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Macro Economic Essays

These are some suggested macro economic essays from different exam boards
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The essays are all relevant for
the current exam syllabus
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I could have made the essays longer, but I preferred to make them concise, only
answering the question and not including any waffle or unnecessary introduction
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If the question begins – Explain – this doesn’t require evaluation
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See also the Macro Revision Guide available at
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Macro Economics Essays
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2
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3
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4
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Do such deficits matter? Justify your answer
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Explain how countries benefit from international trade even though they may
produce similar goods and services
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Discuss the factors that determine the trade competitiveness of the UK
economy
7
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A government is faced with an unacceptably high level of unemployment, but
does not wish to increase its overall expenditure
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10
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11
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12
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13
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14
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15
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16
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17
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18
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19
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20
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21
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22
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23
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24
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Assess the impact on UK macroeconomic performance of a prolonged period
of deflation
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Compare the effectiveness of supply side and fiscal policies to correct deficits
on a country’s current account of the Balance of Payments
A current account deficit means the country imports a greater value of goods and
services than it exports
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Supply side policies aim to increase the productivity of the economy
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This will help increase exports
and reduce the current account deficit
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Vocational training schemes may help increase
labour productivity because workers will have more skills
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Alternatively, the
Government could introduce a free market supply side policy such as reducing the
power of trades unions
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If union
power is reduced it helps reduce time lost to strikes, increases labour market
flexibility and therefore should help increase UK exports
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The nature of the UK
housing market means that it is often difficult for workers to move to areas where jobs
are available
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The problem of supply side policies is that they will take time to have effect
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Also, there is no guarantee that education spending may actually increase
labour productivity, especially if the money is misspent or the workers don’t want to
learn
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Also, some argue trades unions can actually help introduce new
working practises and thereby increase productivity
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Current account deficits often occur during times of economic growth and therefore
high consumer spending on imports
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For example, higher income tax
would reduce consumer’s disposable income and therefore reduce imports
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Deflationary fiscal policy would also reduce inflation and thereby help to make UK
goods more competitive
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Higher taxes will reduce growth and could cause
unemployment
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Also fiscal policy doesn’t address the
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fundamental underlying problem, which is a lack of competitiveness
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It also depends on the type of current account deficit
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If the current account deficit is the result of a consumer led economic
boom, then fiscal policy can be effective in reducing the economic boom and reducing
import spending
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Assess the economic effects of a significant increase in taxation on the UK
economy
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If tax was increased, but spending remained the same, it is likely that aggregate
demand would fall
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If the economy was in a boom, and
the economy was growing above the long term trend rate, an increase in taxes would
help reduce inflation without causing a recession
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But, a fall in AD from AD3 to AD 3 would lead
to a big fall in GDP
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For example, if
consumer confidence is very high, an increase in taxes might not reduce consumer
spending very much because consumers may simply borrow more
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Higher taxes lower AD, but higher government spending
increases AD
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The supply side effects of higher taxes are disputed
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However, income tax in the UK is quite low - 22%, therefore a moderate
increase may not reduce incentives to work because the income effect (people need to
work more to maintain a certain income) counters the substitution effect
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If indirect taxes (VAT and excise duty) are increased it is likely to reduce income
equality
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However, if the government increased income tax it may improve the
distribution of income
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This is
because it is argued the government is more inefficient at spending money than the
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private sector
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It depends on what and how the
extra tax revenue is spent
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This could be important for a country facing a high level
of government borrowing to GDP
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Does higher tax mean higher government
spending? What kind of tax is increased? It is easy to get evaluation marks by considering
different possibilities
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Discuss the Impact of Globalisation on UK economy
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The process of globalisation has
led to increased trade, increased inward investment and greater communication
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There has also been an increased role for multinational corporations and
international bodies such as the IMF
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This has
created several benefits for the UK
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Globalisation has enabled a reduction in
tariffs and transport costs leading to cheaper imports
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It has also enabled a wider choice of goods and services;
for example, supermarkets are now able to stock a wide range of fruit and veg
throughout the year
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Critics argue
multinational corporations have been able to dominate, leading to big multinationals
pushing out smaller independent retailers to the detriment of local firms
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But, others may say globalisation isn't really to blame for
the decline of small shops, it may be due to other factors like out of town shopping
centres; also small shops can still exist even with process of globalisation
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Due to
globalisation, production is increasingly specialised; for example, the manufacture of
a car has increasingly been split up into different countries so that different parts of
the car are assembled in different countries
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Another benefit of globalisation is that it has increased the competitiveness of certain
markets
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This increased competitiveness has helped lower prices for consumers
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For example, British
industry has struggled to remain competitive against countries such as China, which
benefit from lower wage costs
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This is reflected in a persistent UK trade deficit
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However, this process of changing industries is not a new phenomenon and whilst
globalisation has led to the decline of some industries, it has also led to the growth of
others
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Therefore, whilst some sectors have lost from globalisation others
have benefited
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For
example, the UK has experienced net migration of workers from Eastern Europe
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This process of migration helps to make the UK labour market more
flexible; it has helped fill shortages in sectors such as nursing
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People fear it has led to shortages of housing in
places like London; politicians are under pressure to place caps on migration
numbers
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It
means monetary policy decision in Europe and the US can easily impact the UK
economy
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This has both positive and negative effects
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The
fortunes of the UK economy are increasingly tied to the rest of the world, especially
the EU where most of our trade occurs
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In a way globalisation has always been with us, since trade began
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Comment
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t
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The examiner
won’t expect a comprehensive answer which covers everything to do with
globalisation
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• Make sure you specifically say how globalisation affects the UK economy
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4
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Do such deficits matter? Justify your answer
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Firstly, a deficit on trade in goods, usually implies a current
account deficit
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It is argued that a trade deficit is damaging to the economy
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It means consumers are preferring to buy imports
rather than domestic production
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This could involve short term capital inflows from abroad which might dry
up
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g
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This makes the US vulnerable to China withdrawing its dollar holdings
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A deficit on the goods account can cause a depreciation in the currency
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The US has
recently had a current account deficit of over 5%, during this period the US dollar
depreciated significantly as the US struggled to finance the deficit
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However, others argue a goods deficit is not a matter of concern
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For example,
Chinese investors have been willing to purchase US securities and effectively finance
the US deficit
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A devaluation is not necessarily a bad thing
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However, a
depreciation is a bad thing if it causes inflation
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Because insufficient domestic goods are being produced, people buy from abroad
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Countries with trade deficits typically have a
low savings ratio and a high rate consumer spending
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However, you could also argue a goods deficit is the sign of a strong economy –
better than having a large surplus but sluggish growth
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To get a better idea about the state of the economy, it is important to look at other
variables such as inflation, economic growth and unemployment
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Explain how countries benefit from international trade even though they may
produce similar goods and services
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Even if the
difference is quite small, producing goods with a lower opportunity cost enables
greater efficiency and scope for trading
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Consumers will benefit from a greater
choice and lower price of imports
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For example, by specialising in producing a good like cars and
aeroplanes, firms will be able to benefit from economies of scale
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Ultimately, consumers benefit from lower prices
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For
example, producing cars is not just confined to one country
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International trade also opens up domestic monopolies to international competition
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For example, the
UK may have one car manufacturers
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6
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The trade competitiveness refers to the relative export prices of the UK compared to
other countries
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For example, an appreciation in the exchange rate
makes exports more expensive and therefore less competitive
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A depreciation in the
exchange rate will give a boost to competitiveness because exports will become
cheaper
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Therefore, in the long term inflation may rise and competitiveness declines
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Labour costs play an important role in determining competitiveness, especially in
labour intensive manufacturing goods
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However, labour costs are not the only factor to consider
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For example, some goods require
skilled labour, for these goods the education, skills and productivity of the workers is
more important than their basic wage
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economicshelp
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Good transport links and
networks help to reduce the cost of exporting goods
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Quality of
Goods is another factor that determines trade competitiveness
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Price is not the only
factor in determining sales of exports
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Discuss the importance of promoting free trade through organisations such as
the WTO
Free trade involves removing all tariffs on trade between different economies
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The World Trade Organisation exists to help promote free trade
and provide a forum for countries to resolve trade disputes and promote free trade
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If tariffs are removed, there will be an economic advantage
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Some domestic
exporters will lose out (1)
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However, the diagram below shows that overall there will be an increase in economic
welfare of areas 2+4
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Although free trade may lead to a decline in some industries, other industries will
grow and compensate for this
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For

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example, the UK has seen a decline in its clothing industry because of cheaper
competitors in China
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Free trade also enables firms to specialise and benefit from economies of scale
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The greater economies of scale will lead to lower costs and lower prices
for consumers
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With tariffs a domestic monopoly may
be protected from international competitors
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For these reasons free trade has been an important engine of growth and has enabled
many developing economies, especially in the Far East to see an increase in living
standards and economic development
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Firstly, some
developing economies may struggle to remain competitive if tariffs are reduced
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g
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However, they may have good reasons to try and develop a better
manufacturing base
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Tariffs enable a
new (infant) industry to sell to the domestic market before facing international
competition
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Without tariffs to protect infant industries, developing economies may be unable to
diversify their economy
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For this reason,
many argue free trade gives a greater benefit to developed economies (who don't need
to develop infant industries)
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However, it is worth bearing in mind, developing economies have often struggled due
to high tariffs placed on EU and US agriculture
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Another potential disadvantage of free trade is that it could lead to environmental
problems
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Thus free trade can be a way to
overcome environmental laws
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Often the EU has experienced surplus of foodstuffs
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This depresses food prices and therefore incomes
of farmers
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In conclusion, free trade has many potential advantages for consumers, firms and
general economic welfare
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In
particular, developing economies, which try to diversify away from relying solely on
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agriculture, may well benefit from a period of tariff protection until they can compete
on an international scale
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A Government is faced with an unacceptably high level of unemployment, but
does not wish to increase its overall expenditure
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If the unemployment is caused by an economic downturn (low or negative economic
growth), the government should pursue demand side policies to try and increase
aggregate demand
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This would
boost consumers’ disposable incomes and hopefully boost consumer spending
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This policy will be effective for reducing demand
deficient unemployment without causing higher spending
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As output
increases firms demand more workers
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economicshelp
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As firms produce more,
they require more workers
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In a recession confidence may be low, so tax
cuts may be saved rather than spent, therefore there will be no increase in AD and no
jobs created
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To pay for the
tax cuts the government has to borrow from the private sector by selling bonds
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Also
expansionary fiscal policy will not solve unemployment if it is due to supply side
factors
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Unemployment could be voluntary, e
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high unemployment benefits create an
incentive to remain unemployed rather than get a job
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Also to increase the
incentive to take a job, the government could increase the national minimum wage
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However, in the UK, benefits are already quite low compared to the
national minimum wage therefore a cut in benefits may not solve the problem
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However, it might be
effective in reducing unemployment for a country like Germany with generous
unemployment benefits
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These policies enable wages to fall to their equilibrium levels and increase
demand for labour
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Finally, the government could consider tax credits to firms who train workers
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Tax breaks for firms who train workers are a way to
encourage training without spending money
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Also there is no guarantee that subsidies on
training will actually increase the productivity of labour and reduce structural
unemployment; for example, workers may be unreceptive to training schemes
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For example, if the government reduce bureaucracy
surrounding the hiring of workers and prevent restrictive job contracts, firms will
have a greater incentive to hire workers
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However, by making labour markets more flexible, it could make work more
temporary and volatile; workers may become demotivated because they know there
job is only temporary and they have no security of a permanent contract
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Explain the likely economic reasons for government borrowing
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For example,
increased spending on roads and transport could help increase the efficiency of
industry, leading to higher rates of economic growth in the future
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Therefore, borrowing can
be justified to finance the investment
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In a recession, there is negative economic growth
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Firstly, people earn less so income tax falls
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Thirdly, people spend less so VAT revenue declines
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These are known as automatic stabilisers
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g
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This should, in theory
help increase Aggregate Demand and stimulate economic growth
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Therefore, a recession can cause a rapid increase in
government borrowing
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An ageing
population tends to need more government spending but pays less in tax
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Also, old people are more likely to need
expensive health care treatment
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A final reason may be because the government is bailing out the financial sector
...
g
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This is an example of an
unexpected financial shock to government finances
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For
example, before an election a government may try to appear more popular by cutting
tax and increasing spending
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10
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Government borrowing occurs when government spending is greater than tax receipts
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In
return, the government pay interest on the bonds
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) In a period of high growth,
expansionary fiscal policy will increase AD further and is likely to exacerbate the
problem of inflation
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When the economy is in recession,
inflation is unlikely to be a problem; therefore in this situation an increase in
government borrowing is unlikely to cause inflation
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The impact of Government borrowing will depend on situation of economy
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But, in a recession,
AD1 to AD2 helps increase growth
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Firstly if the government has to borrow
more, it may put upward pressure on interest rates as rates on bonds need to rise to
attract sufficient lenders
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This is known as financial crowding out
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This will occur because the government
has to borrow from the private sector
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Therefore, government borrowing doesn’t increase aggregate demand, but just
switches resources from the private sector to the (often more inefficient) public sector
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This is because resources are idle
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In a recession, the private sector save more
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Furthermore,
government borrowing can cause a positive multiplier effect to cause a bigger final
increase in GDP
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This
is because of a lack of incentives for people in the private sector
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However, the government spending
may be to overcome market failure such as transport and health care
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Higher borrowing presents a burden on future taxpayers
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In the UK, debt interest payments
are already over £40 billion a year
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If it does, national debt as % of GDP will increase
making it harder to pay back in the future
...
For example, the government increase borrowing during economic
growth of 2002-2007
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A key issue is whether bond markets feel government borrowing is sustainable
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However, if markets fear that borrowing is too high, they may worry the
government may default or print money and create inflation
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In this case, the
governments may find it very difficult to borrow
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In 2010, EU
countries such as Greece and Ireland were in this situation
...

Some countries may respond to excessive government borrowing by printing money
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However, it means the real value of bonds falls making investors reluctant to
buy debt from that country again
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11
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Economic growth means an increase in Real GDP
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In the short term, economic
growth may be caused by an increase in Aggregate Demand
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This would increase their confidence to spend; it would also enable them to remortgage to gain equity withdrawal
...
Alternatively, aggregate demand could rise due to
higher global economic growth
...
A third factor that may increase economic
growth could be a change in monetary or fiscal policy
...

As well as demand side factors, it is also important to look at supply side factors
...
For example, an increase in
the population, due to immigration, would increase the labour force and increase
aggregate supply
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The above diagram shows economic growth in the long run
...

Technology also plays an important role; improvements in technology are one of the
best ways to increase aggregate supply and productivity
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Their competitiveness in manufacturing has enabled them to export to the
West and this has been an important factor in their growth rates
...


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12
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If the UK joined the single currency, there could be some factors which help boost
economic growth
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Since exports to the EU account for 60% of the UK’s trade it
is important
...
Therefore, a single currency would only have a relatively modest impact
on increasing exports and therefore growth
...
At the moment, UK
exporters could suffer from rapid appreciations in the exchange rate against the Euro
...
Therefore, this gives us greater stability and
might encourage investment
...

If the UK adopts a single currency it might encourage foreign direct investment from
firms (e
...
, Japanese or Chinese) looking to invest in the Euro area
...
However, the Euro is only one
factor of many which determines inward investment
...
If we joined the Euro, it would be easier to compare prices
throughout the Eurozone
...

Economic growth could be influenced to a greater extent by the impact of the single
monetary policy
...
The concern is that interest rates set by the ECB
may be unsuitable for the UK economy
...
If this is the case, UK growth could suffer
...
Furthermore, because
of the nature of the UK housing market (many people have large variable mortgage),
higher interest rates would have a big effect on reducing growth rates
...

Interest rates may be kept low
...

In the boom period of 2002-2007, ECB interest rates were lower than UK interest
rates; if we had been in the Euro, we would have had a bigger bubble in the property
market
...
The UK could also pursue its own
monetary policy - quantitative easing to help the economy recover
...

If the UK economy harmonises with the EU economic cycle, then a common
monetary policy may not be such a problem, and UK economic growth would not be
affected very much
...
For example, there is a lack of labour mobility between the
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UK and EU
...

Overall, membership of the Euro has several benefits, however, a common monetary
policy has potentially a very high cost
...


13
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The EU has expanded to include several former eastern European countries such as
Poland and Slovakia
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The EU has zero tariffs among member states
...
Therefore, trade between the UK and new EU countries should be easier
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As well as traditional exports, the
UK may also benefit from aspects of the economy such as higher education
...
Also, UK consumers will benefit
from the reduced the cost of imports from these countries
...
This means the gains from
greater trade is fairly limited and will not affect the economy significantly
...

Another aspect of the EU is the free movement of labour and capital
...
Because the UK has higher wages than
many of the new members, there has been an influx of migrant workers coming to the
UK
...
They have filled in
job vacancies such as plumbers and teachers
...
Since most immigrants tend to be of working age, it has helped to combat the
demographic problems of an ageing population
...
However, the influx of migrants also creates
problems
...

The EU acts like a single market and therefore, there is increased competitiveness
between member states
...
However, this factor is likely to be still
small
...
The new member countries are relatively
poorer than the UK, therefore, there is likely to be a net flow of money from the UK
to these poorer countries
...
9
billion 2006), the impact on overall GDP will be marginal at best
...
Discuss Policies to Reduce Inflation
Inflation means a sustained increase in the price level
...
If inflation increases above this target they are likely to change
interest rates
...
Higher interest rates would make borrowing more
expensive and increase the incentive to save
...
Householders with variable mortgages would see an increase in mortgage
interest payments and this would cause lower consumer spending
...
However, an increase in interest rates may not be effective if
consumer confidence is very high
...
Also it depends on other variables in the
economy
...

Finally, interest rates typically have a time lag of up to 18 months
...
For example, homeowners may have a two year fixed
mortgage deal; it will only be at the end of their mortgage term that they would realise
the increase in interest rates
...

Alternatively, deflationary fiscal policy could be used
...
Higher income tax will reduce consumer
disposable income and therefore reduce consumer spending and aggregate demand
...

However, higher income tax could have a supply side disincentive effect
...

Supply side policies could also help to reduce inflation
...
If firms are privatised, they have a profit incentive to cut costs
...
This could
lead to lower prices for consumers and therefore lower inflation
...

If wage inflation is a problem, reforming labour markets to increase labour market
flexibility could be a solution
...
However, reducing
power of trade unions could leave labour exploited by monopsonist employers and
increase income inequality
...
Explain how exchange rates are determined in a floating exchange rate
system
...
For
example, the value of the pound would increase if there was an increase in demand for
pound sterling on the foreign exchange market
...
This would cause international investors to move money to British banks and
investment trusts
...

When economic growth is high, currencies tend to appreciate
...

Another factor that affects the currency is long term competitiveness
...
Relative inflation rates play a key role in determining
long run exchange rates
...
For example, if
investors expected the pound to rise in the future because of stronger growth, people
would buy now to try and make a profit
...


16
...

A rise in the value of the pound against our two main trading partners would be
important because they account for over 75% of the total UK trade
...
Similarly imports would become
cheaper, encouraging UK consumers to buy more imports and travel to EU / US
...
Therefore, an
appreciation will cause a fall in aggregate demand or cause the growth of AD to slow
down
...

This diagram assumes a fall in AD, (though in practical terms a slower growth in AD
is more likely)
...

A rise in the value of the pound will help to reduce inflation for three reasons
...
g
...
Imports make up about 40% of the CPI, so are quite
important
...
If this occurs, then the UK
may not lose out in the long run, but gain from increased productivity
...

The impact on the current account again depends on the Marshall Lerner condition
and the elasticities of demand
...

A key question is the elasticity of demand for UK exports
...
The J Curve effect
suggests demand can become more elastic over time
...
But, after
time to adjust to the higher price of exports, the current account deteriorates, as
demand becomes more price elastic
...
For example, if the economy is also experiencing higher interest rates and
falling house prices then consumer spending is likely to be falling
...
However, if the rest of the
economy is booming a rise in the value of the pound could be helpful in reducing
inflationary growth
...
If the pound
increases in value due to a long-term improvement in productivity and
competitiveness then the economy should be able to absorb the rise in the value of the
pound
...


17
...

A falling rate of inflation can have various benefits for the UK economy
...
It encourages firms to
undertake investment
...

A lower inflation rate will help make UK exports more competitive
...

Lower inflation is desirable because it avoids menu costs (costs of changing price
lists) and also prevents redistribution of income from savers to borrowers
...
For example, an inflation
rate of 8% would be seen as undesirable because it would create instability and
discourage long term investment
...
Therefore,
lower inflation would avoid these problems
...
If inflation is falling because of weak
consumer demand then there will be lower economic growth and the possibility of
recession
...

If the inflation rate fell too much and became deflation, then the economy may really
begin to stagnate
...
(e
...
Japan in
1990s) This is why the government have an inflation target of 2%
...

However, some argue, if inflation is high, then it is necessary to reduce it, even if it
means the short term pain of lower economic growth
...
Lower costs and higher productivity will help increase the long run trend rate
of growth and create new job opportunities
...

Ideally inflation will fall due to increased productivity rather than a fall in AD
...


18
...

An increase in interest rates makes borrowing more expensive, therefore it will deter
firms and consumers from borrowing and therefore this will lead to lower spending
and investment
...
Also people with variable mortgages will have higher mortgage
interest payments
...
The
combination of higher borrowing costs, more saving and lower disposable income
will lead to a fall (or slower growth) in consumer spending and investment
...
This will lead to lower economic growth
and lower inflation
...

Also, an increase in interest rates would cause an appreciation in the exchange rate
...
The appreciation in the exchange rate would
make exports more expensive leading to a further fall in AD and also lower inflation
...
Higher interest rates will reduce
consumer spending on imports, this will improve the current account
...
In practice, the negative impact on
import spending tends to outweigh the exchange rate effect
...
For example, if the
government increased interest rates during a boom and high consumer confidence,
there may be little decrease in consumer spending
...

If there was a fall in consumer spending, the impact would depend on the state of the
economy
...
However, if the economy was in a boom (Y1), higher rates
may just reduce inflation but not cause lower growth
...
However, reducing AD from AD3 to AD4 does cause a fall
in real GDP
...
Savers would get more
income from their savings and therefore, there disposable income would rise, this
could increase their consumer spending
...


19
...

An appreciation in the Euro, means the Euro increases in value compared to other
currencies
...
Demand for the Euro would increase if European interest rates increased
compared to other countries
...
This is known as hot money flows and is
an important factor in influencing exchange rates
...
If euro exports become
more competitive, lower inflation, better products then demand for the Euro would
increase, causing an appreciation in the exchange rate
...
If
speculators lost confidence in the dollar, they may buy Euros and decide to keep
foreign currency reserves in Euros rather than dollars
...

Strong economic growth would help increase the value of the Euro, as stronger
growth would encourage the ECB to increase interest rates and therefore, encourage
hot money flows
...
It means that less foreign currency is flowing out of the euro zone
than flowing in
...
Discuss how the government might improve the UK’s long term economic
growth
...

Therefore, the government should focus on policies to improve productivity growth
and help increase AS
...

28

The government could try to increase incentives to work and incentives for people to
join the labour force
...
They could reduce benefits and make
receiving benefits more rigorous
...
Also, there is a danger genuinely sick people will be left
with no income because they don’t qualify for benefits and can’t work
...

Another strategy may be to make work more attractive
...
This may
encourage women into the labour market and increase the size of the labour force
...
Also higher minimum wages and protection for workers could increase
costs for business and actually damage growth prospects
...
For example, they
could privatise industries such as London Underground
...
However, there is a danger the government merely creates private monopolies
who don’t actually reduce prices and help the economy
...
The government
could try and increased educational standards, especially focusing on vocational
training relevant to the modern labour market
...

However, these policies would be quite expensive and there is no guarantee spending
more money actually increases the skills of workers
...

Another policy could involve seeking to overcome market failure in the economy
...
The government needs to provide greater infrastructure because of the
external benefits of these schemes
...

Finally, to improve long-term economic growth, it is also important to think of the
demand side of the economy
...
Instead, the
government should aim at stable growth
...
They could also try and use fiscal policy to
‘fine tune’ the economy
...
However, this is quite difficult to achieve
...
Evaluate the likely economic effects of a decision by the UK to withdraw
from the European Union
...

Firstly it will save the annual cost of membership
...
It is equivalent to about 1
...
However, the UK will also lose out on EU spending such as
on regional policy and the Common agricultural policy
...

It is argued that the European Union is inefficient in spending its money
...
The CAP also
leads to distorted trade and higher prices of goods within the EU
...

If the UK left the EU, it could lose most of the benefits of being in a single market
...

This free trade zone helps British exports and enables cheaper imports
...

Leaving the EU would harm Britain’s trade, especially exporters
...
Also the EU
imposes a common external tariff on many imports from outside the EU, especially in
agriculture
...
This would help developing countries who have their
agriculture exports hit by EU tariffs
...
Due to increased
globalisation, issues such as competition policy are increasingly a European wide
issue
...


22
...
It is the multiplier effect
that can lead to a greater change in the level of Real GDP
...
Workers would receive some of this money
in wages, and firms selling raw materials would gain additional revenue
...
However, the workers with increased wages, will spend
part of their extra income
...
Therefore, there is an additional increase in National
30

Income
...
Therefore, there will be a
further round of increases in National income
...

Note, the multiplier effect will be bigger if – there is a high level of unemployment,
taxes are not increased to pay for the government spending, and there is a high
marginal propensity to consume (e
...
lower savings rate)

23
...

Economic growth rates measure the annual increase in GDP
...

In the long term, the rate of economic growth is determined by the growth of
Aggregate Supply, which is determined by the growth in productivity
...

Growth in the labour force is an important determinant of economic growth
...
This elastic supply of labour helps firms to expand without having to put up
wages and lose competitiveness
...

However, it is not just supply of labour, but also labour productivity that is important
...
For example,
a country like Germany has a good education system and this helps the strong growth
in labour productivity
...

Countries, which have a comparative advantage in primary products, tend to face
limits to growth
...
Therefore, higher global incomes don’t lead to higher
demand for primary products, and earnings will stagnate
...

Strong investment and economic growth requires political stability
...
African countries, which have
suffered civil wars, have often seen reduced GDP during the conflict
...
Similarly levels of corruption and bureaucracy will have an
impact in determining the attractiveness of business in any economy
...
China saw a large increase in economic growth when it privatised state
owned industries
...
China’s high rate of growth is partly due to
the fact they have a lot of ‘catch up’ – improving efficiency in old state owned
industries
...
In a global economy international trade is increasingly important; when
countries remove tariff barriers, it helps to provide a boost to growth
...

For example, a slowdown in growth will affect all countries who rely on exports, such
as Germany, China and Japan
...
Higher saving and investment
levels help promote an increase in productive capacity and higher growth
...
Sometimes, countries can
have a high savings ratio, but struggle to grow
...

A final factor is demand
...
If
there is persistent difficult in maintaining robust growth in consumer spending, then
growth levels will stagnate
...

But, during the 1990s and 2000s, growth rates were much lower because the economy
suffered from slow consumer spending and deflation
...
Discuss the problems an economy might face in recovering from a period of
recession?
A recession is a period of negative economic growth, associated with rising
unemployment, low inflation and higher government borrowing
...
To increase Aggregate Demand, the Central bank
and government could use a combination of Monetary and Fiscal policy
...
However Keynesians argue that wage and price rigidity
can keep the economy below full capacity for a long time
...

In a recession there will be rising unemployment and a fall in consumer confidence
...
In other words, people will spend less of
their disposable income and save more leading to a bigger fall in AD
...
For example, if the government cut income taxes this would increase
disposable income, but if confidence was low people would not be willing to spend
any extra and the economy would remain in a recession
...

In a recession the Bank of England could cut interest rates to stimulate demand
...
However, Monetary policy could be ineffective
...
If a country is a member of the EURO it may
make it more difficult to increase AD in a recession
...
In the recession of 2009/10, interest rates were cut to 0%, but this
often didn't cause a big increase in demand
...
For example, the government could increase
government spending on public work schemes to stimulate demand and economic
growth
...

33

Firstly there will be time lags
...

Also increasing AD may cause crowding out
...
This is
because the govt borrows off the private sector to finance its spending
...
However, another problem with fiscal policy is that in a recession,
government borrowing increases due to high tax rates, this may make it difficult for
the government to borrow more to finance expansionary fiscal policy
...
This is because people
will not spend if they feel that prices will be cheaper in the future
...
E
...
Japan has experienced
deflation during the 1990s and this made it very difficult to increase AD and
economic growth
...
Economists say that a positive inflation
rate is important for overcoming a recession
...

For example if there was a rapid rise in the oil price like in the 1970s then AS would
shift to the left causing lower growth and higher inflation
...


However, although recessions can be difficult to get out of, sometimes economies can
be quite resilient
...
However, if a recession is caused by falling asset prices, and a serious credit
crisis which damages bank balance sheets, then it is more difficult to get out of

34

recession because firms and consumers are less responsive to traditional policy
measures
...
Assess the impact on UK macroeconomic performance of a prolonged period
of deflation
...
Currently,
the MPC target an inflation rate of CPI 2% +/-1

If deflation is caused by a fall in aggregate demand or sluggish growth, then there
could be several economic problems
...
This delay in spending can cause lower aggregate demand and
lower economic growth
...

Another problem of deflation is that it increases the real value of debt
...
This can be a significant
drain on spending and investment leading to lower growth
...
In addition, deflation will make it more difficult for the government to
reduce its debt/GDP ratio
...

Another potential problem of deflation is that it makes it harder for nominal wages to
adjust and avoid real wage unemployment
...
An inflation target of 2%, helps real wages to adjust more easily
...
Interest rates
cannot fall below zero, therefore if we have deflation, real interest rates (nominal inflation) are likely to be too high for that stage in the economic cycle
...
However, there are
alternatives to cutting interest rates
...

However, evidence from Japan suggests that in a period of deflation, increasing the
money supply may be insufficient to overcome deflation and promote growth
...

Deflation is not necessarily a bad thing
...
For example, if there was a period of exceptional technological innovation,
the decline in costs could be passed onto consumers in the form of lower prices, this
leads to deflation but can help increase living standards
...
Sometimes countries pursue deflation as a policy of internal devaluation
...

However, overall the cost of deflation is often potentially high
...
It is interesting to note, that the UK's
longest period of deflation was in the 1920s and 1930s - an era of high unemployment
and low growth
...


For example, if a question asks the effects of higher interest rates, consider how
interest rates will affect all of these
...


Evaluation
This is worth 40% of most essays
...

These are questions which begin with:
•
•
•
•

Discuss
...

Assess
...
E
...
the effect of an increase in interest rates can take up to 18
months to have an effect
...
e
...
However, if house prices are rising, consumer spending
may not fall
...
The effect of higher rates will be
different if economy is in boom compared to if it is close to recession
...
Higher taxes may reduce consumer spending
...

Monetarist vs Keynesian
...

Conflicts of objectives
...
For example, a fall in exports to Australia is not a
significant factor affecting UK economy
...

Note it is important to explain evaluation
...
g
...
Explain why time lags may make monetary
policy less effective e
...
people on fixed rate mortgages for two years
...
economicshelp

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