Managing the Economy

1. Managing the Economy • Policy objectives • Policy instruments • Theoretical issues

2. Objectives 1. Stable prices

3. 2. Full employment

4. Full employment is related to output growth via a relationship known as Okun’s law. Arthur Okun statistically estimated the equation Δu = 0.3 – 0.3ΔY where u is unemployment, Y is GDP and Δ is quarterly change. Hence growth of 4% per annum is needed to keep unemployment constant (this might have fallen to 2½% since Okun’s work).

5. Following Okun, unemployment rises when growth dips

6. 3. External balance Deficits emerge during booms as imports get sucked in

7. Policy instruments 1. Fiscal stance Appropriate to have an expansionary fiscal stance when economy is in recession. Note this did not happen in early 1980s – Thatcher policies.

9. 2. Supply side policies These include benefit payments, labour relations legislation, education policies, welfare to work, New Deal, tax reforms etc. Aim to reduce the natural rate of unemployment

11. 3. Monetary policies 1976-85 monetary targetting and the ‘corset’ 1985-90 shadowing the Deutschmark 1990-92 European Exchange Rate Mechanism 1992-97 inflation targetting 1997- inflation targetting with central bank independence

13. Theory of policy Jan Tinbergen argued that there should be as many policy instruments as there are targets. But note that some targets cannot be set independently of one another. Meade and Weale (1995 Scan J Econ) argue in favour of making each target the responsibility of one authority – on grounds of simplicity. Hence UK monetary policy targets inflation, supply-side policy targets unemployment, exchange rate policy targets external balance.