Macroeconomic Policies

Macroeconomic Policies

1. Fiscal Policy

   • Generally more appropriate for countries with large domestic demand, with C making up a large portion of national income
   • Policy Tools
     • Government Expenditure
       • Expansionary: Increase G leads to increase AD
     • Taxation rates
       • Fall in personal income tax rates creates greater disposable income hence increasing C and thereby increasing AD Fall in corporate income tax raises net profit after tax, increasing incentive to invest hence increasing I and thereby increasing AD
   • Objectives
     • Expansionary FP
       • Suitable in times of recession and cyclical unemployment
       • Increase economic growth
       • Reduce cyclical unemployment
     • Contractionary FP
       • Suitable when economy is operating close to/at full employment, hence experiencing demand-pull inflation When there is a BOT Deficit
       • Curb demand-pull inflation
       • Reduce import expenditure to improve net exports and BOP
   • Limitations
     • Crowding out effect
       • If increased government spending is financed through borrowing from commercial banks, government will be competing with the private sector for loanable funds. Interest rates will rise, reducing investments. Fall in I offsets the increase in G. Overall increase in AD may not be as much
     • Size of multiplier
       • Small multiplier means that even a large increase in G may not cause a very large increase in real national income
     • Government debt
   • Conflicts
     • Expansionary FP and DD-pull inflation
       • Due to overshooting and inability to forecast accurately
     • Expansionary FP and BOT deficit
     • Contractionary FP and social welfare
     • Contractionary FP and recession

2. Monetary Policy

   • Generally more appropriate for countries with large domestic demand with a floating/managed float exchange rate system
   • Policy Tools
     • Increase money supply
       • Increase MS causes fall in interest rates. Cost of borrowing falls, people more likely to borrow to consume goods and services. C increases.  Increased profitability of investment causes increase in investments.
     • Decrease interest rates
   • Objectives
     • Expansionary MP
       • Appropriate during economic recession/when economy experienced cyclical unemployment
       • Increase economic growth
       • Reduce cyclical unemployment
     • Contractionary MP
       • Appropriate to curb demand-pull inflation Appropriate when there is a BOP deficit (given that it is a trade deficit)
       • Curb demand-pull inflation
       • Reduce imports to improve BOP
   • Limitations
     • Elasticity of MEI
       • If it's inelastic, fall in interest rates will not significantly increase investments (possibly during times when economic outlook is bleak), lessened effect on AD
     • Liquidity Trap
     • Capital Flows
       • Increase in interest rates due to increased (?) may cause short term capital inflow, which increases money supply and causes interest rates to fall
     • Size of multiplier
   • Conflicts
     • Expansionary MP and dd-pull inflation
     • Contractionary MP and economic growth
     • Expansionary MP may lead to worsened BOP
       • Increases in national income causes increase in import expenditure Increase MS to bring about lower interest rates could cause short term capital outflow, worsening capital and financial account
     • Contractionary MP and BOP
       • When interest rates rise, short term capital inflow might cause exchange rate to appreciate due to higher demand for domestic currency. Net exports fall if ML condition holds

3. Exchange Rate Policy

   • Policy Tools
   • Objectives
   • Limitations
   • Conflicts

4. Supply-side Policy

   • Policy Tools
     • Market-Oriented
       • Limitations: Effect of reduced public sector size in the economy and lower taxes is debatable - whether people work harder or more efficiently is hard to ascertain. Private sector activity may not increase correspondingly if they are not willing to take risks. tax cuts could also result in governemnt budget deficit
       • Pro-competition policy
         • Privatisation
           • Transfer of ownership of shares from public sector to private shareholders. It aims to reduce inefficiency caused by government bureaucracy and make the privatised industry more responsive to market conditions. Leads to more consumer choices and lower prices
       • Manpower policy
         • Reducing unemployment welfare benefits
           • Unemployment benefits are seen as encouraging people to stay unemployed, especially if the difference between unemployment benefits and the take-home pay of being employed is small. Reducing or removing these benefits will cause the unemployed to try harder to find employment, thus reducing unemployment and increasing the size of the workforce, leading to a rightward shift of LRAS
       • Reducing government expenditure
         • Reducing the size of the public sector to allow greater participation of the private sector. This leads to an increase in private investment. Reduction in size of public sector reduces the inefficiencies caused by bureaucracy, improving efficiency in the utilisation of resources.
       • Tax cuts
         • Incentive to work is increased seeing as the amount of take-home income increases (opportunity cost of not working decreases). 
     • Interventionist
       • Policies whereby the government is directly involved in the provision of goods and services Limitations: Bureaucracy causes time lags and inefficiency. A public sector firm may not be as efficient as a private firm. Over-regulation of an industry may also make it unresponsive to economic conditions, resulting in loss of competitiveness Corruption - some officials may implement policies for their own gain 
       • Nationalisation
         • Case for natural monopoly: services such as public utilities, transport systems. A private firm may not engage extensively in R&D as the private benefits are less than the social benefits, whereas a public firm would ensure its provision
       • Regulation and legislation
       • Providing guidelines and information
         • Providing information to the public and firms to promote certain practices or behaviours that can improve efficiency and increase AS. Such information may include management practices or industry trends. 
       • Subsidising retraining
         • SPUR program to allow for retraining of workers so they can seek employment
   • Objectives
   • Limitations
     • Effects are slow