read the article.

The global liquidity trap turns more treacherous.

A2 Economics – Keynesians vs Monetarists

March 29, 2017 Leave a comment

Just been going through this part of the course with my A2 class and came across a table from some old A Level notes produced by Russell Tillson (ex Epsom College Economics and Politics Department) to help them understand the principal differences.

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