Macroeconomic Goals & Policies Flashcards
A change in AD affects the following goals:
1) Actual growth
2) Demand-pull inflation
3) Cyclical unemployment
A change in (X-M) affects the following goals:
1) Actual growth
2) Demand-pull inflation
3) Cyclical unemployment
4) Balance of Payments (current account)
A change in FDI affects the following goals:
1) Actual growth and potential growth
2) Demand-pull inflation
3) Cyclical unemployment
4) Balance of Payments (capital/financial account)
The main difference between FDI and domestic investment is that:
Domestic investment is affected by the level of domestic interest rates, while FDI is independent of local interest rates (do not confuse FDI with hot money flows).
The main difference between FDI and hot money flows is that:
FDI is long-term, while hot money is short-term. Consequently, FDI contributes towards actual and potential growth in an economy while hot money has no material impact on an economy’s growth prospects.
Note: Hot money flows may even be disruptive for an economy through generating asset-price inflation, and causing wide swings in the exchange rate (which destabilises trade). However, hot money inflows may increase domestic money supply and lower interest rates, which can lead to growth in AD.
Explain how a rise in interest rates affects (X-M) in an economy.
When interest rates rise
Hot money flows in
Demand for country’s currency rises
Exchange rate appreciates
Assuming MLC holds, (X-M) falls.
Explain how a fall in interest rates affects (X-M) in an economy.
When interest rates fall
Hot money flows out
Supply of country’s currency rises in forex market
Exchange rate depreciates
Assuming MLC holds, (X-M) rises.
Is MLC relevant when considering the effect of higher inflation rates on a country’s net exports?
No, because import prices are unchanged. Hence, only PEDx is relevant.
Define economic growth
It is the increase in an economy’s real GDP. For economic growth to be sustainable in the long run, there must be a combination of actual growth (increase in AD) and potential growth (increase in AS)
What is unemployment?
It is a situation where people who are willing and able to work cannot find jobs. There are 3 main types of unemployment - cyclical, structural and frictional.
What is inflation?
It is a sustained increase in the general price level which could be due to demand-pull factors or cost-push factors.
What is the balance of payments?
It is a record of transactions between a country and the rest of the world over a period of time , and consists of the current account, financial (or capital account in some school notes) account and the official financing account
What are the 4 key economic indicators?
1) To achieve sustainable economic growth
2) To keep unemployment low
3) To maintain price stability
4) To maintain a healthy balance of payments
What are the drivers of actual growth?
Mainly ICE, ICE, PIQ
Consumption which depends on disposable income of consumers, the availability and cost of credit, and the expectations of price levels and the economic outlook
Government’s goals and budget
Level of investments, which is affected by interest rates, corporate tax, expectation of the economy
Net exports, which is affected by the price competitiveness of exports, the income levels of trading partners and the quality competitiveness of exports.
Note that stating the components of AD is not enough. The factors affecting each component must be highlighted in your essay.
Do also note that a fall in cost-push inflation can also trigger actual growth.
What are the drivers of potential growth?
Quantity and quality of FOP such as:
Land (land reclamation)
Labour (inducting foreign workers or sending workers for skills upgrading courses
Capital (government spending on infrastructure or attracting foreign investors)
Technology/entrepreneurship
What is cyclical unemployment?
It is a situation where AD in the economy is low and there is not enough demand in the economy to create enough jobs (derived demand for labour is low). This usually occurs during a recession.
What is structural unemployment?
It is a situation where there is a mismatch of worker skills and job requirements. It usually occurs when an economy is restructuring and some workers may find their skills irrelevant.
What is frictional unemployment?
It is a situation where there is imperfect information flows between employers and job seekers. It is usually temporary in nature.
What are the drivers of cyclical unemployment?
Mainly ICE, ICE, PIQ
1) Consumption which depends on disposable income of consumers, the availability and cost of credit, and the expectations of price levels and the economic outlook
2) Government’s goals and budget
3) Level of investments, which is affected by interest rates, corporate tax, expectation of the economy
4) Net exports, which is affected by the price competitiveness of exports, the income levels of trading partners and the quality competitiveness of exports.
Note that stating the components of AD is not enough. The factors affecting each component must be highlighted in your essay, together with AD/AS diagram.
What is demand pull inflation?
It is inflation that results when AD rises as the economy approaches full-employment. This occurs as the growth in an economy’s productive capacity is unable to keep up with the increase in AD.
What is cost-push inflation?
It is inflation that occurs due to an increase in the cost of production, independent of AD.
What are the drivers of demand-pull inflation?
Mainly ICE, ICE, PIQ
1) Consumption which depends on disposable income of consumers, the availability and cost of credit, and the expectations of price levels and the economic outlook
2) Government’s goals and budget
3) Level of investments, which is affected by interest rates, corporate tax, expectation of the economy
4) Net exports, which is affected by the price competitiveness of exports, the income levels of trading partners and the quality competitiveness of exports.
Note that stating the components of AD is not enough. The factors affecting each component must be highlighted in your essay, together with AD/AS diagram. Remember to highlight that the economy is approaching full employment too.
What are the drivers of cost-push inflation?
1) Wage push inflation, which may be triggered due to high trade union power demanding better pay without a commensurate increase in productivity(less relevant in SG context) and expectations of inflation which results in workers negotiating for higher wages to protect their purchasing power (wage-price spiral).
2) Import-push inflation that is triggered by exchange rate depreciation or global supply shocks that lead to an increase in the price of imported goods and raw materials.
3) Tax-push inflation that occurs due to a rise in taxes such as GST
4) Profit-push inflation that occurs as firms with extensive market power may raise prices to increase profits.
What does the current account consist of?
1) Net exports (balance of trade)
2) Income flows
3) Transfer payments
What does the financial (or capital) account consist of?
1) Hot money (short-term), which is affected by interest rate changes and expected changes in interest rates.
2) Direct or portfolio investments (long-term), which are affected by the expectations of the economic outlook. Direct investments (FDI) is also affected by operating costs such as the level of corporate tax, the level of infrastructural development in the economy, the ease of doing business as well as confidence in the economy’s growth prospects.
When a question asks for the importance of the 4 macro goals, the answer should contain:
An explanation of the consequences of achieving/not-achieving the goals (refer to national income
Why is economic growth important?
1) Raises material standard of living as household purchasing power increases
2) Leads to a fall in cyclical unemployment as the derived demand for labour to produce goods and services rises
3) Higher income, sales and corporate tax revenue for the government , which can be deployed towards spending on social amenities or capital goods.
4) Improves business confidence. Higher investment levels further generate potential growth in the economy. FDI inflows also improve the capital/financial account and contributes towards a country’s foreign reserves.
5) Further fuels economic growth with high consumption and investment activities
Students can turn these points around to discuss the costs of a recession.
1-on-3: How can the impacts of high growth feed into the causes of unemployment?
The rise in consumption spending and investment expenditure leads to a multiplied increase in national output, leading to an increase in demand for labour to produce goods and services, hence leading to a fall in cyclical unemployment.
1-on-3: How can the impacts of high growth feed into the causes of inflation?
1) If the increase in consumption spending and investment expenditure occurs while the economy is approaching full employment, demand-pull inflation may occur.
2) However, higher investments into capital goods may lead to potential growth in the long run, which alleviates inflationary pressures.
1-on-3: How can the impacts of high growth affect the BOP?
1) Higher income results in higher import-spending which worsens the BOP through the current account.
2) However, inward FDI due to rising confidence improves the BOP though the capital account.
Why are high unemployment rates undesirable for an economy?
1) High unemployment is usually associated with low consumption and investment spending, which further lowers the economic growth prospects of the country.
2) Unemployment also suggests that the country is not using its resources efficiently, and any potential gains that these resources could have brought about (e.g. increase in amount of goods produced for export which increases the country’s foreign earnings) are lost.
3) Aside from the fall in tax revenue, there is also greater strain on government resources to provide unemployment benefits. Such payments carry opportunity costs, as the funds could be directed into infrastructural projects to increase the economy’s growth performance.
Students can turn these points around to discuss the benefits of low unemployment.
1-on-3: How do the consequences of high unemployment affect economic growth?
1) The fall in consumption spending and investment expenditure leads to a multiplied decrease in national output, hence actual growth and potential growth falls (assuming the investment expenditure were originally directed into capital goods)
2) If workers are unemployed for a long period of time, workers may lose their skills and motivation to work, which leads to further loss of potential growth.
3) If employment is prolonged, countries may face a brain drain as workers may seek jobs elsewhere, leading to a loss in productive capacity.
1-on-3: How do the consequences of high unemployment affect inflation?
1) The fall in AD leads to a fall in demand-pull inflation within the economy.
2) The fall in potential growth may stunt the growth of the country’s productive capacity, and hence it may be more susceptible to inflationary pressures in the future.
1-on-3: How do the consequences of high unemployment affect the balance of payments?
1) The fall in consumer income results in lower-import spending, which improves the BOP through the current account.
2) A fall in investor confidence due to high unemployment may lead to an outflow of FDI, which worsens the capital account.
Why are high inflation rates undesirable for an economy?
1) A rise in a country’s inflation rate relative to other countries will lead to its exports becoming less price competitive. Assuming PEDx>1, quantity demanded falls more than proportionately, leading to a fall in export revenue.
2) Domestic consumers may switch from domestic goods towards imported substitutes as they may be cheaper. This leads to a rise in import expenditure, resulting in a fall in domestic consumption and hence AD. BOP worsens.
3) High inflation deters investment since price instability makes it harder for investors to predict future streams of cost and revenue.
4) Shoe leather and menu costs will be incurred, suggesting resources are not efficiently utilized.
5) Inflation distorts the price signal and there may be inefficient allocation of resources.
Students can flip these points around to discuss the benefits of prce stability.
1-on-3: How do the consequences of inflation affect economic growth?
1) The fall in net exports, consumption and investment expenditure leads to a multiplied decrease in national output. Hence, actual growth falls.
2) The fall in investment expenditure may lead to fall in potential growth (assuming the investment expenditure was originally directed into capital goods)
1-on-3: How do the consequences of inflation affect unemployment?
1) The fall in net exports, consumption and investment expenditure leads to a multiplied decrease in national output. Since the demand for labour is derived from the demand for the goods and services that hired labour is used to produce, cyclical unemployment will increase.
1-on-3: How do the consequences of inflation affect the balance of payments?
1) The fall in net exports and FDI worsens the BOP through the current and capital accounts respectively.
Why is an unhealthy BOP (deficit or surplus) undesirable for an economy?
1) A deteriorating current account that stems from a worsening balance of trade reduces AD and national income through the multiplier process.
2) A worsening of the capital account due to outflow of FDI has negative implications for potential growth in the long-run
3) A deterioration in the capital account due to an outflow of hot money leads to a decrease in the supply of loanable funds, which raises interest rates and decreases AD.
4) A persistent BOP deficit accompanied by high levels of external debt reduces investor confidence in the economy
5) A persistent current account deficit may reflect underlying lack of competitiveness of exports (relating to price and quality)
6) A persistent BOP deficit may lead to a depreciation of the currency due to decreased demand for exports, which leads to the threat of imported inflation.
1-on-3: How can a BOP deficit affect economic growth?
1) The fall in net exports (deficit on current account) leads to a multiplied decrease in national output, hence actual growth falls
2) Potential growth falls as well due to a drop in FDI (deficit on capital/financial account), assuming the investment expenditure were originally directed into capital goods.
1-on-3: How can a BOP deficit affect unemployment?
1) Since there is a fall in national output, the demand for labour to produce goods and services falls, leading to a rise in cyclical unemployment.
1-on-3: How can a BOP deficit affect inflation?
1) The fall in AD leads to a fall in demand-pull inflation.
2) The fall in potential growth may cause the economy to be more susceptible to inflation in the future.
3) Depreciation of the currency generates imported inflation.
How is the 1-on-3 exercise (where the consequences of a macro problem feed into the causes of other macro problems) useful in essays?
1) It is useful in assessing the impact of an event on the economy to ensure that all 4 goals are discussed in detail (using the DICE approach). This is especially the case if the event only has a direct link to one macro problem. Using the 1-on-3 exercise helps us extend the discussion to other macro goals.
2) Assessing the priority of macro-economic goals (using the CFCE approach), specifically to consider how the failure to achieve one goal can thwart other macro goals.
What should we take note of when explaining the priority of goals and what framework can we use?
1) It is insufficient to justify that a certain goal should be prioritized above the others because of the consequences of failing to achieve it. Every goal has consequences of not achieving it, hence every goal is equally important. However, this is still an important content paragraph.
2) We should go on to explain how the failure to achieve a particular goal (e.g. inflation) can frustrate the other macroeconomic goals (using the 1 on 3 exercise)
3) We should also note how there are certain trade-offs between goals which prevents us from achieving all 4 goals at the same time.
4) Overall, which goal to be prioritized depends on the state (mostly) and nature (lesser extent) of the economy and would differ for all economies
5) The approach can be summarized into the CFCE framework, which stands for Consequences of goals, Frustration of other goals, Conflicts with other macroeconomic objectives, and Evaluation
When assessing the impact of an event on the economy, what framework should we use?
Since we are evaluating the consequences on an economy, we should look at how ALL 4 goals are affected, hence the DICE framework should be used.
1) Direct impact of the event
2) Indirect impacts (use the 1 on 3 exercise to see how other goals are affected, if the first step does not cover all 4 goals)
3) Counteracting measures taken to mitigate the impacts
4) Evaluation based on the nature and state of the economy
Crossing the barriers (in relation to macro policies) means that…
Students need to be aware of how demand-management policies can have supply-side effects, and vice-versa.
How does fiscal policy work in influencing AD and AS?
AD
- A change in G affects AD directly
- A change in personal income tax affects consumption, while a change in corporate tax affects investment
AS
- A rise in G on infrastructural development contributes to potential growth and hence shifts LRAS outwards.
- A cut in corporate taxes boosts investments, which if directed to capital goods shifts LRAS outwards.
- A fall in personal income taxes increases the drive and incentive to work, leading to an outwards shift of LRAS due to the higher productivity of labour
To choose or run a budget deficit (surplus) is the same as running:
An expansionary (contractionary) fiscal policy
Fiscal tightening is the same as:
Running a contractionary fiscal policy
Fiscal consolidation means:
Increasing T and reducing G to reduce the government budget deficit or outstanding debt.
Pump priming means
To raise G and reduce T to stimulate and economy, usually during a recession.
A hard landing means
An economy is tipped into recession after a period of rapid growth. This is usually due to tightening of monetary policy in an attempt to rein in inflation.
How does interest-rate policy work in influencing AD and AS?
Change in the money supply to influence interest rates which then affects consumption and investment
AD
- A change in interest rates affects consumption (affects both borrowers and savers through the cost of credit and opp cost of consumption) and investment (through the expected profitability of investments)
- In economies open to capital flows, a change in interest rates can also influence exchange rates (through hot money outflows) and hence impact external demand in the form of net export earnings. (e.g. lower interest rates lead to a depreciation of the currency through hot money outflows. Assuming MLC holds, net exports will rise)
(Take note that the cost and availability of credit are two separate issues. When there is a rise in the money supply, there is a greater availability of credit, which stimulates C and I directly)
AS
- A rise in investments on capital goods increases potential growth
How does exchange-rate policy work?
A change in the external value of a country’s currency to influence the level of external demand
AD
- A change in exchange rates affects (X-M), which affects AD. If imports become relatively more expensive due to depreciation of the currency, the demand for domestic substitutes may also rise, which raises AD through consumption.
SRAS
- An appreciation of the exchange rate reduces imported inflation (cost-push inflation) and raises SRAS.
How do supply-side policies work?
Long-run: The use of market-based or interventionistic policies to boost the productive capacity of an economy.
Short-run: Policies targeting a reduction in the cost of production.
AD
- R & D can boost research quality, which increases the demand for a country’s exports. Hence, AD rises due to an increase in (X-M)
- Having a well-educated and skilled labour force (where workers constantly upgrade their skiils to remain relevant) makes the economy an attractive destination for foreign investors. Hence AD rises due to an increase in FDI and domestic investment.
- Short run supply side policies e.g. maintaining competitive wages or tax levels lowers the cost of production and stimulates actual growth (downward movement along the AD curve)
AS
- Supply side policies generate potential growth through increasing the quantity and quality of a country’s factor of production.
Make sure you revise the difference between interventionistic and supply-side policies.
How does the A3 exercise work?
To evaluate whether a certain policy is useful in tackling the various macroeconomic problems.
1) Break down the macro-economic problems into their root cause
2) For every policy, circle the factors where the policy can exert an effect
3) Where areas are not circled, the policy cannot effectively target these areas and other policies may be needed as complementary policies.
4) Factors not circled could represent specific limitations of the chosen policy.
5) Recall generic limitations e.g. size of k, time lag.
Summarise the effectiveness of fiscal policy in boosting economic growth
Pros:
1) Fiscal policy can directly increase AD through government spending.
2) A decrease in personal income tax increases consumption, while a decrease in corporate tax increases investment, further boosting actual growth.
3) Fiscal policy in the form of infrastructural spending can boost potential growth
Cons:
1) The ability to engage in fiscal spending depends on the state of the government budget. If the government needs to borrow to finance its spending, crowding out may occur
2) The effectiveness of tax cuts depends on expectations of the economic outlook.
3) Fiscal policy is not able to stimulate external demand which renders it less effective for small and open countries like Singapore
4) The effectiveness of fiscal policy in boosting economic growth depends on the size of the multiplier
5) Time lags associated with the use of fiscal policy and recognition, administrative and operational lag
Evaluate the effectiveness of interest-rate policy in boosting economic growth
Pros
1) Interest policy can boost actual growth by stimulating consumption and investment through a cut in interest rates.
2) A cut in interest rates will lead to outflow of hot money, hence a depreciation of the exchange rate and stimulate external demand through boosting price competitiveness of exports.
3) Interest-rate policy can boost potential growth by encouraging investments into capital goods.
Cons
1) The effectiveness of interest rate cuts depends on expectations of the economic outlook.
2) Interest rates cannot affect net exports and hence external demand for countries which are not open to capital (hot money) flows or where exchange rates are tightly controlled.
3) The effectiveness of monetary policy in increasing national income depends on the size of the multiplier.
4) If an economy is near the liquidity trap (i.e. interest rates cannot be further lowered), interest-rate policy is not feasible.
Evaluate the effectiveness of exchange-rate policy in boosting economic growth
Pros
1) A depreciation of exchange rates can stimulate external demand by boosting price-competitiveness of exports and is especially useful for export-driven economies such as Singapore.
Cons
1) However, a weak currency may lead to cost-push inflation, which partially offsets the gain in export price-competitiveness from a weaker currency.
2) The Marshall Lerner’s condition must hold before a depreciation of the currency will lead to an increase in net exports. MLC may not hold in the short run due to the presence of import contracts.
3) No direct impact on potential growth.
4) Less effective in boosting domestic demand.
5) Size of multiplier may limit effectiveness of policy.
Evaluate the effectiveness of supply side policies in boosting economic growth
Pros
1) Supply-side policies can promote potential growth by boosting quality and quantity of factor of production
2) Research and development efforts can boost export quality, which increases the demand for a country’s exports. Hence, actual growth rises through a rise in net exports
3) Having a well-trained workforce and a skilled labour force makes a country a more attractive destination for investors, hence boosting the level of investments, which raises actual growth as well.
Cons
1) Effects can only be seen in the long-term
2) Success of training programmes depend on receptiveness of workforce.
Evaluate the effectiveness of fiscal policy in reducing unemployment.
Refer to points under how fiscal policy boosts economic growth
- Fiscal policy has no direct impact on structural and frictional unemployment
Evaluate the effectiveness of interest rate policy in reducing unemployment.
Refer to points under how interest-rate policy boosts economic growth
- Interest-rate policy has no direct impact on structural and frictional unemployment
Evaluate the effectiveness of exchange rate policy in reducing unemployment.
Refer to points under how exchange-rate policy boosts economic growth
- Exchange-rate policy has no direct impact on structural and frictional unemployment
Evaluate the effectiveness of supply side policies in reducing unemployment.
Refer to points under how supply side policies boosts economic growth
- Supply-side policies can tackle structural and frictional unemployment through re-training or career fairs
Evaluate the effectiveness of fiscal policy in alleviating inflation
Pros
1) Fiscal policy can reduce demand-pull inflation through a direct cut in G
2) A rise in taxes can cut consumption and investment spending, reducing demand pull inflation
3) By directing funds into infrastructure, potential growth can occur in the long-term which lowers demand-inflation in the future (although demand-pull inflation worsens in the short-run).
Cons
1) Due to the inflexibility of government spending, it may not be straightforward to cut G (especially spending on merit goods e.g. the building of hospitals to provide healthcare)
2) The effectiveness of tax hikes depends on expectations of the economic outlook
3) Fiscal policy is unable to influence external demand and is less effective in small and open countries such as Singapore.
4) Fiscal policy has no direct impact on cost-push inflation
Note that the budget is not a concern here, since contractionary policies are used.
Evaluate the effectiveness of interest-rate policy in alleviating inflation
Pros
1) Interest-rate policy can reduce demand pull inflation by reducing C and I through a rise in interest rates.
2) A rise in interest rates can lead to an appreciation of the exchange rate (through the inflow of hot money) and reduce external demand, provided MLC holds.
3) The effectiveness of interest-rate hikes in alleviating inflation depends on the expectations of economic outlook.
Cons
1) Interest-rate policy has no direct impact on cost-push inflation
2) Interest rate hikes cannot affect net exports in economies which are not open to hot money flows (such as China)
Evaluate the effectiveness of exchange-rate policy in alleviating inflation.
Pros
1) An appreciation of the exchange rate can reduce imported inflation directly (a form of cost-push inflation) – MLC not needed.
2) It can also reduce demand pull inflation by lowering the price-competitiveness of the country’s exports – MLC must hold.
Cons
1) However, a stronger currency can lower net exports which lead to trade-offs with the goals of growth and low unemployment.
Evaluate the effectiveness of supply side policy in alleviating inflation.
Pros
1) Supply-side policies can promote potential growth which raises the country’s productive capacity and reduces demand-pull inflationary pressures
2) R and D can lead to import substitutes which lowers the vulnerability of a country to imported inflation
3) Raising labour productivity, assuming unchanged wages means that each worker is more efficient which lowers the per-unit cost of production and reduces wage-push inflation
Cons
1) Effects can only be seen in the long-run
2) Receptiveness of workers to being retrained may be in doubt.
Evaluate the effectiveness of fiscal policy in rectifying an imbalance of payments
Pros
1) The use of a contractionary fiscal policy can tackle a current account deficit by reducing national income and hence import spending.
2) A contractionary fiscal policy can reduce demand-pull inflation and boost export price-competitiveness, hence improving the current account
3) Lower corporate taxes help to attract foreign investments due to lower operating costs
Cons
1) There is a trade-off with other macroeconomic goals, since a contractionary fiscal policy can lead to lower growth and higher unemployment
Evaluate the effectiveness of interest-rate policy in rectifying an imbalance of payments
Pros
Refer to first 2 points above to evaluate how interest-rate policy can rectify a current account deficit.(Evaluate the effectiveness of fiscal policy in rectifying an imbalance of payments)
Cons
1) While higher interest rates can lead to hot money inflows which improve the capital, this is not a viable solution in the long run given the volatile nature of hot money.
2) There is a trade-off with other macroeconomic goals since a contractionary policy can lead to lower growth and cyclical unemployment
Evaluate the effectiveness of exchange rate policy in rectifying an imbalance of payments
Pros
1) A deprecation of the exchange rate can improve the current account through raising net exports, provided the MLC condition holds
Cons
1) A weaker currency can lead to imported inflation which partially offsets the gain in export price-competitiveness from a weaker currency
Evaluate the effectiveness of supply side policy in rectifying an imbalance of payments
Pros
1) R and D can improve the quality-competitiveness of exports
2) Having a well-trained workforce and skilled labour force makes the country a more attractive destination for foreign investors hence improving the capital account
Cons
1) Effects can only be seen in the long-run
What essay framework can we use when assessing the effectiveness of a policy in rectifying a macroeconomic problem?
The GPLS framework
Goal (context is important in determining root cause of problem)
Policy
Limitations of policy (context is important in determining specific limitations)
Supporting policies
What is the framework for assessing conflicts between macroeconomic goals?
1) Policy trigger
2) Explain conflict
3) Evaluate likelihood of conflict.
Apply TEE to analyzing the conflict between growth and demand-pull inflation.
Trigger: expansionary fiscal policy, interest-rate policy and exchange-rate policy.
Explanation (with fiscal policy as example): The use of an expansionary fiscal policy results in an increase in GPL as the increase in AD brings the economy closer to full employment level. Supply constraints experienced in the economy results in higher strain on limited resources, leading to an increase in COP which is then passed on to consumers. Additionally, the competition for the limited goods and services produced also results in an increase in GPL.
Evaluation: If the country is experiencing severe recession, the likelihood of conflict is low. The trade-off may be temporary if the government employs fiscal policy with a supply-side slant (e.g. infrastructure and capital goods) which increases potential growth.
Apply TEE to analyzing the conflict between growth and external stability.
Trigger: expansionary fiscal policy and interest-rate policy
Explanation: Expansionary fiscal policy leads to a higher level of national income and purchasing power, which stimulates higher consumption of goods and services, including on imports, hence leading to a deterioration of current account. This is especially the case for import-reliant countries like Singapore.
Evaluation: This should not be a huge concern as higher import spending leads to higher material SOL. However, if the country is facing a persistent BOP deficit, any further deterioration of the current account may lead to a larger deficit which will deplete the country’s foreign reserves.
Apply TEE to analyzing the conflict between growth (or external stability) and imported inflation.
Trigger: Depreciation of the exchange-rate
Explanation: Small and open countries may depreciate the country’s currency to boost net exports to bolster growth or improve BOP. Assuming the MLC holds, net exports will rise, leading to higher growth. The BOP improves through the current account. However the depreciation of the currency results in imported inflation.
Evaluation: The conflict is less likely in economies which are resource-rich and less independent on imports.
Apply TEE to analyzing the conflict between sustained growth and employment.
Trigger: supply-side policy.
Explanation: Some economies may need to restructure their economies to develop new areas of comparative advantage. This may lead to a mismatch of skills, hence leading to structural unemployment.
Evaluation: The trade-off with structural unemployment can be minimized if forward-looking policies are put in place to accompany the restructuring process.
Name the specific drivers of economic growth in Singapore
Actual growth (export-driven): Since Singapore has a small domestic market, the impact of a change in C or I on aggregate demand is relatively small. Hence, actual growth is largely driven by (X-M). Equivalently, the threat to Singapore’s economic growth is mostly likely to emerge from an external recession, which leads to falling net exports for Singapore.
Potential growth: Given that Singapore is a small economy, resource endowment is poor. Hence, Singapore has to focus on promoting potential growth to increase the country’s productive capacity.
Name the specific drivers of inflation in Singapore
Cost-push inflation (import-reliant): Given that Singapore is a small economy which is resource-scarce, it has to rely on other countries for imported raw materials and finished products. Hence, it is vulnerable to price changes in other countries, which may trigger imported inflation. For example, a supply shock arising from instability in the Middle East can lead to an increase in the global price of oil, which leads to a substantial increase in the cost of production in Singapore.
Demand-pull inflation (export-driven): In view of the small size of Singapore’s domestic economy, demand-pull inflationary pressures are likely to arise from a spike in net exports instead of domestic sources. This is because net exports constitute a significant component of AD.
Name the RECENT causes of inflation in Singapore.
QE measures in US and Europe have led to an inflow of hot money to Singapore. This has pushed up prices of assets in Singapore. – housing is a component in the CPI basket
Wage-push inflation: To reduce reliance on foreign workers, the government has raised the foreign worker levy, which contributes toward some degree of wage-push inflation.
Higher COE prices feeding into higher transport prices – transport is a component in the CPI basket
Name the specific drivers of unemployment in Singapore
Cyclical unemployment (export-driven): Since Singapore has a small domestic market, Singapore is more vulnerable to demand-deficient unemployment arising from a fall in external demand.
Structural unemployment: Being a small economy with few natural resources, Singapore has to continually restructure her economy to produce goods and services which are increasingly capital-intensive. This is to differentiate Singapore’s comparative advantage from other countries. The restructuring of the economy has contributed to structural unemployment in Singapore due to the resultant mismatch of skills.
Frictional unemployment is not a major concern as job fairs and portals are frequently set up to ensure information flows from potential employers to potential employees and vice versa.
Is fiscal policy useful in the Singapore context?
Since Singapore’s domestic economy is small and mainly driven by exports, fiscal policy is not the main demand-management tool. However, it may be used as a short term tool to boost AD during a severe recession.
Singapore focuses on fiscal prudence and does not actively engage in pump-priming activities. However, the government spends on infrastructure that will contribute to both actual and potential growth. Income and corporate tax rates are kept low to attract talent and foreign investors.
Fiscal policy can be used as a tool to tackle inequity (through a progressive tax system), externalities (taxing demerit goods) and missing markets.
Is the interest-rate policy useful in the Singapore context?
Since we are an open economy which is open to capital flows, any change in interest rates would lead to hot money flows which has a disruptive impact on the economy. Specifically, there would be wide-changes in Singapore’s exchange rates, which is disruptive to our trade, since our trading partners would be less confident about the stability of Singapore’s currency.
Additionally, the flow of hot money due to a change in interest rates will lead to a change in Singapore’s money supply, negating the effects of the monetary policy.
Hence, Singapore does NOT adopt the interest-rate policy.
Is the exchange-rate policy useful in the Singapore context?
Singapore maintains a modest and gradual appreciation of the currency to keep out imported inflation since we are very reliant on imported raw-materials. However, assuming the MLC condition holds, this would have a contractionary effect on our economy. During recessionary periods, the bank may adopt a zero-appreciation stand or depreciate the exchange rate slightly to boost net exports.
Are supply-side policies useful in the Singapore context?
Singapore focuses on the use of supply-side policies to boost potential growth such as providing skills-upgrading programmes (interventionistic) and maintaining a business-friendly climate to attract investments. (Market-based)
Supply-side policies are also used to reduce structural unemployment in Singapore through boosting labour productivity. (Eg SPUR and CET) Grants are also given to employers to encourage their employees to attend such courses. At the same time, compensation is paid to employers for the loss of man-hours.
When are we not able to use fiscal policy?
When the government debt is unsustainable and borrowing of funds to further stimulate the economy is impossible
When are we not able to use the indirect mechanism of monetary policy (interest-rates)?
When nominal interest-rates are near zero and they cannot be further lowered.
How do austerity measures work?
Taxes are increased and government expenditure is reduced in the hope of reducing government debt. In the long run, austerity measures reduce the risk of government default which improves investor confidence. The rise in investment activities contributes towards a rise in corporate tax revenue which improves the budget.
What are the limitations of austerity measures? (GRIT)
Cutting G lowers growth and results in higher unemployment. Through automatic stabilizers, income revenue falls while government spending on transfers increases, hence increasing the debt in the short term.
The country’s credit Rating may worsen in the short term, which leads to higher borrowing costs. Hence the burden of interest repayments rises
Inflexibility of public spending means that cutting G is not so straightforward.
Higher income Tax drives out high-income earners while higher corporate taxes discourage foreign investors. Hence overall tax revenue may fall.
How do austerity measures affect Singapore?
Impacts: Austerity results in a contractionary impact on EU countries, hence purchasing power falls which results in a fall in demand for Singapore exports. The fall in exports leads to lower growth, higher cyclical unemployment and a worsening BOP. Higher taxes may lead to foreign investors gravitating towards Singapore. The rise on FDI has a positive impact on growth, employment and on the BOP. Imported inflation will fall in Singapore as there is lower global demand for resources against European recession. In the long run, the economic prospects in European countries may improve and Singapore’s exports and growth will grow.
Counteracting measures: Given the contractionary impacts of austerity measures on SG’s economy in the short term, expansionary measures such as a slight depreciation of the Sing dollar or an increase in G can be used.
Evaluation: The fall in net exports will have a significant impact on growth. Singapore is likely to be already facing slow growth since austerity usually occurs against a backdrop of a slowing EU economy. Hence, Singapore’s economy will further worsen in the short term.
What is quantitative easing?
QE taps on the direct mechanism of monetary policy when increasing money supply cannot further lower nominal interest rates. This is done through the bank buying long-term bonds, effectively handing out cheap money. This encourages banks to make more consumer loans and allows companies to have access to capital for investment purposes.
With greater availability of credit, consumption spending rises. Firms may also invest in new capital goods. Hence, AD rises through C and I.
When C and I spending on assets such as stocks and property rises, owners of these assets feel richer, compelling them to consume more through the wealth effect.
Some money pumped into the economy may flow overseas as hot money. This outflow results in a depreciation of the home currency, which stimulates exports earnings.
If the above effects led to inflation in the economy, real interest rates become negative since real interest rates = nominal interest rates (near 0) – inflation rate. Negative real I returns on savings is a disincentive to save and spurs further spending.
What are the limitations of QE?
QE may not be effective if expectations are poor.
What is the impact of QE on Singapore?
Impacts: QE in the US may lead to an outflow of hot money into SG, which leads to appreciation of the SGD, worsening price-competitiveness. This threatens actual growth, employment and the country’s BOP position. Demand-pull inflation pressures may fall. Since Singapore’s interest rates are tied to US rates, maintaining low rates in the US also leads to low borrowing costs in SG. This stimulates consumption which may lead to asset-price inflation. Hot money inflows into SG can also aggravate asset-price inflation.
Counteracting measures: Contractionary fiscal policy targeting the property sector can help to lower asset-price inflation.
Evaluation: The change in net exports would have a significant impact on our economy. Since Singapore is likely to be facing slow growth (QE takes place during recession), the rise in net exports due to QE will be welcomed.
What is the role of productivity in driving a country’s economic performance?
Higher productivity generates potential growth (LRAS shifts right).
Assuming wages are unchanged, higher productivity results in lower wage-push inflation (LRAS shifts right).
Hence, exports become more price-competitive and net exports rise, assuming PEDx>1. Actual growth results (movement along AD curve).
Investor confidence may improve. Rise in domestic investments and FDI shifts AD to the right and further bolsters growth.
How can a country’s competitiveness be measured?
The global competitiveness of an economy can be considered from three perspectives – (i) export price and quality competitiveness; (ii) the country’s attractiveness as a foreign direct investment (FDI) destination; and (iii) its labour competitiveness.
Refer to Youtube video under www.thateconstutor.com for more details.
What is the rebalancing act which China is trying to perform?
Shift reliance from external drivers of growth towards domestic C and I. This entails raising C (through tax cuts) and increasing the size of China’s multiplier (through lowering mpm, mps and mpt).
Refer to Youtube video under www.thateconstutor.com for more details.
