Macroeconomics Real World Examples

Question 1

UK Macroeconomic Objectives

Answer 1

Growth - Strong, Sustained, Sustainable - GDP and GDP/capita
Unemployment - Low Unemployment, Full Employment - Labour Force Survey (LFS)
Inflation - Low and Stable; 2% +/-1% - CPl and CPIH
Trade - Balanced - Current Account of the Balance of
Payments
Distribution of Income - Fair - Gini Coefficient

Question 2

Determinants of AD (Consumption) - Low Interest Rates

Answer 2

1) In the UK interest rates stand at historic lows of 0.1% to boost consumption and AD given the pandemic economic shock and uncertain economic outlook with Brexit.

2) In the Eurozone economy interest rates are at 0% to stimulate consumption, AD, and economic growth, aiding recovery from the pandemic-driven recession.

3) Japanese interest rates are officially at -0.1% to promote consumption and fight against consistent bouts of deflation.

Question 3

Determinants of AD (Consumption) - High Interest Rates

Answer 3

1) Turkey has been grappling with high rates of inflation since the end of 2019 driven mainly by a very weak currency. Confidence in the economy fell further in 2020 as Covid plunged the economy into a deep recession with the Lira in free fall. To combat inflation and to stabilize the currency, the central bank has been forced to increase interest rates multiple times in 2020 from 4% in September all the way to 15% in November with the potential for further rises despite the ongoing recession.

2) In Argentina interest rates have soared to between 38% and 78% as the country grapples with a deep recession caused by a collapse in the Peso and very high inflation rates. To combat inflation and a very weak peso, authorities have had to hike interest rates implementing interest rate floors.

3) The US Federal Reserve had been increasing interest rates regularly from 2016 to early 2019 in a bid to normalize rates after the Financial Crisis. More recently, given negative growth, rates have been cut.

Question 4

Determinants of AD (Consumption) - High Consumer Confidence

Answer 4

1) Strong economic recovery from Coronavirus lockdowns has led to rapid increases in consumer confidence in China, back to pre-pandemic levels, with consumers willing to spend on big-ticket items.

2) Record low rates of unemployment and rising real wages allowed consumer confidence in the USA to hit an 18-year high in 2018, remaining strong throughout 2019 but trade wars and the economic devastation of Coronavirus have led to consumer confidence levels falling rapidly ni 2020.

Question 5

Determinants of AD (Consumption) - Low Consumer Confidence

Answer 5

1) In the Eurozone, consumer confidence has taken a sharp downturn given the impact of Covid restrictions on incomes and unemployment as well as slower export growth across the bloc due to weak external demand, where trade is highly significant for growth, employment and incomes.

2) Consumer confidence in the UK has been extremely low throughout 2020 for similar Covid-driven reasons as in the Eurozone but also due to ongoing uncertainty regarding the impact of Brexit on macroeconomic performance and personal finances.

Question 6

Determinants of AD (Consumption) - High Asset Prices (Positive Wealth Effect)

Answer 6

1) In the UK there is a very strong correlation between house price growth and consumption. The rate of house price rises has been strong in 2020 allowing for a positive wealth effect.

2) The Chinese Stock Market has been performing strongly throughout 2020, ending the year with a value greater than peaks ni 2015 due to the strength of economic recovery ni the country.

Question 7

Determinants of AD (Consumption) - Low Asset Prices (Negative Wealth Effect)

Answer 7

1) Stock markets in the UK, USA, and Japan experienced
huge declines in March 2020 as Coronavirus lockdowns were
imposed creating a huge economic shock and drastically reducing business profitability. With this, share prices crashed, reducing the wealth and thus consumption of those holding shares. Towards the end of 2020, stock markets in these countries are recovering, though still far below pre-crisis peaks, with growth rates improving and vaccines to be used to control both the spread of the virus and further economic damage into 2021.

Question 8

Determinants of AD (Consumption) - Low Household Indebtedness

Answer 8

1) German household indebtedness is extremely low for a Western economy at only 55% of GDP equivalent to just over $2,100 per household (excluding mortgage debt). It is engrained in German culture to spend mainly from accumulated savings rather than reliance on debt to fund consumption.

Question 9

Determinants of AD (Consumption) - High Household Indebtedness

Answer 9

1) Economies like the UK and the USA are highly reliant on credit and debt to drive consumption, aggregate demand, and economic growth. In the UK, household indebtedness stands at 86% of GDP equivalent to approximately £12,800 per household excluding mortgage debt. For many who face a debt mountain, this will encourage more saving than spending.

Question 10

Determinants of AD (Consumption) - High Real Disposable Income

Answer 10

1) Economic growth in China has been strong throughout 2020 with a quick recovery from Coronavirus lockdowns and a surge ni exports allowing real disposable incomes to rise sharply.

2) The South Korean economy has also been performing well backed by a strong trade surplus boosting AD, growth, and real incomes.

Question 11

Determinants of AD (Consumption) - Low Real Disposable Income

Answer 11

1) Coronavirus lockdowns, continued restrictions, and further virus waves have badly damaged economic growth and employment in the UK, USA, and Eurozone resulting in lower real disposable incomes despite a variety of policies aimed at protecting jobs and income.

2) The economic crisis in Venezuela has led to significant reductions in real disposable income, falling from a peak of approximately $18,000 GDP/capita (PPP) in 2013 to around $6,000 GDP/capita (PPP) in 2020.

3) Nigeria and Zambia are reliant on the export of oil and copper respectively for growth and development. Both countries have been driven into deep recessions with collapses in oil and copper prices due to crumbling global demand throughout 2020. As a result, real disposable incomes in both countries have fallen considerably.

Question 12

Determinants of AD (Consumption) - Low Income Tax Rates

Answer 12

1) In 2018, Donald Trump announced income tax reductions in the USA on 5 of the 7 tax bands as denoted by the table on the right-hand side. The new, lower percentage rates would remain up until 2025 and the actual income amounts in each threshold would rise by inflation every year preventing fiscal drag.

The intention of this policy was to raise real disposable incomes and
boost consumer spending resulting in consistent and high growth rates in the economy.

2) Since the conservative party took power in 2010, income tax rates in the UK have been falling consistently year on year in a variety of ways. The personal income tax-free allowance has increased from £6,500 in 2010 to £12,500 in 2020 meaning basic rate taxpayers pay £1,205 less tax than in 2010.

The income threshold before the 40% higher rate of tax si due has increased from £37,400 ni 2010 to £50,000 ni 2020 with 1 million fewer taxpayers ni this bracket than ni 2015. The tax rate of the highest income earners ni the country was also lowered ni 2013 from 50% to 45%.

3) In 2020, the Australian government brought forward income tax cuts to promote economic recovery, widening the upper limit on both the 19% and 32.5% tax bands to benefit al income earners.

Question 13

Determinants of AD (Investment) - Low Interest Rates

Answer 13

1) With low-interest rates in the UK, Eurozone, and Japan, theory would suggest that investment would rise given the lower cost of borrowing for firms looking to invest. However low business confidence in al three countries has offset this factor, leading to low levels of investment.

Question 14

Determinants of AD (Investment) - High Interest Rates

Answer 14

1) Turkey has been grappling with high rates of inflation since the end of 2019 driven mainly by a very weak currency. Confidence in the economy fell further in 2020 as Covid plunged the economy into a deep recession with the Lira in free fall. To combat inflation and to stabilize the currency, the central bank has been forced to increase interest rates multiple times in 2020 from 4% in September all the way to 15% in November with the potential for further rises despite the ongoing recession.

2) In Argentina interest rates have soared to between 38% and 78% as the country grapples with a deep recession caused by a collapse in the Peso and very high inflation rates. To combat inflation and a very weak peso, authorities have had to hike interest rates implementing interest rate floors.

Question 15

Determinants of AD (Investment) - High Business Confidence

Answer 15

1) Business confidence in China is high given expectations of strong economic growth, employment, and improving overseas demand. Once more, China has entered more regional trade blocs such as the RCEP with further hopes of improved US trade relations al raising Chinese expected business profitability.

Question 16

Determinants of AD (Investment) - Low Business Confidence

Answer 16

1) Brexit uncertainty in the UK has dampened business
confidence markedly ever since the vote to leave the EU in 2016. UK businesses remain
very unsure over supply chains, trade arrangements with the EU and the rest of the world, and the potential state of both the UK and Eurozone economies. Couple this with the devastating impact of the Covid-driven recession, it is clear that the incentive to invest has reduced considerably.

2) Brexit uncertainty and Coronavirus consequences are also impacting negatively on business confidence in the Eurozone where firms are unsure of potential hits to economic growth and profitability. Strict lockdowns and the profit hit of businesses only opening at limited capacity have also drastically reduced business confidence in the USA and Australia.

Question 17

Determinants of AD (Investment) - Low Corporation Tax

Answer 17

1) Since the conservative party came into power in 2010, corporation tax rates in the UK have fallen significantly from 28% in 2010 to 19% in 2020.

2) In 2018 as part of wide-ranging tax cuts across the US economy, Donald Trump cut corporation tax from 35% to 21% to promote more domestic capital investment, and FDI and to encourage US firms operating outside the country to come back to the US.

3) Ireland has one of the lowest corporation tax rates in the Western world at only 12.5%. It is for this reason that they are able to attract substantial inflows of foreign direct investment as well as strongly promote domestic investment.

4) In September 2019, India cut its base corporation tax rate from 30% to 2% to stimulate investment, growth, and employment in the country.

Question 18

Determinants of AD (Investment) - High Corporation Tax

Answer 18

1) France has a high corporation tax rate of 31% for large companies and 28% for small companies; figures that are not hugely surprising as the French government continues to battle regular budget deficits and very high government debt levels.

Question 19

Determinants of AD (Government Spending) - Government Spending Stimulus

Answer 19

1) In September 2020, France unveiled a huge €100bn stimulus package consisting mainly of loans and grants to businesses hit hardest by the Covid pandemic but also government spending on renewable energy, job support, and infrastructure to promote both short and long-run growth.

2) To support employment and promote strong economic recovery, Germany enacted a fiscal stimulus worth €130bn consisting of financial aid to households and greater government spending on childcare services, renewable energy, and digital infrastructure.

3) From March up to the end of 2020, the UK government spent approximately £300bn on a variety of policies such as wage subsidies, infrastructure, and welfare to boost growth and protect jobs.

4) The USA and Japan enacted some of the largest fiscal stimulus packages in the world in 2020 to fight back against Coronavirus recessions, worth 12% and 20% of GDP for the US and Japan respectively. Both countries favored more direct use of public money by providing payouts to households and businesses whilst also increasing payment thresholds for welfare benefits.

Question 20

Determinants of AD (Government Spending) - Austerity (Government Spending Cuts)

Answer 20

1) From 2010 to 2019, the conservative party in the UK
adopted an austerity policy ni the form of government spending cuts to reduce the level of annual public borrowing (the budget deficit). Government spending cuts
have focussed mainly on government departments, local councils, police services, defense, and welfare.

2) Greece was reliant on bailout funds from the IMF and the Eurozone starting in 2010 to avoid complete economic collapse but with these emergency funds came forced austerity demands, including deep spending cuts. Between 2010 and 2015, government spending on healthcare fell by 50% and education spending fell by 20%, furthermore, Greek governments reduced employment in the public sector, reduced public sector wages, and cut spending on pensions.

Other examples of countries that implemented austerity policy through cuts to government spending; 3) Spain 4) Italy 5) Portugal 6) Ireland 7) France

Question 21

Determinants of AD (Net Exports) - Weak Exchange Rate

Answer 21

Examples of countries with weak currencies which ni theory could increase net exports and boost aggregate demand by making exports cheaper and imports dearer; 1) Argentina (Peso) 2) Nigeria (Naira) 3) UK (Pound) 4) Turkey (Lira) 5) USA (Dollar) 6) South Africa (Rand)

Question 22

Determinants of AD (Net Exports) - Strong Exchange Rate

Answer 22

1) The Chinese Yuan has strengthened against major currencies in 2020 due to relatively higher interest rates and the strong performance of the Chinese economy, theoretically harming net exports.

Question 22

Determinants of Short Run Aggregate Supply

Answer 22

1) The global prices of oil, gas, and metals have been falling throughout 2020; therefore for countries reliant on oil, gas, and metals as an input to production such as the UK, this has helped reduce costs of production significantly thus shifting SRAS to the right.

2) Business taxes affect the costs of production for all firms in an economy thus shifting SRAS. In 2020, the UK cut VAT for the hospitality and tourism industries, and Germany cut VAT across the entire economy from 19% to 16% helping to reduce costs of production for firms thus shifting SRAS to the right.

In India, large-scale reform to the goods and services tax (GST) meant harmonization of tax rates across states and in many cases a reduction of tax rates for various goods and services, reducing costs of production for firms thus shifting SRAS to the right.
The following countries have all experienced increases in VAT (sales tax) with SRAS shifting left as a result; the UK (VAT increase from 17.5% to 20% in 2010), Japan (sales tax increase from 5% to 8% in 2014
and an increase from 8% to 10% in 2019), UAE (implementing VAT for the first time at 5% in 2018), South Africa (sales tax increased from 14% to 15% in 2018) and Saudi Arabia (VAT increase from 5% to 15% in 2020).

3) Countries with weak exchange rates face dearer imports and therefore it becomes more expensive for firms to import raw materials increasing costs of production and shifting SRAS to the left as seen in the UK for example. However, if the currency depreciates significantly, a large shift to the left of SRAS can result in stagflation, the phenomenon of high inflation with negative economic growth as is
currently being seen in 1) Nigeria (Naira) 2) Turkey (Lira) 3) Venezuela (Bolivar) 4) Argentina (Peso)

Question 22

Causes of Recession - Demand Side Shocks

Answer 22

1) The Coronavirus pandemic in 2020 forced many countries to shut down large parts of their economy and even when open, only allowing businesses to run at limited capacity. Despite support packages
and policies implemented, growth and employment rates plummeted with deep recessions around the world, prolonged by further waves of infections and consumer fears of venturing out to spend.

2) The Great Financial Crisis of 2008 led to a widespread banking sector collapse in various countries; USA, UK, Ireland, Real Greece, Spain, Italy, Iceland, and Cyprus as
well as many others. This led to a huge fall in consumption and investment triggering large recessions in all these countries with some like Greece, Iceland, and Cyprus going bankrupt and reliant on IMF bailouts.

3) As well as suffering a banking crisis in 2008/9 the US economy also suffered a huge housing market crash with prices falling by almost 30% between 2007 and 2009. Stock markets also crashed losing 50% of their value triggering huge reductions in wealth and with that, big declines in AD.

4) In 2014, the Russian central bank made a dramatic overnight move to increase interest rates from 10.5% to 17% to combat both high inflation and steep declines in the value of the Ruble. This sharp and sudden increase caused a collapse of consumption and investment triggering a deep recession in the country. Interest rate rises for similar reasons were seen in Brazil in 2015 with a recession the consequence soon after.

5) The collapse of commodity prices in 2020 as a result of falling global demand from the Covid crisis drove countries reliant on the export of primary commodities like Nigeria, Angola, and Zambia into recession with huge falls ni export revenues from oil (Nigeria/Angola) and copper (Zambia).

Question 22

Benefits of Growth

Answer 22

The best country to use when applying the benefits of growth is China. Despite many costs of growth applying to China as well, the benefits have far exceeded the costs with higher incomes, poverty alleviation, living standards benefits, job creation, profits for firms and large fiscal benefits for the government all witnessed.

Question 23

Causes of Recession - Supply Side Shocks

Answer 23

1) In both 2008 and 2010, the UK was in recession battling not just lower growth and higher unemployment but also higher than target rates of inflation. The reason was higher commodity prices, in particular oil, energy, and food, which deepened the recession in both instances.

2) Japan increased its sales tax from 5% to 8% in 2014 to increase tax revenue, reduce government debt, and battle deflation. The impact of this rise shocked the economy into recession later that year with President Abe having to delay further rises in the sales tax. A further rise took effect in October 2019 from 8% to 10% again acting as a major contributor to recession in 2020.

3) With increases in interest rates in the US throughout 2018 and into 2019, many countries (emerging economies in particular) saw their currencies weaken markedly, none more so than Argentina where the value of the Peso fell against the US Dolar by 59% ni 2018. Such a large, sustained fall in currency value has led to a huge supply-side shock in Argentina resulting in stagflation. Other countries such as Turkey and Nigeria have also seen large currency declines in 2020 resulting in recession with high rates of cost push inflation.

Question 23

Problems with CPl as a Measure of Inflation - UK

Answer 23

1) In the UK with a wide range of tastes, preferences, and income differences it is clear that no individual’s spending habits will perfectly represent the average basket of goods and services with personal inflation rates differing from the headline figure.

2) In recent years, many firms have been responding to higher costs of production as a result of the weak pound not by raising prices to consumers but instead by reducing the size of their products, a phenomenon known as ‘shrinkflation’. Products like Jaffa Cakes, Snickers, Kit Kat, Twix, Toblerone, and many others products have all become smaller in size but at the same price. This is in reality an increase in inflation but is not taken into account by official inflation figures.

3) Housing costs make up a large proportion of monthly spending for households in the UK but these costs are not included in the UK’s CPI basket. This is why the ONS has moved to using the CPIH, which includes owner-occupied housing costs, as their headline figure.

4) It could be argued that the UK CPI basket is too slow to adapt to changes in consumer spending habits. For example, in 2015, music streaming subscriptions and protein powder came into the basket whilst external satellite navigation systems came out when many would argue these consumer trends had been taking place long before their additions or removals from the basket.

Question 23

Problems with GDP as a Measure of Growth and Living Standards and Costs of Economic Growth

Answer 23

1) The size of the informal sector in countries like Italy and Greece is very large, with some estimates approximating both to be 25% of GDP. In many developing countries like Indonesia, the number of unlicensed businesses, subsistence farmers, and jobs in the informal sector is very high. This unofficial, unrecorded activity does not count towards official GDP figures and therefore leads to growth figures being lower than what they should be.

2) India and China have experienced rampant economic growth since the 1990s but with that has come serious environmental costs in the form of air pollution and resource degradation. Malaysia and
Indonesia has been grappling with the problem of deforestation with their economic growth, not taking into account GDP figures.

3) Over-specialised countries like Nigeria (oil) and Botswana (diamonds) have wide unequal distributions of income as the benefits of high rates of growth are confined mainly to those who work in those industries and to corrupt politicians. In the US, income inequality as measured by the Gini coefficient is one of the highest in the developed world, proving that high rates of growth and GDP/capita will not necessarily raise the income and living standards of all in the economy.

4) Switzerland and Norway have highly over-valued currencies causing problems when converting to US Dollars using the nominal exchange rate to provide GDP/capita data. As a result, final figures will over-report average incomes and living standards not taking into account the fact that goods and services are much more expensive in these countries than abroad therefore reducing the purchasing power of this income. India has a largely under-valued rupee with the opposite problem of interpreting GDP/capita figures.

5) With strong economic growth in 2018 and 2019, the US economy was in danger of overheating and inflation rates reaching the 3% mark. Between the years 2000 and 2007, rampant Chinese growth translated into high rates of demand-pull inflation peaking at 9%.

6) In both the UK and USA strong growth and high incomes throughout the 2010s decade led to rising current account deficits. As incomes rose, consumers sucked in imports increasing import expenditure. In the UK, current account deficits in this decade have ranged from between 4-6% of GDP, and in the USA recent current account deficits have averaged 2.5% of GDP.

Question 23

Bad Deflation

Answer 23

1) Japan has suffered from decades of demand-side deflation after a widespread banking crisis in the 1990s. Deflation was long-term and seeped into expectations where consumers delayed spending and firms discounted heavily, real interest rates were positive and the real value of debt increased all of which led to a vicious deflationary spiral. Greece since the financial crisis of 2007 has also suffered a prolonged period of bad, demand-side deflation with similar negative consequences.

Many Eurozone economies such as Germany, Italy, Spain, and Ireland entered deflation in 2020 with concerns of this becoming entrenched into expectations, stifling economic recovery into 2021.

Question 23

Good Deflation

Answer 23

1) Between 2015 and 2016 the UK and Eurozone economies experienced a bout of good deflation caused by the supply side mainly due to falling oil and commodity prices. In the UK, the inflation rate hit a low of -0.1%, and in the Eurozone, the rate went as low as -0.6% but in both cases, deflation proved temporary and did not feed through to consumer expectations. Therefore consumers and producers purely benefitted from the relief of lower prices and costs respectively.

Question 23

Cost-Push Inflation

Answer 23

1) In November 2017, the inflation rate in the UK hit 3.1%, overshooting the 2% inflation target blamed by the Bank of England purely on the weakness of the pound increasing import prices and thus costs of production for firms in the UK. Similar examples of cost-push inflation due to weaknesses in a country’s currency can be seen in Turkey and Nigeria. A more radical case is Venezuela suffering from extreme hyperinflation.

2) In Argentina, dramatic falls in the value of Peso have triggered very high inflation rates anywhere between 20% and 50% in recent years. Wage price spirals and
consumers bringing consumption forward triggering further price spirals are common in the country.

3) Japan’s sales tax rises in 2014 from 5% to 8% and in 2019 from 8% to 10% helped to maintain consistent positive rates of inflation; rare for a country that has battled deflation since the early 1990s.

Question 23

Demand-Pull Inflation

Answer 23

1) With strong economic growth ni 2018 and 2019, the US economy was ni danger of overheating with inflation rates reaching the 3% mark - this was a clear case of demand-pull inflation.

2) Between the years 2000 and 2007 rampant Chinese growth translated into high rates of demand pul inflation peaking at 9%.

Question 23

Costs of Inflation

Answer 23

1) Higher than target rates of inflation from the end of 2016 through to the end of 2018 in the UK led to negative real wage growth and thus a fall in individual
purchasing power. Very high rates of inflation in Argentina and Turkey have also significantly reduced purchasing power with many households struggling to even buy basic groceries.

2) With interest rates at near zero levels since 2009 in the UK, bouts of inflation as witnessed due to the weak pound post the Brexit vote
resulted ni negative real interest rates eroding real returns from savings considerably.

3) For an export-dominant country like Brazil, high relative inflation rates beyond 10%, as experienced at the heart of their economic crisis in 2016, significantly reduced international competitiveness making it harder to export.

4) Rates of inflation in Argentina touching 50% have led to damaging wage-price spirals, where workers consistently ask for higher wages to maintain pace with rising prices, and consumer price spirals where consumers bring forward their spending to beat higher prices in the future. All this has done is accelerate the inflation rate year on year to worrying highs.

Question 24

Problems with the LFS Measure of Unemployment

Answer 24

1) In the UK, the Labour Force Survey (LFS) has a sample size of 100,000 people in 40,000 households, representing 1 in 440 of the working-age population. This small sample size is due to the high cost of carrying out the survey resulting in a +-/ 3% margin of uncertainty with the final unemployment rate.

2) Unemployment rates in Greece and Spain peaked at 28% following recessions in 2010 with youth unemployment rates hitting highs of approximately 65% in both countries. As a result, many youngsters became discouraged and dropped out of the labor force forming the ‘hidden unemployed’ who do not count towards official unemployment figures, as they were no longer seeking work.

3) In the UK in 2020 20.9% of those aged between 16-64 were economically inactive. Of those, a large proportion were either early retired or looking after the family home; inactive groups that perhaps should count towards official unemployment figures but don’t. In Japan the official jobless rate is 3% but this fails to take into account the proportion of women who are not part of the workforce. In 2020 71.3% of women aged between 15-64 were in work suggesting a large number of women missing from official unemployment statistics.

4) There were approximately 8.1 million people working
part-time in the UK in 2020, representing a large proportion of the workforce. These workers are recorded as fully employed even though they may be seeking full time work but can only receive part-time work and are thus, in reality, underemployed.
Once more in 2020 3.2% of all UK employees were working on zero-hours contracts again representing the underemployed despite being counted as fully employed.

5) In the UK there are large unemployment disparities between Northern and Southern regions with unemployment much higher in the north than in the south but this is not shown in official data. In the US there are unemployment disparities between black and Hispanic unemployment rates, 10.8% and 8.8% respectively in October 2020 with a 6.8% overall unemployment rate, though this disparity is much lower than historic levels. In Greece, Spain, and South Africa, youth unemployment rates are much higher than official rates suggesting underlying structural issues in the economy not noticeable from the LFS figure.

Question 25

Types of Unemployment - Cyclical Unemployment

Answer 25

1) Coronavirus recessions have led to cyclical unemployment soaring in many countries across the world. Countries that experienced double-digit rates of unemployment include the USA, Greece, and Spain though more Eurozone economies are expected to reach unemployment rates beyond 10% into 2021 as the economic crisis continues.

2) Turkey, Nigeria, Argentina, and South Africa have suffered extremely high rates of cyclical unemployment as very weak exchange rates have created economic crises. The jobless rate has been above 10% in Turkey and Argentina, above 20% in Nigeria, and even above 30% in South Africa.

Question 26

Types of Unemployment - Structural Unemployment

Answer 26

1) In India 50% of the population is aged 25 or below yet the majority of these youngsters are being trained for professions where job vacancies are limited resulting ni a skills mismatch and occupational immobility of labor. Instead, there is a high demand for workers in the engineering sector for example but current skills do not match.

2) In the UK many youngsters are leaving university with degrees that compete for very similar jobs in finance and banking for example whereas huge gaps remain in the engineering, manufacturing, medicine, and nursing sectors as four examples where few trained graduates exist.

3) Technological advances in the supermarket, farming, banking, manufacturing, print media, and retail sectors have resulted in occupational immobility for workers across the world who used to be employed in such sectors. The Coronavirus crisis has accelerated this substitution even more.

4) In countries like France and Spain, structural unemployment rates are naturally high due to very strict hiring and firing regulations, driven through strong trade unions. As a result, it is a huge risk for a firm to hire low-skilled workers given the difficulty in firing them if that worker proves ineffective for the firm over time, keeping structural unemployment stubbornly high. This is represented by high natural rates of unemployment between 8-10% in France and approximately 12% in Spain, compared to a significantly lower natural rate of unemployment of around 3.5% in the USA.

Question 27

Types of Unemployment - Real Wage Unemployment

Answer 27

1) Germany introduced a minimum wage for the first time in 2015 but with concerns that, especially in regions of low wages, real wage unemployment could result. However, evidence has shown that
the minimum wage and increases since implementation have done nothing to W1 halt employment growth with employers instead absorbing the higher costs and accepting lower profits. The same can be said of the UK’s recent increases in the living wage where concerns had been raised regarding job losses in the retail and hospitality sectors in particular but again employers have instead chosen to absorb costs rather than reduce the size of their workforces.

Question 27

Costs of Unemployment - Greece

Answer 27

With unemployment rates in excess of 15%, Greek national debt has skyrocketed to 180% of GDP, the highest in Europe; a large chunk of government revenue is directed to dealing with the social costs of poverty, crime, riots, and mental health conditions. The Greek economy has been working well below its potential with individuals suffering from drastically lower incomes and many youngsters finding it impossible to find work, dropping out of the labor force, and adjusting to life on low incomes - the problem of hysteresis. Many countries are experiencing similar consequences as unemployment has risen from Covid-driven recessions but with job support policies in place to prevent long-term unemployment and hysteresis.

Question 27

Expansionary Monetary Policy - Lower Interest Rates

Answer 27

1) In response to the economic crisis from Coronavirus, the Monetary Policy Committee (MPC) of the Bank of England enacted dual expansionary monetary policy, reducing interest rates from 0.75% to 0.1% and pumping an extra £450bn of money into the UK economy through quantitative easing. The intention of this policy move was to promote economic growth and employment thus reducing the overall impact of the recession on UK macro performance. However as interest rates were already very low before the cuts took place, this avenue of monetary policy has been limited in its effectiveness forcing huge increases in quantitative easing to provide further stimulus to the economy. But with extremely weak consumer and business confidence the idea of lower interest rates promoting greater borrowing, spending, and investment was unlikely. In reality, businesses have used borrowed funds to protect jobs and continue paying bills thus preventing mass bankruptcy and skyrocketing rates of unemployment.

2) In 2020, the Reserve Bank of Australia cut interest rates numerous times from 0.75% to 0.1% (an al time historic low) along with rounds of quantitative easing in a bid to stimulate the economy, protect jobs but also to fight against the risk of deflationary pressures.

3) The Reserve Bank of India continued its trend of expansionary monetary policy with further interest cuts from 5.15% at the start of 2020 to a record low of %4 by December to aid an economy badly hit by Coronavirus restrictions. Rising inflation due to rising food prices in India has made interest policy all the more difficult.

4) The US Federal Reserve reversed its path of interest rate rises in 2019 given slowing growth but with the extreme Covid recession in 2020 causing unemployment levels to rise rapidly and growth to contract enormously, interest rates were cut all the way back down to 0.25% by the end of year.

Question 28

Extreme Expansionary Monetary Policy - Negative Interest Rates

Answer 28

1) In January 2016, the Bank of Japan surprised economists with a shock move to negative interest rates. Interest rates have remained at -0.1% with the intention to boost economic growth and ensure positive inflation rates during the COVID-19 recession. The negative interest rate applies only to commercial bank deposits; all commercial banks have an account at the central bank to keep reserves as a form of security and to earn a return. However with negative interest rates, commercial banks are charged on deposits held at the central bank incentivizing them not to keep excess reserves but instead to lend out that cash to consumers and businesses to boost AD, stimulate the economy, and provide much-needed demand-pull inflation. In Japan’s case, the negative rate has applied only to commercial deposits at the central bank; ti hasn’t fed through to saving and borrowing rates applicable to customer bank accounts.

2) In June 2014, the European Central Bank (ECB) reduced its deposit rate to -0.1% in a bid to fight off deflation, stimulate growth and reduce cyclical unemployment across the Eurozone. A few months later in 2015, the ECB also announced the start of their quantitative easing programme, which combined with such low interest rates, would also help in weakening the Euro thus stimulating the largely export-dependent Eurozone economy, with a further deposit rate cut to -0.5% in 2020 to fight Covid recessions.

3) The Swiss National Bank in January 2015 reduced interest rates to -0.75% in Switzerland in order to reduce the value of a highly overvalued Swiss Franc which reached undesirable highs when money poured into the country for safekeeping due to economic crisis abroad. Again negative interest rates only applied to commercial bank deposits at the central bank but the intention of the policy was realised with the Franc depreciating as hoped for but still, it remains highly overvalued.

Other examples of countries who have used negative interest rates in the past; 4) Sweden 5) Denmark

Question 29

Extreme Expansionary Monetary Policy - Quantitative Easing (QE)

Answer 29

1) In response to the Financial Crisis of 2008 and the lower bound of interest rates, the Federal Reserve in the US opted to use a more extreme expansionary monetary policy, quantitative easing (QE), involving the purchasing of bonds by the central bank to reduce interest rates across the economy and thus stimulate lending, borrowing, AD and economic growth. In the US between 2008 and 2015, three rounds of QE led to $3.7 trillion worth of bonds bought up by the Fed in a bid to boost the economy. Long-term interest rates in the US did fall and growth stabilised soon after the QE programme with some crediting QE directly for this economic recovery. From 2013 to 2017, the Fed had been ‘tapering’ QE, reducing the number of bonds it was buying up on a monthly basis before completely ending the programme soon after, allowing the bonds it holds to mature and not replacing them thus effectively taking money of the economy; a process known as Quantitative Tightening. However, the economic crisis driven by Coronavirus in March 2020 forced the Fed to restart its bond-buying programme starting with $700bn of new money pumped into the economy via the purchase of bonds and other securities.

2) QE was used in the Eurozone in 2015, worth €2.5 trillion, to both stimulate the Eurozone economy and to weaken the Euro providing a boost to net exports. The Eurozone’s asset purchasing programme ended in December 2018 but restarted in 2020 given shocks to growth and risks of deflation spirals from Covid recessions. QE has also been used in Japan since the 1990s but in Japan, there has not been substantial evidence of QE increasing borrowing and boosting economic growth.

3) In the UK, the Bank of England bought up £375bn worth of bonds between 2009 and 2012 before increasing purchases further by £60bn in 2016 after the Brexit vote. The implementation of QE was a direct response to the Financial Crisis and deep recession it caused and due to the limited nature of interest rates that had reached their zero bound. QE has been credited for UK growth stabilisation and for its part in promoting economic recovery although critics argue that it has only served to create an asset bubble in the stock market and widen wealth inequality. The deep Covid recession has led to a further £450n worth of EQ taking the overall total to £895bn by the end of 2020.

Question 30

Contractionary Monetary Policy - Higher Interest Rates

Answer 30

1) The Federal Reserve in the US increased interest rates numerous times from 2016 to 2019 and has been tapering back QE. Interest rates were 0.25% in 2016 reaching 2.5% at the start of 2019. The reason for rate rises were two
fold; to protect against demand-pull inflationary pressure,
cooling down a booming US economy and also to
normalize interest rates after a uniquely long period of
near-zero rates. More recently, however, interest rates have been slashed to boost slowing economic growth, first due to ongoing trade tensions with China and more recently cut all the way down to 0.25% given the depth of the Covid recession. The MPC in the UK, prior to the economic crisis from Covid, was hoping for interest rates to follow a similar upward path reaching more normal and sustainable levels but with Brexit uncertainty, and one of the deepest recessions in Europe from Coronavirus, interest rates have actually been cut to record lows of 0.1% and are likely to stay at record lows for a considerable period of time.

2) In Argentina, interest rates soared to dramatic highs of 70% in 2019 to fight against a plummeting Peso and uncontrollably high rates of inflation. Naturally, such high interest rates only deepened the economic crisis in the country impacting negatively upon growth and unemployment as the incentives to borrow and spend or invest were reduced significantly. Turkey in 2020 has also hiked up interest rates from 8.25% to 15% in 2020 to stave off a currency crisis with similar negative macro tradeoffs.

Question 31

Expansionary Fiscal Policy

Answer 31

As a response to the economic crisis of Coronavirus in 2020, many governments around the world enacted large-scale fiscal stimulus (expansionary fiscal policy) to revive their economies. Below is a selection of fiscal stimulus packages used by various governments:

1) In the fiscal year ending March 2021, the UK government is forecast to borrow £400bn, 20% of GDP with much of this borrowed money used to finance huge fiscal stimulus to fight one of the deepest recessions in Europe. The UK economy shrunk by 11% throughout 2020 prompting the government to increase spending on wage subsidy schemes, grants, and business loans to protect employment and welfare benefits, making it easier to claim benefits and raising the amounts claimants could claim to help the unemployed. In addition, spending on healthcare, education, and infrastructure increased with further government spending on initiatives to encourage more consumer spending in the summer such as the Eat Out to Help Out Scheme and numerous job support packages to promote greater apprenticeships and in-work training opportunities for the youth. Furthermore, there have been cuts to VAT for the hospitality and tourism industry from 20% to 5% up to March 2021 as well as the cancellation of business rates for industries hardest hit by the pandemic. Though growth rates are some of the lowest in Europe, unemployment rates remain far below levels seen in other European nations suggesting the job support policies in particular have prevented a large spike in unemployment, though the burden of such large borrowing and increases in the national debt will be felt for many years to come with national debt hovering around 100% of GDP.

2) The French government announced a €100bn stimulus package comprising of business tax cuts that businesses pay on top of corporation tax as well various increases in government spending to both fights against immediate damage caused by the Covid recession but to also to promote long run sustainable growth via greater spending on renewable energy, infrastructure, and skills training.

3) Germany deployed a huge fiscal stimulus in June on top of already implemented wage subsidies and business grants, including a widespread VAT cut from 19% to 16% and greater government spending including cheques direct to households with children to promote greater consumption. The government also increased spending on childcare services to enable more adults to get back to work with greater funding for renewable energy storage and digital infrastructure to promote long-run growth.

4) The USA and Japan both implemented some of the largest fiscal stimulus packages in the world worth $2.2tn and $1.1tn respectively favoring a more direct avenue of public money to fund ailing businesses, those unemployed, and in the case of the US, depositing households with cash to provide economic relief and protect incomes. For both countries, further stimulus is likely as debt climbs far beyond 100% of GDP in the USA and beyond 200% of GDP in Japan.

Question 32

Contractionary Fiscal Policy - Austerity Policy

Answer 32

1) Greece was reliant on bailout funds from the IMF and the Eurozone starting in 2010 to avoid complete economic collapse but with these emergency funds came
forced austerity including deep spending cuts and tax rises. Between 2010 and 2015,
government spending on healthcare fell by 50% and education spending fell by 20%. Furthermore, Greek governments reduced employment in the public sector, lowered public sector wages, and cut spending on
pensions. Wide spread tax rises included income tax, corporation tax, VAT, petrol duties, alcohol and cigarette taxes, tourism taxes, imported cars, and many others.

As well as these conditions forced on Greece, liberalizing policies like privatization, deregulation, and labor market reforms were pushed through with many arguing that these policies strangled the economy and prevented any prospect of growth. Budget deficit reduction has come at a huge cost of living standards improvement, economic growth, unemployment, and incomes. The Greek economy has suffered a deep economic crisis with output contracting by 25% since 2009, unemployment peaking at 25%, youth unemployment hitting highs of 66%, and spiraling deflation every year. Italy experienced austerity in a comparable way with similar crippling macroeconomic effects.

2) Since 2010, the conservative party in the UK has adopted austerity policy mainly in the form of government spending cuts to reduce the level of annual public borrowing and the budget deficit). Government spending cuts have focused on government departments, local councils, police services, defense, and welfare. UK austerity policy has differed from that in the Eurozone as tax rises have been limited to a VAT rise from 17.5% to 20% in 2010. Other than this, the government has regularly reduced direct taxes such as income tax and corporation tax to allow for continual growth during austerity years. Austerity policy has worked in that budget deficits have come down from peaks of 10% of GDP in 2009 to 2% of GDP in March 2020. Debt reduction has been successful enough for the government to implement a huge fiscal stimulus to fight the COVID-19 economic crisis in 2020. Though austerity in the UK has stabilized government finances and has brought confidence back in the government’s ability to pay its debt, government spending cuts have been felt especially amongst the poor with welfare cuts and cuts to local government budgets. Some also argue that growth rates could have been much higher if fiscal policy had been looser, actually reducing debt/GDP levels given how low-interest rates have been for the government to borrow at.

Other examples of countries that implemented austerity during the Financial Crisis; 3) Spain 4) Portugal 6) Ireland 7) France

Question 33

Supply Side Policies - UK

Answer 33

1) The UK government has committed to spending £640bn over the next five years as part of a National Investment Strategy to boost productivity and promote greater regional equality.

2) From 2019 to 2022, the investment tax-free allowance has increased fivefold from £200,000 to £1 million meaning that businesses who invest in plant and capital machinery are able to claim back up to £1m from its taxable profits incentivizing businesses to bring forward investment plans thus boosting the capital stock in the economy. There are also subsidies and tax relief available for small and medium enterprises that partake in research and development expenditure.

3) Since the conservative party came into power in 2010, corporation tax rates have fallen significantly from 28% in 2010 to 19% in 2020 encouraging more capital re-investment from greater retained profits.

4i) The income tax-free allowance has been raised from £6,500 in 2010 to £12,500 in 2020 with rate taxpayers paying £1,205 less tax than in 2010. The income threshold
before the 40% rate is due has increased from £37,400 in 2010 to £50,000 in 2020 with 1 million fewer workers in this bracket than in 2015. These policies encourage entry into the workforce and provide incentives for those who work to raise productivity and earn greater disposable income.

i) The government has also committed to providing more apprenticeship schemes in order to fill skills shortages in the economy via an apprenticeship levy on businesses where firms earning over £3m profit commit to spending 0.5% of their payroll costs on apprenticeship training. Businesses earning less than this commit to spending 5% in 2020 (a reduction from 10% prior) of apprenticeship training costs with
the government funding the remaining 95%.

iii) Since 2015, there has been widespread curriculum reform including changes to both primary and secondary curriculum, large-scale reform of GCSE and Level examinations, the introduction of TLevels (practical subject qualifications as an alternative to A Levels) and greater government funding for maths and computer science subjects in schools. Again such education reform is intended to increase and vary skills to fill shortages in the economy but also to raise productivity of the workforce when students finish their education. There has also been a commitment to a further £2.2bn of funding for schools in 2021 representing a 2.2% increase in funding per pupil.

iv) For adults who want to re-train and gain new skills, there are subsidies/grants available to encourage them, improving the affordability of attaining new qualifications. For adults without any ALevels, it is now free to enrol in college courses.

v) The NHS budget will increase by £20.5bn on top of inflation by 2024, which will help to maintain a healthy and productive workforce, whilst further funding has been confirmed for vaccinations, testing, PE and other health services to battle the Coronavirus pandemic and maintain productivity.

5i) £28.8bn will be spent by the government between 2020-2025 as part of a National Roads Fund. Most funding will be allocated to the upkeep and maintenance of roads and bridges whilst £420m will go directly to local authorities to fix potholes and renew tunnels and bridges. £150m will be used for improving road systems at traffic hotspots reducing journey times and thus boosting productivity.

i) The government has committed to two of the largest rail infrastructure projects in Europe, designed to improve labour mobility, flexibility and productivity; Crossrail at a cost of £18.7n and HS2 at an estimated cost of £106bn.

iii) £1bn will be spent on improving digital infrastructure to
boost productivity with the major allocations being £176m to increase the range of 5G mobile internet networks and
£200m to promote full fibre networks in local areas ensuring the entire country has access to super fast Wi-Fi speeds.

iv) In a further push to improve labour mobility and flexibility, there have been cuts to planning permission for new housing infrastructure to be built and local authorities have had their borrowing caps lifted allowing them to borrow and spend more on house-building programmes. These policies are in addition to many others to make housing more affordable such as The Help to Buy Scheme and stamp duty exemptions for first-time buyers.

6) The UK government aims to ensure the welfare system is equitable but also not too bloated where there are minimal incentives to work. To achieve this, the government has implemented Universal Credit; a brand new benefits scheme designed to incorporate previous individual benefits into one general benefit payment. Within Universal Credit, there are also caps and other restrictions on the level of benefits that can be claimed which is forecast to lead to a cost saving of f1bn by 2023 when the scheme has been fully rolled out.

7) To make markets more competitive, thus improving the productive efficiency of the economy, the government have promised widespread deregulation, cutting £10bn worth of red tape, committing to scrapping three regulations for everyone they impose and challenging businesses to find burdensome regulations that can be disposed of.

8) It is expected that the UK will be a promoter of free trade post official withdrawal from the EU, liberalising trade by signing international trade deals, and reducing both tariff and non-tariff barriers.