Macroeconomic Problems & Management

Introduction & 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 maintain
economy

Types of fiscal policy

1. Discretionary fiscal policy

a. Deliberate
b. Time lags involved
I. Recognition lag
II. Implementation lag
III.Impact lag
Supply-Side Management
2. Non-discretionary fiscal policy
a. Automatic stabilisers
Shift AS outwards
b. Eg. taxes, transfer payments (welfare benefits)

Monetary Policy
Market Oriented Supply-Side Policies
Operation of monetary policy
1. Encouraging market competition
1. Expansionary 2. Lower taxes
a. Expand money supply 3. Reducing influence of trade unions by legislation
b. Lower interest rate 4. Reducing welfare benefits → encourage employment
2. Contractionary
5. Reducing government expenditure to encourage efficiency within
a. Contract money supply
public sector
b. Raise interest rate

Interventionist Supply-Side Policies

Effect of Interest Rate on Aggregate Demand

1. Sponsor R&D
Lower interest rate...
2. Encourage mergers and reorganisation
3. Schemes to improve efficiency
1. Lowers rate of returns for saving → encouraging consumption 4. Develop infrastructure to promote growth
2. Lowers cost of borrowing → encouraging consumption and investment
Unemployment
3. If interest rate is lower compared to other countries → Net capital
outflows → Supply of currencies shift to the right → Exchange rate Types of Unemployment
depreciates → Net exports increases (Marshall-Lerner Condition must
be met) 1. Cyclical
a. Falling and weak AD
Singapore’s Monetary Policy
b. Causes:
I. Rising interest rate
• Exchange rate management
II. Exchange rate appreciation
III.Loss in country’s competitiveness
Reasons:
IV. External shocks from foreign countries
2. Structural
1. Price taker in interest rate
a. Jobs and skills mismatch
2. Reliant on imports
b. Caused by economy undergoes restructuring
3. Frictional
How:
a. Caused by imperfection information
4. Seasonal
1. Appreciation – buy domestic currency, sell foreign currencies →
increase demand Consequences of Unemployment
2. Depreciation – sell domestic currency, buy foreign currencies →
1. Economic costs
increase supply
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 management
b. 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 causing rise in cost

Factors Affecting Economic Growth
1. Wage costs (wage-push inflation)
1. Investment level 2. Inflation in prices of imported raw materials (import-price push
2. Technological progress inflation)
3. Human capital 3. Higher prices by monopolies (profit-push inflation)
4. Management skills 4. Structural rigidities

Inflation
5. Exhaustion of resources

Inflationary spiral:
Measuring Inflation
Excessive growth in AD → higher factor costs → higher product prices →
1. Consumer Price Index higher wages
2. Producer Price Index
Consequences of High Inflation
3. GDP Deflator

Internal effects
Limitations of CPI

1. Redistributive effects
1. Does not reflect upper and lower income groups
a. Different types of people will suffer or benefit
2. Changing consumption pattern creates statistical inaccuracy
2. Rising unemployment
3. Does not reflect quality changes of products
3. Dampen economic growth
4. Profits of firms decrease
Types of Inflation
5. Fall in investments
Demand pull inflation 6. Cut in productions

1. Rising AD, unmatched by any increase in AS External effects

2. Wage-price spiral – Wages rise with consumer prices, resulting in
1. Balance of payments deficit
sustained inflation
a. Net exports decrease
Factors causing rise in AD b. Foreign firms relocate → capital outflow
2. Depreciation of currency
1. Lower interest rates
2. Speculation of higher prices Policies to Reduce Inflation
3. Government budget deficit
4. Net exports increases Demand pull inflation
5. Higher foreign direct investments
6. Post-war spending 1. Contractionary monetary policy
7. Excessive supply of money (monetarist view)
a. Raise interest rate → lower domestic demand
Factors causing rigidity in AS b. Appreciate exchange rate → net exports drops
2. Contractionary fiscal policy
1. Lack of infrastructure
a. Reduce government expenditure
2. Lack of supply of labour
b. Raise taxes
3. Shortage of resources
3. Expand country’s production capacity
a. Increase labour productivity
Cost push inflation
b. Investment in plant capacity
1. Increase in input costs
Cost push inflation
2. Lower output
3. Cost passed to consumers → Workers ask for higher wage → Producers 1. Curb wage increases (to stem wage-price spiral)
absorb by pushing up prices → Inflationary 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 unemployment

2. 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 competition
5. Greater thrift
6. Imported deflation

Policies to deal with deflation

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