economics - macroeconomic problems & management 1

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Macroeconomic Problems & ManagementIntroduction & Domestic Issues

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Demand Management

Fiscal Policy

Budget balance

1. Surplus budget Contractionary fiscal policy

2. Deficit budget Expansionary fiscal policy

3. Balanced budget Overall expansionary, stabilise and maintaineconomy

Types of fiscal policy

1. Discretionary fiscal policy

a. Deliberate

b. Time lags involved

I. Recognition lag

II. Implementation lag

III.Impact lag

2. Non-discretionary fiscal policy

a. Automatic stabilisers

b. Eg. taxes, transfer payments (welfare benefits)

Monetary Policy

Operation of monetary policy

1. Expansionary

a. Expand money supply

b. Lower interest rate

2. Contractionary

a. Contract money supply

b. Raise interest rate

Effect of Interest Rate on Aggregate Demand

Lower interest rate...

1. Lowers rate of returns for saving encouraging consumption

2. Lowers cost of borrowing encouraging consumption and investment3. 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)

Singapores Monetary Policy

Exchange rate management

Reasons:

1. Price taker in interest rate

2. Reliant on imports

How:

1. Appreciation buy domestic currency, sell foreign currencies increase demand

2. Depreciation sell domestic currency, buy foreign currencies increase supply

Supply-Side Management

Shift AS outwards

Market Oriented Supply-Side Policies

1. Encouraging market competition

2. Lower taxes

3. Reducing influence of trade unions by legislation

4. Reducing welfare benefits encourage employment5. Reducing government expenditure to encourage efficiency within

public sector

Interventionist Supply-Side Policies

1. Sponsor R&D

2. Encourage mergers and reorganisation

3. Schemes to improve efficiency

4. Develop infrastructure to promote growth

Unemployment

Types of Unemployment

1. Cyclicala. Falling and weak AD

b. Causes:

I. Rising interest rate

II. Exchange rate appreciation

III.Loss in countrys competitiveness

IV.External shocks from foreign countries

2. Structural

a. Jobs and skills mismatch

b. Caused by economy undergoes restructuring

3. Frictional

a. Caused by imperfection information4. Seasonal

Consequences of Unemployment

1. Economic costs

a. Waste of resources

b. Lower standard of living

2. Increase government expenditure

a. Unemployment benefits

3. Social costs

a. Eg. crime, violence, social and political unrest

Policies to Reduce Unemployment

1. Create jobs

a. Demand managementb. Protectionist trade policy

c. Supply-side policies

2. Shorten job search time

3. Improve skills and retraining

Economic Growth

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Types of Economic Growth

1. Actual growth

2. Potential growth

a. Availability of resources

b. Productivity

Factors Affecting Economic Growth

1. Investment level

2. Technological progress

3. Human capital

4. Management skills

nflation

Measuring Inflation

1. Consumer Price Index

2. Producer Price Index

3. GDP Deflator

Limitations of CPI

1. Does not reflect upper and lower income groups

2. Changing consumption pattern creates statistical inaccuracy

3. Does not reflect quality changes of products

Types of Inflation

Demand pull inflation

1. Rising AD, unmatched by any increase in AS

2. Wage-price spiral Wages rise with consumer prices, resulting in

sustained inflation

Factors causing rise in AD

1. Lower interest rates

2. Speculation of higher prices

3. Government budget deficit

4. Net exports increases

5. Higher foreign direct investments

6. Post-war spending

7. Excessive supply of money (monetarist view)

Factors causing rigidity in AS

1. Lack of infrastructure

2. Lack of supply of labour

3. Shortage of resources

Cost push inflation

1. Increase in input costs

2. Lower output

3. Cost passed to consumers Workers ask for higher wage Producersabsorb by pushing up prices Inflationary spiral

Factors causing rise in cost

1. Wage costs (wage-push inflation)

2. Inflation in prices of imported raw materials (import-price push

inflation)

3. Higher prices by monopolies (profit-push inflation)

4. 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. Redistributive effects

a. Different types of people will suffer or benefit

2. Rising unemployment

3. Dampen economic growth

4. Profits of firms decrease

5. Fall in investments

6. Cut in productions

External effects

1. Balance of payments deficit

a. Net exports decrease

b. Foreign firms relocate capital outflow2. Depreciation of currency

Policies to Reduce Inflation

Demand pull inflation

1. Contractionary monetary policy

a. Raise interest rate lower domestic demand

b. Appreciate exchange rate net exports drops2. Contractionary fiscal policy

a. Reduce government expenditure

b. Raise taxes

3. Expand countrys production capacity

a. Increase labour productivity

b. Investment in plant capacity

Cost push inflation

1. Curb wage increases (to stem wage-price spiral)

2. Allow exchange rate appreciation (if caused by rising prices of foreign

imports)

3. Deal directly with the actual cause of cost increase

Demand management policies to reduce inflation

1. Reduce AD Trade-off of rising unemployment2. Phillips Curve

a. Trade-off between unemployment and inflation rate


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Supply management policies to reduce inflation

1. Price policies

2. Wage policies

3. Policies to increase productivity

4. 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. Excess production capacity (supply curve shifts to the right)2. Tight monetary policy

a. Too little money chasing after goods

3. Technological improvements

4. Lower barriers of entry more market competition5. Greater thrift

6. Imported deflation

Policies to deal with deflation

1. Expand AD

a. Lower interest rate

b. Expansionary fiscal policy

economics - macroeconomic problems & management 1

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