IB ECON Macroeconomics: Key Evaluation Points

Contraints of Monetary Policy

lessened effectiveness in a recession; cannot reduce interest rates below zero; not effective if conusmer/business confidence is low; banks fearful of lending; no guaranteed effect on AD; low interest rates can easily become inflationary; worsen cost push inflation

Strengths of Monetary Policy

best for demand management; independent of government (enacted by central bank) and limited political restraints; shorter time lags; flexible, incremental changes interest rate; relatively easy to implement; no burden on goverment budget; easily reverisble;

Constraints of Fiscal Policy

burden on budget; exceed sustainible debt; long time lags to design policy then see outcomes; conflict with polictical motivations and pressure; tax cuts not as effective in recession/consumer pessimism due to increased saving; cannot fine tune (outcomes be be less predictable; crowding out effect (HL)

Strengths of Fiscal Policy

best at addressing deep recession; target sectors of economy; address government priorities; multiplier effect from increasing disposable income through lowered taxes; direct impact of goverment expenditure; impact potential employment through investments in infrastructure or human capital; automatic stabilisers reduce severity of flucuations (progressive taxes and unemployment benefits);

Responsibilities of the Central Bank

regulate commercial banks; conduct monetary policy; issuer of notes and coins; holding foreign exchange reserves; conduct exchange rate policy

Benefit of a low and stable inflation rate

less uncertainty leading to encourages business investment, leading to economic growth; confidence in economy; export competitiveness, avoiding BOP problems; avoid deflationtionary spiral; maintain efficiency of the price mechanism in allocation of resources

Limitations of CPI

inflation rate is different for difference income earners; changes in consumption patterns due to increasing discounts, sales and substitutions (usually overstating inflation); differences in basket contents affect ability to make international comparasions and comparasions over long periods of time

Costs of high inflation

uncertainty; decreased business confidence; less investment and economic growth; international competitiveness decreases, BOP problems; incentive to save less, spend now to avoid future uncertain inflation; decreased effectiveness of price mechanisms and signalling; allocative ineffciency; redistribution effects

Costs of deflation

uncertainty; deferred consumption leading to decreased consumer expenditure and deflationary spiral; increased real value of debt; inefficient resource allocation as prices fall ununiformly; ineffectiveness of monetary policy due to changed consumer mindset of spending less

Rarity of deflation

due to wages (cost of labour) do not fall easily; due to firms risk engaging in price wars when reducing prices

Difficulties measuring poverty

different meanings and approaches to measurement (i.e not always based on lacking income); income does not account for wealth held in assests; no information about how far below a poverty line people are, just the number that are below; value of national poverty line can be somewhat arbitrary and over/underestimation can be used to skew policymakers

Impact of inequality on Economic Growth

lower income households unable to invest in improving human capital (health, education, skills) leading to low labour productivity

political control by the rich may decrease government expenditure on provision of merit goods like education and healthcare

poor are unable to obtain loans and credit as they have no wealth, leading to poorer outcomes and lower growth

income inequality leads to polarisation, political instability, social dissatisfaction and unrest

Causes of Poverty and Inequality

unequal opportunities like race, ethnicity, parent's education and income, gender
different levels of human capital leading to differing productivity
different levels of resource and asset ownership
discrimination
unequal status and political favouritism
government policies
technological change replacing low-skilled workers, favouring high skilled workers
unemployment
age
market-based supply side policies

Pros/Cons Taxation for wealth redistribution

conflict between economic growth and economic inequality: what is the relationship?

PROS: taking wealth away from the highest income earners in order to redistribute towards lower income earners in progressive tax systems - literally designed to reduce income inequalities

CONS: income/corporation taxes reduce disposable income/profit and COULD disincentivise working, saving and investment and overall affecting productivity, production and growth

Pros/Cons Investment and Expediture into human capital for inequality and poverty reduction

investment into merit goods: direct provision, subsidies or contracting out prviate sector

PROS: addresses inequality of opportunity (i.e factors out of individual control) by remedying the deprivation of education and healthcare, allowing higher quality and productive population; investment in infrastructure beneficial for productivity

CONS: can be a large burden on government budget, with many opportunity costs in terms of the foregone alternatives

Pros/Cons Transfer Payments for inequality and poverty reduction

PROS: conditional transfers build human capital (i.e must send children to school to get money; immediately increase incomes of vulnerable groups

CONS: costly to governments; potentially create incentive for people NOT to work in order to keep receiving essentially free money

Pros/Cons Price Controls for inequality and poverty reduction

PROS: minimum wage legislation increases income of lowest earners; price floors and ceilings protect low income earners OR producers with volatile, low incomes (e.g farmers)

CONS: create allocative ineffiency, social surplus decreases, government may have to purchase surplus impacting budget

Constraints of GDP and GNI for measuring output

don't include underground/parallel/black markets
don't include "nonmarketed" output, such as working one's own farmland to feed a family
don't include value of negative externalities or depletion of natural resources which reduce the wellbeing of society

Constratins of measuring of output as indicators for ecnomic well being

GDP/GNI not great for measuing ECONOMIC WELLBEING
no distinction about composition of output (spending on military will improve the lives of very few people compared to spending on education)
no reflection of health, education, life expectancy, skill level of citizens
no reflection on level of income and wealth inequality or poverty level
no reflection of quality of life factors such as lesuire time, stress levels, corruption and political freedom etc

GDP and GNI comparasions over time and between countries

OVER TIME: may not be suitable for comparasions over time due to changing factors like eduction, product quality, leisure time, size of parallel markets, value of non-marketed output

BETWEEN COUNTRIES: may not be suitable as prices for the same good differ greatly between countries; population sizese can severely distort per capita figures

Costs of high government debt

large debt servicing obligations take money away from the economy
poor credit ratings force governments to offer higher interest rates in order to make loans (causing problems like large debt servicing)
attempts to create budget surpluses by increases taxes/decreasing spending are VERY unpopular politically and may actually backfire by causing a recession
increase income inequaltiy, as buyers of bonds (who tend to be quite well off) earn revenue from interest, hence becoming even richer
uncertainty and lower investment
debt trap in which country's must keep borrowing to service old debts (very bad)

Goals of Supply Side Policies

promote long term growth and increase potential output/full employment level (shifting LRAS/Keynesian AS rightward)
Encourage competition
Improve efficiency
Incentivise firms to invest in R&D and improve productive capacity (PPC shift outward) by lowering costs of production (allowing greater after-tax profits)

Pros/Cons Market-based supply side policies

PROS: freeing up market forces allows greater allocative efficiency
may not burden government budget
reduce inflationary pressures by allowing firms to reduce costs of production through increase efficiency and lower wages/ability to fire workers freely

CONS:
time lags
unfavourable impact on unemployment (increased competition often leads to job losses to decrease cost of production, larbour market reforms make it easier for workers to be fired)
unfavourable impact on equity (labour market reforms damaging to lowest income earners, while taxx cuts favour high income earners)
less tax revenue for government causing budget deficit
less regulation leads to increased degrading of environment

Pros/Cons Inteventionist supply side policies

PROS: direct support for key sectors of improvement
create employment through eduation and training programs, as well as providing job information and relocation assistance
positive effect on equity by creating more skilled, educated and healthy workers which are more likely to have jobs and by productive in society, allowing income to be well distributed

CONS: time lag for investments and development of new tech etc
heavily based on government spending -> could be inflationary, or cause budget deficit

Causes of Deflation

Decreasing AD (consumer and business pessimism, high imports, contractionary fiscal policy)

Increasing SRAS (more subsidies, less taxes, falling costs of production and in non-labour resources, falling wages from market based supply side policies)