Macroeconomics: Economic Policies, Money, and Financial Markets
ITEM 11
Objectives of Economic Policies
Sustainable Economic Growth: The state intervenes to increase the production of goods and services sustainably over time. One of its key objectives is to improve the welfare of citizens. As economic growth can increase the quantity and quality of goods and services offered to society, the state intervenes to increase or, at least, maintain the level of production. The most significant economic indicators of economic growth are GDP and GNP.
Full Employment: Rationality in economic decision-making has no meaning without the use of all available resources, including the human factor. However, it’s acknowledged that it’s difficult to provide work to the entire population of a country. Therefore, full employment is considered to exist when 98% of the workforce is employed. Indicators that measure the level of employment are activity rates, employment, and unemployment.
Price Stability: Controlling the prices of goods and services is essential to maintain consumer purchasing power and avoid the uncertainty caused by inflation. The CPI is the indicator that expresses the average prices of a basket of goods and services purchased by a group of families representing the Spanish population, while the inflation rate measures the change in the CPI between two periods.
Economic Policy
Economic policies are the forms of state intervention in the economy to achieve economic objectives related to employment, output, and prices, using tools such as taxes, public spending, or the price of money.
Income Policy
Income policy aims to achieve price stability by controlling inflation. When prices soar, the state tries to control the prices of more volatile products. It can also adjust the salaries of civil servants.
General State Budget (PGE)
The General State Budget (PGE) is a document that contains the annual revenue and expenditure of the state.
State Government Revenues
The state obtains revenues through social security contributions, taxes (taxes and fees), current transfers, property income, the sale of investments, and capital transfers.
Public Costs
Current Expenditure:
Current expenditures are intended to provide public services such as health, education, justice, national defense, and many others. These can be divided into two broad categories:
- Salaries of officials
- Purchases of goods and services from private companies
Cost of Investment:
These expenditures are designed to maintain and expand the productive capacity of the country. Almost all of this expenditure is concentrated in infrastructure: roads, hospitals, schools, airports, ports, etc.
Transfers and Subsidies:
The state obtains resources through taxes, social security, etc., and then transfers them to individuals or companies most in need. When the recipients of aid are individuals, they are called transfers (retirement and disability pensions, scholarships, unemployment benefits, etc.), while if the beneficiaries are companies, they are called subsidies (for business creation, investment in capital goods, job creation, etc.).
Financing the State’s Public Deficit
- Issue public debt: Just like asking for a loan from a bank, the State asks for money from businesses and individuals in exchange for securities that give their holders the right to have the money returned plus an agreed-upon fixed interest rate. The agency responsible for public financing is the Public Treasury.
- Raise taxes: In addition to being unpopular, raising existing taxes or establishing new ones curbs demand for goods and services, so the application of this measure is usually during economic upturns as it generates less social impact.
- Increase the money in circulation: This action often causes an increase in prices (inflation), so governments are very cautious in applying this measure. In the Eurozone countries, for stability reasons, this decision can only be implemented by the European Central Bank.
ITEM 12
Differences Between Commodity Money and Paper Money
Commodity money: A commodity with a determined value becomes money. Examples: furs, precious stones, gold, metals, etc.
Paper money: Money is no longer a commodity itself but a representation of it, acting as a medium of exchange.
Financial Entities and Major Spanish Financial Institutions
Financial entities have the function of channeling savings into investment. Major Spanish financial institutions are banks and savings banks.
Monetary Base and State’s Control
The monetary base is the sum of currency in circulation in the hands of the public and the deposits that banks have in the central bank.
The means to control the monetary base are open market operations and the rediscount rate.
Rediscount of Bills
This operation is common between commercial banks and the central bank.
Reasons for Traders to Demand Cash
- For transactions: These are purchases of goods and services that the operator wishes to make.
- As a precaution: The precautionary motive for holding cash is to cope with unforeseen events that may arise.
- For speculation: Speculation involves potentially profiting from a decrease in the price of an asset when a good opportunity presents itself.
Dependent Variables in Money Demand
- The income level of economic activity: When prices vary, people’s desire for liquidity can be affected. If, for example, the price level rises (which is the most common scenario), people demand more money to maintain their purchasing power.
- The market interest rate: The interest rate and money demand are inversely proportional. If interest rates are low, many people may understand that it doesn’t compensate them to have more cash on hand than in a bank that produces few interests.
- Expectations about inflation (risk assessment): It’s normal for people to avoid risk. Therefore, the more risky the return on alternative assets to money, the greater the amount of demand for money.