Macroeconomics and Economic Policy
Macroeconomics
The Economy as a Whole
Macroeconomics is influenced by external market shocks, internal factors, and state intervention. These factors impact supply and demand.
Aggregate Demand
Aggregate demand (AD) is the total expenditure in an economy at a given price level. It includes spending by households, businesses, the public sector, and foreign entities. The formula for AD mirrors that of GDP: AD = C + I + G + (X-M).
Factors Affecting Demand:
- Income Level
- Money Supply
- Taxes
Aggregate Supply
Aggregate supply (AS) is the total amount of goods and services that firms are willing to produce and sell at a given average price level and production cost.
Factors Affecting Supply:
- Average Price Level: Lower prices typically lead to lower profits and reduced production.
- Business Expectations: Positive market expectations encourage increased production, while uncertainty can hinder it.
Consumption
Household expenditure on goods and services can be categorized as:
- Durable Goods
- Perishable Goods
- Services (e.g., healthcare, education)
Factors Affecting Consumption
Disposable Income: Higher disposable income leads to increased consumption.
Permanent Income: The perceived long-term average income level influences consumption patterns.
Life Cycle Hypothesis: Individuals save to maintain a consistent level of consumption throughout their lives.
Wealth: Accumulated savings and assets provide additional income and influence consumption.
Investing
Investing involves purchasing capital goods that indirectly contribute to the production of other goods. Business investment plays a crucial role in the economy.
Impact of Investment:
- Increased Demand: Investment leads to increased production and employment, boosting demand.
- Increased Production Capacity: Capital goods accumulation enhances a country’s production potential.
Factors Affecting Investment
Revenue: Businesses invest to generate additional income.
Costs: Investment decisions are influenced by interest rates on borrowings and taxes.
Capacity Utilization: High capacity utilization and increasing demand encourage further investment.
Future Expectations: Positive economic indicators and stability promote investment.
The Investment Multiplier
The investment multiplier measures the overall increase in spending throughout the economy resulting from an increase in investment. It is related to the marginal propensity to consume (MPC), which represents the proportion of additional income that people spend on goods and services.
Saving
Saving is the portion of disposable income that is not consumed. It is essential for business investment.
Reasons for Saving:
- Future well-being
- Asset accumulation
- Retirement planning
- Contingency planning
Marginal Propensity to Save (MPS): The MPS is the proportion of additional income that people save.
Economic Cycle Phases:
- Depression/Trough: The lowest point of a recession, characterized by underutilized resources and high unemployment.
- Expansion/Recovery: A period of economic growth.
- Boom/Peak: The highest point of expansion, where production capacity is fully utilized.
Economic Policy
Economic policy refers to government interventions aimed at achieving specific economic goals.
Objectives of Economic Policy
Sustainable Economic Growth: Increasing the production of goods and services over time to improve citizen welfare, measured by GDP and disposable income.
Full Employment: Utilizing all resources efficiently, with a target employment rate around 90%.
Price Stability: Controlling inflation and maintaining the purchasing power of consumers, measured by the Consumer Price Index (CPI).
Types of Economic Policy
Fiscal Policy: Government actions involving taxes and public spending to influence economic activity.
Monetary Policy: Actions taken by the central bank to control inflation and maintain price stability by managing the money supply and interest rates.
Foreign Policy: Government intervention in regulating imports, exports, and exchange rates.
Income Policy: Measures to control inflation by influencing wages and prices.
Fiscal Policy
Fiscal policy involves government revenue (taxes) and expenditure to achieve economic objectives.
Types of Fiscal Policy
Discretionary Instruments: Active policy changes implemented by the government, such as public works programs, employment and training plans, transfer programs, and tax rate modifications.
Automatic Stabilizers: Built-in mechanisms that automatically adjust government revenue and expenditure in response to economic fluctuations, such as proportional taxes, social security contributions, and unemployment benefits.
General State Budget (PGE)
The PGE details the government’s planned revenue and expenditure for a given year.
Expenditure
Current Expenditure: Costs of providing public services like healthcare, education, and justice.
Investment Expenditure: Spending on infrastructure and maintaining productive capacity.
Transfers and Subsidies: Payments to individuals and businesses, such as pensions, scholarships, and job creation incentives.
Revenue
Social Security Contributions: Payments made by workers and employers.
Taxes: Compulsory contributions to the government, including direct taxes (e.g., income tax) and indirect taxes (e.g., VAT).
Fees: Payments for the use of public services.
Other Income: Includes transfers (e.g., lottery), property income, asset sales, and capital transfers from the EU.
Budget Balance
- Balanced Budget: Revenue equals expenditure.
- Surplus: Revenue exceeds expenditure.
- Deficit: Revenue is less than expenditure.
Managing Budget Deficits:
- Issuing public debt
- Raising taxes
- Increasing the money supply
Monetary Policy
Monetary policy involves actions by the central bank to achieve its objectives, primarily price stability, by managing the money supply and interest rates.
Money
Money serves as a medium of exchange.
Types of Money
Legal Tender: Banknotes and coins issued by the monetary authority.
Bank Money: Deposits held in various accounts, including current accounts.
Time Deposits: Deposits held for a specific period with agreed-upon interest.
Other Assets: Treasury bills and other securities.
The money supply is the total amount of money circulating in an economy.
Banks and Money Creation
Banks operate by accepting deposits and lending a portion of those funds, while reserving a fraction (fractional reserve) to meet withdrawals. This process leads to the creation of money.
Money Multiplier
The money multiplier describes the expansion of the money supply resulting from an initial deposit. It is inversely related to the reserve requirement.
Types of Monetary Policy
Reserve Requirements: Mandating a minimum reserve ratio for financial institutions.
Open Market Operations: The central bank buying or selling government securities to influence the money supply and interest rates.
Financial System
The financial system comprises intermediaries that channel savings into financing consumption, investment, and public spending.
Financial Intermediaries in Spain
Bank Financial Intermediaries:
- Bank of Spain
- Commercial Banks
- Savings Banks
- Credit Unions
Non-Bank Financial Intermediaries:
- ICO (Official Credit Institute)
- Insurance Companies
- Pension Funds
- Leasing Companies
- Factoring Companies
- Mutual Guarantee Societies
The Stock Market
Stock markets facilitate the trading of securities in a competitive and orderly manner.
Types of Securities
Bonds: Debt instruments with fixed interest payments.
Stocks: Ownership shares in a company, with potential dividend payments.
Primary Market:
Where companies issue new securities to raise capital.
Secondary Market:
Where previously issued securities are traded among investors.
International Economic Organizations
Following World War II, various international organizations were established to promote economic and political cooperation.
Political Organizations
- United Nations (UN)
Economic Organizations
- GATT (General Agreement on Tariffs and Trade)
- WTO (World Trade Organization)
- IMF (International Monetary Fund)
- OECD (Organisation for Economic Co-operation and Development)
GATT
Established in 1947 to regulate international trade and reduce protectionism.
Principles of GATT
Most-Favored-Nation Clause: Trade agreements between two countries apply to all GATT members.
Transparency and Tariff-Only Protection: Focus on tariffs and eliminating non-tariff barriers.
Collective Action for LDCs: Supporting developing countries.
Periodic Negotiations: Regular meetings to reach agreements.
WTO
Succeeded GATT in 1995.
Principles of WTO
Non-Discrimination: Equal treatment for all WTO members.
Market Access: Reducing trade barriers.
Fair Competition: Addressing unfair trade practices.
Development and Economic Reform: Supporting developing countries.
IMF
Linked to the UN, established in 1944.
Objectives of IMF
Exchange Rate Stability: Promoting stable exchange rates.
International Liquidity: Ensuring sufficient international reserves.
International Loans and Assistance: Providing financial support to developing countries.
OECD
A forum for economic policy consultation and coordination among member countries.
Underdevelopment
Underdevelopment can be viewed from economic and human perspectives.
Factors Contributing to Underdevelopment
Low Per Capita Income: Limited consumption and saving capacity.
Primary Production Structure: Dependence on agriculture, fishing, or mining.
Inefficient Markets: Imperfect markets and reliance on external funding.
High Population Growth: Strain on resources.
Political Instability: Weak institutions hindering development.
Poor Infrastructure: Lack of essential infrastructure.
Low Cultural and Social Development: Shortage of skilled labor.
High External Debt: Burden on export earnings.
Globalization
Globalization is the process of increasing interconnectedness and integration of economies worldwide.
Drivers of Globalization
Technology: Facilitating communication and transactions.
Economic Liberalism: Reducing trade and capital barriers.
Dimensions of Globalization
Commercial Globalization: Increased international trade.
Production Globalization: Companies locating production in lower-cost countries.
Financial Globalization: Increased cross-border capital flows.