Economics - Macroeconomic Problems & Management 1

Macroeconomic Problems & Management Introduction & Domestic Issues

Page | 1 Demand Management Fiscal Policy Budget balance 1. 2. 3.

Surplus budget – Contractionary fiscal policy Deficit budget – Expansionary fiscal policy Balanced budget – Overall expansionary, stabilise and maintain economy

Types of fiscal policy 1.

2.

Discretionary fiscal policy a. Deliberate b. Time lags involved I. Recognition lag II. Implementation lag III.Impact lag Non-discretionary fiscal policy a. Automatic stabilisers

b.

Operation of monetary policy

2.

Expansionary a. Expand money supply b. Lower interest rate Contractionary a. Contract money supply b. Raise interest rate

Effect of Interest Rate on Aggregate Demand Lower interest rate...

1. 2. 3.

Shift AS outwards

Eg. taxes, transfer payments (welfare benefits)

Monetary Policy

1.

Supply-Side Management

Lowers rate of returns for saving → encouraging consumption Lowers cost of borrowing → encouraging consumption and investment If interest rate is lower compared to other countries → Net capital outflows → Supply of currencies shift to the right → Exchange rate depreciates → Net exports increases (Marshall-Lerner Condition must be met)

Market Oriented Supply-Side Policies 1. 2. 3.

Encouraging market competition Lower taxes Reducing influence of trade unions by legislation

4.

Reducing welfare benefits → encourage employment

5.

Interventionist Supply-Side Policies 1. 2. 3. 4.

Types of Unemployment

1.

Exchange rate management

Price taker in interest rate Reliant on imports

1. 2.

2.

3.

How: Appreciation – buy domestic currency, sell foreign currencies → increase demand Depreciation – sell domestic currency, buy foreign currencies → increase supply

Cyclical a. b.

Reasons: 1. 2.

Sponsor R&D Encourage mergers and reorganisation Schemes to improve efficiency Develop infrastructure to promote growth

Unemployment

Singapore’s Monetary Policy •

Reducing government expenditure to encourage efficiency within public sector

4.

Falling and weak AD Causes: I. Rising interest rate II. Exchange rate appreciation III.Loss in country’s competitiveness IV. External shocks from foreign countries

Structural a. Jobs and skills mismatch b. Caused by economy undergoes restructuring Frictional a. Caused by imperfection information Seasonal

Consequences of Unemployment 1.

2. 3.

Economic costs a. Waste of resources b. Lower standard of living Increase government expenditure a. Unemployment benefits Social costs a. Eg. crime, violence, social and political unrest

Policies to Reduce Unemployment 1.

2. 3.

Create jobs a. Demand management b. Protectionist trade policy c. Supply-side policies Shorten job search time Improve skills and retraining

Economic Growth http://education.helixated.com An Open Source Education Project

2 | Page Types of Economic Growth 1. 2.

Actual growth Potential growth a. Availability of resources b. Productivity

Factors causing rise in cost Factors Affecting Economic Growth 1. 2. 3. 4.

Investment level Technological progress Human capital Management skills

Inflation Measuring Inflation 1. 2. 3.

Consumer Price Index Producer Price Index GDP Deflator

Limitations of CPI 1. 2. 3.

Does not reflect upper and lower income groups Changing consumption pattern creates statistical inaccuracy Does not reflect quality changes of products

Types of Inflation Demand pull inflation 1. 2.

Rising AD, unmatched by any increase in AS Wage-price spiral – Wages rise with consumer prices, resulting in sustained inflation

1. 2. 3. 4.

Wage costs (wage-push inflation) Inflation in prices of imported raw materials (import-price push inflation) Higher prices by monopolies (profit-push inflation) Structural rigidities

5.

Exhaustion of resources

Inflationary spiral: Excessive growth in AD → higher factor costs → higher product prices → higher wages Consequences of High Inflation Internal effects 1. 2. 3. 4. 5. 6.

External effects 1.

Balance of payments deficit a. Net exports decrease

2.

Depreciation of currency

b.

Factors causing rise in AD 1. 2. 3. 4. 5. 6. 7.

Lower interest rates Speculation of higher prices Government budget deficit Net exports increases Higher foreign direct investments Post-war spending Excessive supply of money (monetarist view)

Lack of infrastructure Lack of supply of labour Shortage of resources

Demand pull inflation 1.

3.

Contractionary monetary policy

a. b. 2.

3.

Cost push inflation 1. 2.

Foreign firms relocate → capital outflow

Policies to Reduce Inflation

Factors causing rigidity in AS 1. 2. 3.

Redistributive effects a. Different types of people will suffer or benefit Rising unemployment Dampen economic growth Profits of firms decrease Fall in investments Cut in productions

Raise interest rate → lower domestic demand Appreciate exchange rate → net exports drops

Contractionary fiscal policy a. Reduce government expenditure b. Raise taxes Expand country’s production capacity a. Increase labour productivity b. Investment in plant capacity

Increase in input costs Lower output

Cost push inflation

Cost passed to consumers → Workers ask for higher wage → Producers absorb by pushing up prices → Inflationary spiral

1. 2. 3.

Curb wage increases (to stem wage-price spiral) Allow exchange rate appreciation (if caused by rising prices of foreign imports) Deal directly with the actual cause of cost increase

Demand management policies to reduce inflation

1. 2.

Reduce AD → Trade-off of rising unemployment Phillips Curve a. Trade-off between unemployment and inflation rate

Page | 3

Supply management policies to reduce inflation 1. 2. 3. 4.

Price policies Wage policies Policies to increase productivity Indexation a. Links economic variables (eg. wages) to an index of price inflation

Deflation 1.

Persistent fall in prices

2.

Slackening AD → High unemployment, excess production capacity

Causes of deflation

1. 2.

Excess production capacity (supply curve shifts to the right)

3.

Tight monetary policy a. Too little money chasing after goods Technological improvements

4.

Lower barriers of entry → more market competition

5. 6.

Greater thrift Imported deflation

Policies to deal with deflation 1.

Expand AD a. Lower interest rate b. Expansionary fiscal policy