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1

What is macroeconomic policy

Macroeconomic policy is the management of the economy by government in such a way as to influence the performance and behaviour of the economy as a whole.

2

What are the objectives of the macroeconomic policy

▪ Achieving a certain level of economic growth e.g. 2% each year
▪ Keeping inflation below a certain level e.g. 3%
▪ Redistribution of wealth and income
▪ full employment of resources- especially labour force; Maintaining high levels of employment

▪ The balance of payments; the ratio of imports to exports. A payment surplus would mean the value of exports exceeds that of imports. A payment deficit would occur where imports exceed exports.

3

What are the two Trade offs or potential for conflict?

Full employment vs Price stability
Economic growth vs balance of payments

4

Explain
Full employment vs Price stability

Full employment vs Price stability ( suggested that Inflation and employment are inversely related) The achievement of full employment may therefore lead to excessive inflation through an excess level of aggregate demand in the economy.

5

Explain Economic growth vs balance of payments

Rapid economic growth may, in the short-term at least, have damaging consequences for the balance of payments since rapidly rising incomes may lead to a rising level of imports.

6

What is aggregate demand

The aggregate demand is the total demand for goods and services in an economy.
If aggregate demand is too low this can lead to unemployment. If aggregate demand is too high this can lead to a rise in inflation.

7

What things does aggregate demand affect?

the level of AD is central to the determination of the level of unemployment and the rate of inflation. If AD is too low, unemployment might result; if AD is too high, inflation induced by excess demand might result.

8

Changes in AD will affect all businesses to varying degrees. Thus effective business planning requires that businesses can: ?

predict the likely thrust of macroeconomic policy in the short- to medium-term

predict the consequences for sales growth of the overall stance of macroeconomic policy and any likely changes in it.

9

Macroeconomic policy may influence the costs of the busines sector in important areas- identify them

Exchange rates
Taxation
Interest rates

10

How are exchange rates impacted?

Most businesses use some imported goods in the production process; hence this leads to a rise in production costs.

11

How are taxation impacted?

e.g. a change in the employers’ national insurance contribution (NIC) will have a direct effect on labour costs for all businesses.

Changes in indirect taxes (e.g. a rise in sales tax or excise duties) will either have to be absorbed or the business will have to attempt to pass on the tax to its customers.

12

How are interest rates impacted?

Costs of servicing debts will change, especially for highly-geared firms.

the viability of investment will be affected since all models of investment appraisal include the rate of interest as one, if not the main, variable.

13

What is monetary policy

Monetary policy is concerned with influencing the overall monetary conditions in the economy in particular:

the volume of money in circulation – the money supply
the price of money – interest rates.

14

does controlling money supply work and explain

In practice, attempts by governments to control the economy by controlling the money supply have failed and have been abandoned. However, growth in the money supply is monitored, because excessive growth could be destabilising.

15

What are some examples of governemnt actions relating to monetary policy

Decreasing interest rates in order to stimulate consumer spending

Using official foreign currency reserves to buy the domestic currency

Regulating foreign exchange rates

16

When interest rates are changed, it is expected that the general level of demand in the economy will be affected. Thus, a rise in interest rates will discourage expenditure, by raising the cost of credit. However, the effects will vary:

Mention the ways

1)Investment may be affected more than consumption.
2) Effects are uneven

17

Investment may be affected more than consumption.

explain

The rate of interest is the main cost of investment by businesses,

However, most consumption (by individuals) is not financed by credit and hence is less affected by interest rate changes.

Since the level of investment in the economy is an important determinant of economic growth and international competitiveness there may be serious long-term implications arising from high interest rates.

18

2) Effects are uneven
explain

Even where consumption is affected by rising interest rates, the effects are uneven.

The demand for consumer durable goods and houses is most affected since these are normally credit-based purchases.

Hence active interest policy may induce instability in some sectors of business.

19

2) Effects are uneven
explain

Even where consumption is affected by rising interest rates, the effects are uneven.

The demand for consumer durable goods and houses is most affected since these are normally credit-based purchases.

Hence active interest policy may induce instability in some sectors of business.

20

Explain how exchange rates are affected

High interest rates attracts foreign investment -> increase in exchange rates:
 exports dearer
 imports cheap

There is now a very high degree of capital mobility between economies: large sums of short-term capital move from one financial centre to another in pursuit of higher interest rates.

Changes in domestic interest rates relative to those in other financial centres will produce large inflows and outflows of short-term capital.

Inflows of capital represent a demand for the domestic currency and hence push up the exchange rate. Outflows represent sales of the domestic currency and hence depress the exchange rate.

This may bring about unacceptable movements in the exchange rate.

21

What is the central banks role?

the central bank has been given responsibility by the government for controlling short-term interest rates. Short-term interest rates are controlled with a view to influencing the rate of inflation in the economy over the long-term.

Central governments can control short-term interest rates through their activities in the money markets. This is because the commercial banks need to borrow regularly from the central bank. The central bank lends to the commercial banks at a rate of its own choosing. This borrowing rate for banks affects the interest rates that the banks set for their own customers.

Action by a central bank to raise or lower interest rates normally results in an immediate increase or reduction in bank base rates

22

What is interest rate smoothing?

the policy of some central banks to move official interest rates in a sequence of relatively small steps in the same direction, rather than waiting until making a single larger change.

This is usually for the following reasons:

economic (e.g. to avoid instability and the need for reversals in policy) and

political (e.g. higher rates are broken to the electorate gently).

23

When does Saving becomes more attractive, spending less attractive

Achieved by increasing interest rates

24

Changes in monetary policy will impact what

Availability of finance
cost of finance
level of consumer demand
exchange rates

25

How is Availability of finance affected from monetary policy

Credit restrictions achieved via the banking system or by direct legislation will reduce the availability of loans. This can make it difficult for small- or medium-sized new businesses to raise finance. The threat of such restrictions in the future will influence financial decisions by companies, making them more likely to seek long-term, stable finance for projects.

26

How is Availability of finance affected from monetary policy

Credit restrictions achieved via the banking system or by direct legislation will reduce the availability of loans.

This can make it difficult for small- or medium-sized new businesses to raise finance.

The threat of such restrictions in the future will influence financial decisions by companies, making them more likely to seek long-term, stable finance for projects.

27

How is cost of finance affected from monetary policy

Any restrictions on the stock of money, or restrictions on credit, will raise the cost of borrowing, making fewer investment projects worthwhile and discouraging expansion by companies.

Also, any increase in the level of general interest rates will increase shareholders’ required rates of return so unless companies can increase their return, share prices will fall as interest rates rise.

Thus, in times of ‘tight’ money and high interest rates, organizations are less likely to borrow money and will probably contract rather than expand operations.

28

How is level of consumer demand affected from monetary policy

Individuals find it more difficult and more expensive to borrow to fund consumption, whilst saving becomes more attractive. The lowering of demand for goods and services is another reason for organizations to have to contract operations.

29

How is exchange rates affected from monetary policy

Monetary policy which increases the level of domestic interest rates is likely to raise exchange rates as capital is attracted into the country.

Very many organisations now deal with both suppliers and customers abroad and thus cannot ignore the effect of future exchange rate movements.

Financial managers must consider methods of hedging exchange rate risk and the effect of changes in exchange rates on their positions as importers and exporters.

30

What are the two types of inflation

demand-pull inflation – excess demand
cost-push inflation – high production costs.

Both can have a negative impact on cash flows and profits.