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В Reading 1
Fiscal policy
As we saw in unit 12. fiscal policy is one of tin- tools that governments have to Keep the economy on a steady path. The two main components of fiscal |*>licy are changes to the tax system and changes in government spending Hut what changes can governments make in these two areas, and how do changes affect the growth of tlu economy?
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governments operate a system called progressive taxation. This means that the more you earn, the more tax you pay. People are usually allowed to keep some ot' their income without paying any tax. This is called the personal allmcance. The rest of their income is then taxed using the progressive system. For example:
Tax to pay after allowance
£o - u,<m
*
5,000
Governments can decide to change the size of the personal allowance, or change the percentage that each income group has to pay. If the economy is growing too fast, and demand for goods and services is more than the economy can supply, the government will want to slow down sjiending.
To do this, they can decrease the personal allowance, or they can increase the percentage to pay in tax. This will mean people have less disposable income, and spending w ill slow down. It the economy is slowing down loo much, governments can do the opposite.
What about government spending? How does that affect economic growth': The key to this is something called the multiplier effect. To understand how this works, let's look at an example. Imagine that the economy is not growing. This will make aggregate demand fall. In turn, productivity falls. This situation means that the nation's resources arc not all IxMiig used. In other words, there are surplus raw materials, machines arc not being used and workers are unemployed What the economy needs is а pull in demand for goods and services.
Flie government can provide this pull by spending a large amount of money on public projects. For example, imagine that the transport department decides to spend £200 million 011 building a new motorway. This will give work to building companies and jobs to unemployed workers. I11 other words, more resources are being used and the nation's productivity is increased.
Personal
allowance
Income
iK'fore tax
10%
22% 40%
income for others in the economy. If half of the £2oo million is spent, then the total national income has grown by this much:
£200 million + (0.5 x £200 million )
Facli time a proportion of the income is passed 011. the economy grows again:
£200 million + (0.5 x £200 million) + (0.5 x £100 million). etc
In theory, the multiplier effect will continue until there is full employment and the nation's resources arc being used to their fullest extent.
P В Comprehension
Now read the text again and answer these questions in your own words.
What are the two tools of fiscal policy?
What is someone's personal allowance?
What will the government do to taxes if the economy is slowing down?
How can the government create more demand in the economy?
When does the multiplier effect stop working?
Before you listen
Discuss these questions with your partner.
-» What do you think makes a good tax?
Which four things listed below do you think are the most important?
It's easy to collect.
It's paid often.
It's easy to understand.
It's not paid too often.
Its a low percentage of income.
It's easy to pay. 2 It's fair.
T
С Listening 4)))
Now listen to someone talking about Adam Smith's four rules for good taxation.Which four ideas from the list above are mentioned?
M * с r .. a G u ' d • to V t >if •. ijnn (4 /3
Before you read
Discuss the following with your partner.
Sometimes people feel like spending money. Other times they prefer to save their money. Why is this?
0 D Vocabulary
central bank commercial banks confident credit exchange rate expand frequently impact mortgage proportion repayments
We have to pay our bills too in
my opinion!
A country's is the government bank.
The are the high street banks that
everyone uses.
When a loan is t,)ken out. usually each month have to be made.
A is a special loan for people who
want to buy a house.
When you feel you feel sure that
what you are doing is safe.
Many people these days buy things on instead of paying in cash.
A large of people use banks to
deposit their savings.
The compares the values of
different currencies.
If a company wants to to move
infonew markets !or example, it vnll need to borrow money.
High interest rates have an on the
74
н
Monetary policy
Monetary ) mi icy is another tool that governments use to control the economy. Monetary [wiliey mainly involves making changes to the interest rate. It ean also involve changing the amount of money that circulates round the economy However, this second kind of monetary policy isn't used very often lvcatise it can lead to inflation ("hanginginterest rates, on the other hand, is ,i method that is used quite Irei|iientl> for slowing down or speeding up the economy So how does it work?
Basically, commercial hanks the ones that you and 1 use to keep our savings in and to lx»rrow from - borrow their money from the country's central bank. This is the national or government bank, and it has the power to sel interest rates. The interest rate of the central bank will influence the rates commercial banks set for tlu u customers When interest rates go up. borrowing money Incomes more expensive. When they g«. down, ii Incomes cheaper.
People get loans from banks for all sorts <>i reasons, but the biggest loan most peopk talu out is to buy a house. This kind of loan is called a mortf>ag< When interest rates increase, mortgages lveome more expensive People who already have a mortgage will need to pay more oil their repayments, and will have less money to spend on other tilings, fewer people will want to buy flew houses and house prices will tall
hi (urn. home owners will feel less confident about their own wealth and w ill spend less. As a result, the economy slows down A fall in interest rates will have the opposite effect on the house buying chain.
(Consumers also buy other tilings usingIxirrowed money. This is called huyinii on era til. and interest rates w ill also affect how much people spend 011 credit. Purchases made using credit cards are now a huge proportion of total spending in many countries This means that interest rale changes have a big impact on consumer spending and the economy as a whole
Companies, too. are affected by interest rate changes When interest rates are low. they feci more confident alxiut investing in order to expand their business. I.ow interest rates will encourage them to lake out loans in order to build factories, buy machines and increase production. All of this increases the si/e ot national output Again, higher interest rates will have the opposite effect.
Finally, interest rates can have an effect on the amount ot exports a country sells. This is because the value ol a currency (the exchange rale) often tails when the interest rate falls. When the value ol a currency falls, a nation's products and services become cheaper for customers from other countries. This increases export sales, and more money comes into the economy And. of course, a rise in interest rates will mean a rise in the exchange rate. This will reduce export sales, and reduce the total output of the economy.
PARAGRAPH 3
High interest rates are good for the housing market.
Mortgages are the most common type of loan. High interest rates are bad foi the housing market. PARAGRAPH 4
Interest rates influence consumer spending. In every country the proportion of credit card holders is high.
Most people borrow money with then credit card.
PARAGRAPH 5
Businesses invest more when interest rates are low.
National output drops when interest rates are low.
Business investment is not affected by interest rates. PARAGRAPH 6
How much a country exports affects the interest rate.
The interest rate can affect exports. A rise in exports reduces the total national income.
Before you listen
Discuss the following with your partner.
Every solution to a problem has its drawbacks. What do you think are the disadvantages of fiscal and monetary policy? Think about:
changes in people's behaviour
length of time policies need to take effect
rehension
Now read the text again and choose the sentence which best summarises each paragraph.
Changing interest rates is the most common typo of monetary policy. Governments never change the amount of money circulating in the economy. Changing interest rates increases the amount of money in the economy. PARAGRAPH 2
The commercial banks set exactly the same interest rate as the central bank. The central bank controls all other commercial banks.
/01
Now listen and choose the best way to complete each sentence.
One problem with macroeconomic policy is that...
A people never do what you want. В you can never bo sure how people will act.
С you can't stop people spending.
An increase in government spending may make people ...
В
F Listening 4)))
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i
с
m
л
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# i
I
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■■ ■ • ' - 75
3 Another problem with macroeconomic policy is that...
A it costs money.
В it takes time.
С it almost never works.
G Speaking
Discuss these questions with your partner.
Do you believe people really think about the interest rate when they decide to save or spend money?
What affect do you think taxes have on the way people work?
Give a two-minute talk on monetary policy. First read through text 2 again and make notes below about the following.
the toolsof monetary policy that the government can use
how interest rates affect...
house buying
consumer spending
76 M j . m i ч * • d * t ' > t г i) n o <»■< i t s J r. ' т 4
business investment exports
Notes:
Pronunciation guide
Allowance .Maooib Taxation ta?ksetfn Circulate Vukpleit Mortgage 'imiquH
Imagine you run a business which has customers at home and abroad.Things are going well, and to make things better, the government has just announced a drop in interest rates.This is a good time to get a loan and invest in your business. Write a letter to your bank manager asking for a business loan.
Formal letter
Use this plan to help you.
INTRODUCTION
Dear Mr/Mrs/Miss |give a name]. Say briefly why you're writing.
Useful words and phrases:
I am writing to request... I would be grateful if you could ...
PARAGRAPH 1
Explain what your business is. Say how much you want to borrow.
Useful words and phrases:
I run a ... company which ... I would like to borrow approximately ...
PARAGRAPH 2
Explain why now is a good time to expand: (increasing sales / interest rate cut and its effect on the economy).
Useful words and phrases:
The reason why ... I believe this is the right time because ...
It would be sensible to take advantage of...
PARAGRAPH 3
Say how you will spend the money.
Useful words and phrases:
I intend to spend the money as follows ... The majority of the money will be needed for ... In addition, some of the funds will be spent on . .
PARAGRAPH 4
Ask for details about the loan: How long can you borrow for? What will the interest rate be?
Useful words and phrases:
Could you tell me how ... 1 would be grateful if you could let me know ...
CONCLUSION
Sign off politely
Useful words and phrases:
I look forward to hearing from you soon ... Yours sincerely,
Write about 200 words
Before you read
Discuss these questions with your partner.
Why do banks charge interest on loans? -» Why do banks pay interest on savings? -* How often do interest rates change? -» Why do you think they change?
A Vocabulary
purse
cash
till
form
willing a plus
target
reserve
account
В
to
ensure
shortage
obliged
state
securities
small
bag to keep money in
when there is not enough of something
where a store of bank's money is kept
to так» sure
an advantage
has to
prepared to do say formally
place in shop where money is kept
kind (of)
something you aim to achieve
Й Reading 1
Interest rates and the money market
Keonomie growth is a plus. hut. like all good things, it's best not to have too much at once If the economy grows too rapidly, the result can be inflation. Steady growth is best, and governments use fiscal and monetary policy tools to achieve this. For example, they set interest rates in order to control borrowing and investment. However, the government can't just state, 'today's interest rate is four per cent' and expect all the other banks to follow As usual, tilings are a bit more complicated!
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* С ГТ»I I t
4 П 0»i4«to
|I««IW1I U■ 11 IS
77
Also, just like other markets, there can be shifts in the demand and supply curves. When shifts happen, the equilibrium point (the interest rate that is set) changes. This new interest rate may be above or below the government's target. What can they do about it? One thing they can do is to influence the supply of money in the market.
What exactly is the money supply and how can the government influence it? Obviously, the money supply includes all the notes and coins in purses, pockets and cash tills. Some of this money will be money that has been borrowed from banks, so loans form part of the money supply too. The supply also includes money that people and companies have in bank accounts, and the money that banks have in their reserve accounts in the central government bank.
Remember that banks lend most of the money that customers deposit. When customers want to make withdrawals, the bank takes cash from its reserve account with the central government bank. If the commercial bank has a shortage of cash in its reserve account, it is obliged to borrow from the central bank. When a commercial bank borrows from the central bank, it must borrow at the government's rate of interest. This is how the government can influence the interest rate equilibrium point of the market.
However, the government needs to ensure that at the end of each day the commercial banks have a shortage of cash. And, of course, they have ways of doing this!