Incentives

Incentives designed to increase effort, reward enterprise and encourage saving and investment include:

1. an emphasis on the effect of a reduction in the marginal rate of income tax on effort, etc. even though it may reduce total tax revenue;

2. a lower corporation tax to encourage investment and the taking of entrepreneurial risks;

3. special help for new firms to obtain the initial capital, e.g. 'start-up' schemes, the Business Enterprise Scheme;

4. profit-related pay (which gives employees a direct stake in the success of the company and enables pay to respond more readily to changing market conditions), share option schemes and wider share ownership generally.

The above represent a variety of measures to create conditions in which the free play of market forces can stimulate the economy to work more efficiently. They have formed a major part of the Thatcher government economic program since 1979.

NCE does not claim that a Friedman-style of the money supply is preferable to a money growth rate which responds positively to the unemployment rate. It claims that the unemployment rate is insensitive to demand policy choices and thereby suggests that these choices should be made on the basis of implications of alternative policy parameters for the stochastic evolution of the price level (and, therefore, the inflation rate).

Many macroeconomic models imply that the change in the unemployment rate depends upon lagged values of the unemployment rate (or ratio of actual to capacity output), real shocks and the forecast error between the current price level and the value anticipated by the market on the basis of information at an earlier date, when production and spending decisions were made. A necessary condition for the validity of the NCE is the Muth Rational Expectations Hypothesis (MRE) that the forecast error is a serially uncorrelated term with a zero expectation. It follows that the mathematical expectation of the change in the unemployment rate just depends upon lagged unemployment rates which reflect frictions in the economy resulting from costs of adjustments.