macroeconomics (3.5, 3.6, 3.7)

demand-side policies, fiscal policies, supply-side policies

monetary policy

monetary policy

use of interest rates and money supply to influence the level of aggregate demand and economic activity

central bank

monetary authority responsible for regulating a country's financial system and implementing monetary policy

interest rate

the price of money (expressed as a percentage)

essentially the cost of borrowing money

demand-side policy

strategy to influence the level of aggregate demand

ex: reducing interest rates to reduce the costs of borrowing money to finance consumer spending and investments.

money supply

the amount of money in circulation within the economy at a particular time as determined by the central bank

goals of demand-side policies

• low & stable inflation

• low unemployment

• reduced business cycle fluctuations

• stable environment for economic growth

• external balance (net export balance)

the money supply is regulated by

• setting reserve requirements

• lending money to banks

• open market operations

• quantitative easing

reserve requirement

the percent of deposits that banks must hold (cannot loan)

decrease the reserve requirement

banks hold less money & have more excess reserves

banks create more money by loaning out excess

money supply increases

interest rates fall

AD goes up

increase the reserve requirement

banks hold more money & have fewer excess reserves

banks create less money

money supply decreases

interest rates go up

AD goes down

discount rate

the interest rate the central bank charges commercial banks

open market operation

the central bank buys or sells govt. bonds (securities)

(buying bonds increases MS)

(selling bonds decreases MS)

real interest rates

the percentage increase in purchasing power that a borrower pays (adjusted for inflation)

real = nominal - inflation

nominal interest rates

the percentage increase in money that the borrower pays (not adjusted for inflation)

nominal = real + inflation

expansionary monetary policy

loose or easy monetary policy

aim to increase the level of aggregate demand

closes the deflationary gap

(Vietnam banks reducing interest rates by 1-3% from 2022 to 2023)

contractionary monetary policy

tight monetary policy

aim to decrease the level of aggregate demand and real national output

closes inflationary gap

(US Fed raises interest rates by 0.25% to a target range of 5.25% - 5.5%, continuously raising interest rates since March 2022 to fight inflation)

limitations of monetary policy

• low consumer and business confidence

• limited scope of reducing interest rates when close to zero

strengths of monetary policy

• incremental, flexible & easily reversible (reducing the risks of a huge disruption)

• short time lags (quick effect/reaction)

fiscal policy

use of taxation and government expenditure policies to influence the level of economic activity

fiscal policy used to influence

1. government spending on physical capital goods

2. government spending on human capital formation

3. provision of incentives for firms to invest

government revenue

• direct & indirect taxation

• the sale of goods and services from government owned enterprises

• privatization

government expenditures

• current expenditures: govt. spending on goods and services consumed within the year

• capital expenditures: long-term govt. spending (investments) that boost the economy’s productive capacity

• transfer payments: redistributing income in society by funding essential services

contractionary fiscal policy

laws that reduce inflation, decrease GDP

(closing an inflationary gap)

• decrease G

• increase taxes (decreasing disposable income)

(Turkey 5% business tax raise from 20-25% and from 25-30%)

expansionary fiscal policy

laws that reduce unemployment and increase GDP

(closing a deflationary gap)

• increase G

• decrease taxes (increasing disposable income)

(Philadelphia personal income tax cut form 3.8% to 3.75%)

money multiplier effect

spending is magnified in an economy

as the money changes hands, even if it’s the same money, it increases GDP with every transaction

limitations of fiscal policy

• govt. spending is often influenced by political factors or pressures

• there are budgetary constraints to implementing fiscal policy, and the effectiveness depends on the govts. ability to sustain a budget deficit (debt)

• crowding out occurs when increased govt. borrowing causes IR to rise, thus reducing public sector investment expenditure

• time lags: changes to fiscal policies take time to plan, approve and execute before impact can be measured (recognition, administrative and impact time lags)

strengths of fiscal policy

• targeting specific economic sectors

• government spending effective in deep recession (or depression)

goals of supply side policies

• increase productive capacity

• improve quality/quantity of factors of production

market-based policies

focus on freeing up industries and improving market incentives

• policies to encourage competition

• labour market policies

• incentive-related policies

deregulation

the reduction/removal of govt. rules in an industry,

with the intention of creating competition and greater efficiency

(policies to encourage competition)

(Alberta deregulated electricity market has created competition that lead to a surge in prices from 10-25 cents/kWh)

privatization

transfer of ownership of government assets from the public sector to owners in the private sector

to improve competition, productivity & efficiency

(policies to encourage competition)

(Egypt govt. selling assets in the oil and petrochemical sector worth 800 million)

trade liberalization

reduction/removal of trade barriers (tariffs & quotas)

to increase competition, productivity & efficiency

(policies to encourage competition)

anti-monopoly regulation

laws that control/limit restrictive practices and market power of dominant firms in an industry

(South Korea announced new guidelines/regulations for online platforms, an “emerging sector” in South Korea, with the aim of reducing possibility in monopolies forming and increasing competition)

labour market policies

govt. policies to create greater flexibility & efficiency in the labour market

types of labour market policies

• reducing power of labour unions: labour is a resource that gets more expensive when labour unions demand more pay & benefits

• reducing unemployment benefits: the existence of generous unemployment benefits can give people an incentive not to work (if people want jobs more they’re willing to accept lower wages)

• abolishing minimum wages: the possibility for lower wages will decrease costs

(US government is reducing the power of labour unions by taking away their power to carry out strike action)

incentive-related policies

create greater incentives to work,

by cutting personal income tax and business taxes

personal income tax

direct tax on total earnings

reducing will create incentive to work or seek employment opportunities

business tax

a cut in this tax can be used as incentive for firms to invest by reducing financial risks/returns for investments

similarily, cuts in rate of capital gains taxes can encourage risk taking and investments in the economy

(The German recorded flat growth, having fallen into recession at the turn of the year → a cut in corporate taxes for small and medium-sized enterprises, which will amount to about 7.6 billion euros per year)

limitations of market-based supply-side policies

• equity issues: economic growth can create greater disparities and inequalities in income distribution

• time lags

• vested interests: stakeholders sometimes have personal reasons for being involved (companies often have links to govt.)

• environmental impact: by increasing potential output, there is a opportunity cost to the natural environment

strengths of market-based supply-side policies

• improved resource allocation: sustainable economic growth achieved by increasing the economy’s potential capacity by making more efficient use of scarce resources (and labour)

• no burden on govt. budget: improved resources allocation without substantial costs on govt.

interventionist policies

deliberate attempts by a government to influence aggregate supply and productive capacity (LRAS) of an economy

• education & training

• improve quality, quantity and access to healthcare

• research and development

• provision of infrastructure

• industrial policies

(The US gov investing $280 billion into funding domestic research & manufacturing of semiconductors)

(world bank has agreed to loan $300 million to the Bangladeshi govt. for investing in early childhood development (such as education)

(Estonia, Latvia, Lithuania, Poland & Finland: 6 billion euros invested in building a railway system (infrastructure) spanning the countries)

limitations of interventionist supply-side policies

• costs: govts. budget stretched and possibly going into further deficit

• time lags: takes so much time to see the effects

strengths of interventionist supply-side policies

direct support of sectors important to growth: can be used to target sectors and facilitate their growth

(inflation in retail price in India by 7.44%, the shelf life for food products is very low, and the aggregate supply cannot keep up with the aggregate demand → government is going to invest in technology for farms to be able to produce more agricultural products)