Macro Essay Plans

Evaluate whether a persistent current account deficit is damaging for the economy, such as for UK & US

‎Para 1: Fall in AD → ↓EG & ↑u/e

• ↓Net exports → ↓AD → ↓SREG

• +↓DD4L → ↑u/e

IDO: % composition of AD - APP: UK’s net exports only -1.7% of AD, so impact minimal

‎

Para 2: Helps control demand-pull inflation

IDO: Size of output gap

‎

Para 3: Importing capital & technology

• Imports may be importing capital goods & technology

• → ↑Factor endowment → ↑Productive potential → LRAS right → LREG → Sustainable, NICE growth

IDO: Whether driven by high imports or low exports

‎

OB: IS damaging

MIP: In UK & US, CAD has been persistent for DECADES. Given UK having weak EG rates recently (1.4%), this negative export balance is acting as a drag. Duration is important as failing to achieve its ‘avoid persistent current account deficit’ objective.

ICDO: Cause/type of deficit. If structural, it is harder to solve and more important/ more of an issue. If cyclical, is easier to solve & can be self-correcting

Recommend: Assess underlying cause

Evaluate which is the most effective policy to solve the UKs current account deficit in the short and long run

‎Para 1: Expenditure-reducing

• Contractionary fiscal policy

APP: During Eurozone debt crisis, countries like Greece couldn’t devalue currency so gov implemented contractionary fiscal by slashing gov spending

IDO: Size of output gap

‎

Para 2: Expenditure-switching

• Depreciating exchange-rate via supplying more currency on forex market

APP: China has been accused of ‘currency manipulation’ by keeping RMB undervalued through massive purchases of foreign reserves

IDO: Marshall-Lerner condition

‎

Para 3: Expenditure-switching

• Protectionism - tariffs

APP: US Trump Tariffs

IDO: Risk of retaliation - trade wars

‎

Para 4: Supply-side policies

• Investment in education & training

APP: Germany has low youth unemployment rate, attributed to its strong vocational education and training programs.

IDO: Long time lag, or Brain Drain (e.g. Poland)

‎

OB: SSP’s best

MIP: Allows for NICE growth, achieving multiple objectives - reduces inflation, achieves SREG, achieves LREG, reduces u/e, improves CAD. Furthermore, UK has persistent productivity gap + lack of investment (UK lowest in G7), so UK needs to improve it through SSPs - treating root cause.

ICDO: Cause of deficit. If structural, then use SSPs. However if cyclical, better to use contractionary fiscal or monetary policy. Furthermore, SSP’s are expensive - UK has persistent budget deficit and national debt 100% of GDP.

Recommend: Use combination of policies as some work better in SR and some better in LR.

Evaluate the extent to which a country would benefit from joining a CURRENCY union

Intro: Currency union = An agreement between a group of countries to share a common currency, and usually have a single monetary & forex policy.

• e.g. Eurozone

‎

Para 1: Trade Creation

• Sharing a currency eliminates ER fluctuation risks → Lowers uncertainty in trade

• +Reduced transaction costs as no need for currency conversion

• ↑Exports → ↑AD → ↑Emp → ↓U/E

• +Trade creation diagram - World supply shifts downwards → Price falls

IDO: Amount of trade done with member countries

‎

Para 2: Access to fiscal transfers/assistance from other members

• If in financial difficulties w/ high national debt, can get cheaper loans or emergency grants from other member countries

IDO: Whether countries are willing to make fiscal transfers

‎

Para 3: Loss of independent monetary policy

• Share a single monetary policy with currency union, so individual countries cannot use monetary policy to achieve their own macroeconomic objectives

• → Risk of Asymmetric shocks - Countries have different needs - currency union cannot adjust IR just for one country’s needs because it affects all the other countries in the union too

• If an economic shock affects one country more than others, can be difficult to manage the risk.

• APP: Greece sovereign debt crisis - Greece couldn’t reduce IR to support falling GDP and high u/e

IDO: How aligned the economic cycles of countries are

‎

OB: Would benefit

MIP: Evidence from other countries that have joined

ICDO: Extent to which it is an Optimal Currency Area - alignment of economic cycles, amount of trade done, flexibility/mobility of labour market, whether willign to make fiscal transfers

Evaluate the extent to which aid is the most effective policy to deliver economic development / whether aid is effective at increasing economic development

Intro: Aid = Financial or resource transfers from one country/organisation to another country. Economic Development = The process of improving people’s economic wellbeing and living standards, measured by HDI

‎ ‎

Para 1: Technical assistance can build stronger institutions

• APP: IMF helped Rwanda build modern tax systems

• Improves gov ability to collect tax revenue → ↑Tax revenue → Improve gov fiscal budget position

• → Increased funds for gov to spend on improving citizen’s wellbeing, e.g. spending on healthcare & education → ↑Mean years of schooling + ↑Life expectancy → ↑HDI → ↑Economic development

IDO: Quality of governance & level of corruption - may not try to improve running of institutions even with help

‎

Para 2: Project aid can help infrastructure

• Aid for building infrastructure, e.g. roads, schools, hospitals

• ↑Transport

• ↑Education

• ↑Healthcare

• ↑Quality & quantity of capital and labour → ↑factor endowment → ↑LRAS → LREG

• APP: Mumbai-Ahmedabad High-Speed Rail Corridor (Japan to India)

IDO:

‎

Para 3: Dependency culture

• If constantly receiving aid, become dependent

• Lack of incentive to develop its own domestic resources and institutions → Decreased entrepreneurial culture → LRAS left

• Long-term aid if stopped, living standards plummet

• APP: Afghanistan, where international aid has made up 40% of GDP

IDO: Length of aid

‎

OB: Is effective at boosting ED but it has limitations so gov may want to consider combining with other interventionist or market-based development policies

MIP: Has many benefits especially technical assistance helping improve fundamental issues in institutions, before other policies can be pursued.

ICDO: Type of aid & conditions of aid - if has many conditions attached from donor country, then may hinder EG & ED in the LT as may need to repay. Also how well implemented and targeted aid is

Evaluate the extent to which monetary policy is the most important tool to deliver strong economic performance

Para 1: Yes - interest rates transmission mechanism works through 3 out of 4 AD components

• Consumption

• Investment

• X-M

IDO: However, only effective for demand-pull inflation not cost-push

‎

Para 2: Yes - IR can be supplemented by Quantitative Easing

• Can increase EG & avoid deflationary spiral

• IR down, if doesnt work can then use QE

• APP: QE post Global Financial Crisis

IDO: Risk of liquidity trap (e.g. after GFC)

‎

Para 3: No - Supply-side policies better for structural/supply-side problems

• Invetment in education & training

• Shift SRAS & LRAS right

• Achieve NICE growth

IDO: However, interest rates can also help control some cost-push inf through rising ER → cheaper imports

‎

Para 4: No - Monetary policy has flaws

• Blunt instrument - many side effects (e.g. asset price bubbles) & cannot be tailored to specific regions & industries

• Time lag - Takes up to 2 years to have full effect

• Zero bound

‎

OB: Monetary policy IS most important

MIP: MP is most powerful in short-term. Used by economies all over the world. Examples from GFC and COVID to see how important IR and QE was at helping economies avoid recession/deflationary spiral

ICDO: Time frame - In LR, SSPs more important for LREG to allow SREG to continue.

Recommend: Combination - MP, Fiscal, SSPs, Trade

Evaluate the extent to which unemployment is always harmful for an economy

Para 1: Yes - reduces incomes & living standards

• Loss of income → Less money to spend on g&s → ↓Material standard of living → ↑health risks, stress

• → ↓Consumption → ↓AD

• → Less consumption → ↓Investment → ↓AD → Negative SREG → Further falls of employment - virtuous cycle

• → Higher spending on welfare benefits + lower tax revenue→ worsening fiscal budget position → ↑national debt

IDO: Level of u/e benefits

‎

Para 2: Yes - decrease LRAS

• ↓Consumption → ↓AD → Negative SREG → Negative accelerator effect → ↓Investment → ↓QQE of Capital → ↓Factor endowment → ↓Productive potential → ↓LRAS

• + long-term u/e → Hyteresis → ↓Quantity & quality of labour force → ↓Factor endowment → ↓LRAS

• → ↑CoP → SRAS left → Cost-push inflation → less int price competitive → worsening BoP

APP: Especially important if u/e is related to the young e.g. 50% Spanish youth unemployment

IDO: Length of u/e

‎

Para 3: No - Controls inflationary pressures

• Unemployment → Wider pool of labour for firms to recruit from → ↓Costs of recruitment + improved quality of workers as many spare available to choose most efficient ones → ↓Wage pressure → ↓CoP

• + workers more motivated to work harder due to fears of u/e → ↑productivity

• + less risk of industrial unrest / strikes

• + Lower demand-pull inflation from less consumption

IDO: Size of u/e

‎

OB: U/E is NOT always harmful

MIP: Word ‘always’ - indeed some u/e is inevitable, like frictional. But in not all situations is it damaging.

ICDO: Type of u/e. Structural most harmful. Cyclical & frictional less worrying as short-term.

Recommend: Aim for low u/e (e.g. the natural rate of 3-5%) and concentrte on structural & cyclical.

Evaluate the extent to which free trade will always benefit an economy

Evaluate whether protectionism will benefit an Economy

Evaluate the extent to which comparative advantage explains the current patterns of global trade for the UK

Para 1: Yes - comparative advantage

• UK has comparative advantage in financial services & pharmaceuticals due to skilled labour force, advanced infrastructure & strong institutions → Specialisation in these sectors → Net exporter of these sectors

• UK imports labour-intensive goods like clothing & electronics from countries like China, Vietnam, India, where labour & production is cheaper → Trading based on specialising in lower opp cost (comparative adv)

• UK lost comparative adv in oil due to depletion of North Sea Oil → Net importer of oil

IDO: Model of comparative adv has unrealistic assumptions (no transport costs) → in reality, countries don’t specialise in one good/service

‎

Para 2: No - Protectionism/tariffs

• US tariffs on UK exports (10% generic, 25% specific) → UK exports to US decrease

• Shown by tariff diagram - USA market UK to UK+tariff

IDO: Elasticity of demand for UK exports

‎

Para 3: No - Exchange rate

• Post-brexit → Pound depreciated → Exports cheaper, imports more expensive

• UK buys a lot of exports from CHINA due to their low value currency

IDO: However, ER arguably short-term. In long-term, comparative adv may be better to explain underlying cause of trade patterns

‎‎

OB: Does NOT FULLY explain current pattern of trade

MIP: Whilst CA provides core essence of trade, there are too many other significant factors which also play an important role. As seen recently, Trump tariffs have had a significant impact on global markets. The word "current" implies short-term. Tariff most significant in short-term, while CA provides fundamental pattern of trade in LR

ICDO: Extent to which global free trade agreements are forged and stuck to. The WTO working hard, one may argue CA will become increasingly important. However, otherese argue that world politics like trump tariffs and china retaliation, ca becoming less important.

Explain the regulation of the financial system in the UK (15)

Assess which is the most important determinant of investment in a country/UK

Para 1: Interest rates

• Low IR → Reduces costs of borrowing → I↑

• Low IR → ↓Incentive to save → I↑

IDO: Liquidity trap

‎

Para 2: Economic Growth / Accelerator effect

• Accelerator effect - SREG → Need to meet rising demand → Spare capacity falls → Must invest in new machinery → ↑I → Shifts AD further - VIRTUOUS CYCLE

• Therefore, accelerator effect states that level of investment is determined by rate of change of real GDP

IDO: Size of Negative Output Gap - if large, firms dont need to invest to meet increased AD

‎

Para 3: Business confidence & animal spirits

• Investment is a ‘sunk cost’ so firms must be certain of macroeconomic stability before committing funds

• Uncertainty e.g. from BREXIT → Low business confidence → Firms postpone investment projects → ↓I

• + Expectations of future tax rises → ↓I

IDO: Confidence is SUBJECTIVE → some economists argue that even with uncertainty, firms still invest if capacity utilisation at its limit

‎

Para 4: Expected profitability / Corporation Tax

• ↓Corp tax → ↑Retained + potential profits → More money to invest + more incentive to invest → ↑I

IDO: Crowding out effect - If gov lowers taxes, gov may need to borrow heavily instead to fund investment, pushing up interest rates → Increased costs of borrownig for firms → reducing private investment.

‎

OB: FOR UK, Rate of EG is most important, expressed through the accelerator effect

MIP: That UK’s persistent ‘investment gap’ is rooted in a lack of long-term stability. The Brexit Uncertainty Premium and threat of future tax rises to repair public finances have suppressed 'animal spirits', leading firms to prioritise shareholder dividends over R&D

ICDO: Level of capacity utilisation (size of NOG) - UK current 0.8%. As long as there is a gap, firms will continue to meet rising demand by using existing labour & capital rather than new investment

Recommend: UK gov should provide a 10 year roadmap for corp tax to reduce uncertainty. Pair this with AD stimulus to close 0.8% output gap.

Evaluate whether demand and supply-side shocks are the most important factor in determining economic growth

Explain reasons for investment in the UK being lower than in other G7 economies (15)

UK has lowest investment in the G7

‎

Higher Interest Rates:

• Currently 3.75%

• High IR → Increases costs of borrowing → ↓I

• High IR → ↑Incentive to save → ↓I

‎

Higher Corporation Tax:

• Main rate of 25% of profits in UK

• ↑Corp tax → ↓Retained profits + potential profits → ↓Money to invest + incentive to invest → ↓I

‎‎

Uncertainty:

• Investment is a ‘sunk cost’ so firms must be certain of macroeconomic stability before committing funds

• Uncertainty e.g. from BREXIT → Low business confidence → Firms postpone investment projects → ↓I

• + Expectations of future tax rises → ↓I

• The Brexit Uncertainty Premium and threat of future tax rises to repair public finances have suppressed 'animal spirits', leading firms to prioritise shareholder dividends over R&D