macroeconomic policies

Question 1

demand-management policies

Answer 1

affect the level of aggregate demand, which in turn influences the level of RNY, employment, and GPL in the economy

Question 2

supply-side policies

Answer 2

affects the level of aggregate supply, which influences the level of actual and potential output, employment and GPL

Question 3

fiscal policy

Answer 3

the deliberate management of government spending and taxation to influence the level of economic activity to achieve the economic goals of the government

Question 4

economic goals

Answer 4

sustained, sustainable and inclusive economic growth
to push the economy closer to full employment
to maintain price stability
to maintain a favourable BoT

Question 5

short-term purpose of fiscal policy

Answer 5

macroeconomic stabilisation to counter effects of the business cycle (recession/inflation)

Question 6

long-term purpose of fiscal policy

Answer 6

foster sustainable and inclusive economic growth and raise the overall standard of living of their citizens (lift people out of poverty, ageing population, maintaining natural resources)

Question 7

sources of government revenue

Answer 7

taxation: compulsory payments made by individuals or firms to the government
sale of goods and services: state enterprises, sale of government bonds, licence fees and fines

Question 8

types of taxes: impact + incidence

Answer 8

direct: taxes on income and wealth, which impact is not easily shifted (personal income tax, corporate tax)
indirect: taxes on expenditure or production of goods and services, partially borne by consumers as well (GST)

Question 9

tax burdens

Answer 9

marginal tax rate = change in tax paid/change in income -> additional tax burden imposed on additional income earned
average tax rate = total tax paid/total income -> overall tax burden upon taxpayers

Question 10

tax categories

Answer 10

proportional tax: same proportion of income is paid as income rises (corporate tax)
progressive tax: the rate of tax increases as income increases, helps to reduce post-tax income differential (personal income tax)
regressive tax: rate of tax decreases as income increases (GST, especially on necessities), broad-based as foreigners contribute to GST payments too

Question 11

effects of high and steeply progressive direct income taxes

Answer 11

can discourage work and reduce the labour supply (income effect to maintain the same level of consumption vs substitution effect as the opportunity cost of leisure reduces – depends on financial commitments)
reduction in disposable income -> reduces dd for g&s -> reduces prices
reduction in the ability and willingness to save -> reduction in available loanable funds for investment

Question 12

effects of a decrease in corporate tax

Answer 12

increase financial capital available for investment as it would increase the after-tax profit of firms -> increase the level of investment

must be complemented by other supporting measures as investment is dependent on many factors (i/r levels, expectations of the future)

Question 13

effects of tax incentives

Answer 13

influence the production of g&s and resource allocation through tax deductions
influence the supply of labour (higher income tax -> move to countries with lower income tax)
influence consumption through indirect taxes

Question 14

types of government expenditure

Answer 14

operating expenditure: recurrent and routine spending (administration, economic, social, community services)
development expenditure: economic and social development (expressways, schools etc)

Question 15

economic effects of government expenditure

Answer 15

through a progressive tax system -> redistribution of income and wealth
increased standard of living
economic growth (infrastructural development increases productive efficiency -> sustained economic growth)
affects resource allocation through grants and subsidies

Question 16

discretionary fiscal policy

Answer 16

a deliberate change in government expenditure/taxes to bring abut the desired change in AD

main tool: budget (plans out government expenditure and revenue in the coming financial year)
balanced budget, budget surplus, budget deficit

Question 17

expansionary fiscal policy

Answer 17

used to boost economic growth and employment and maintain a good standard of living
used during a recession, when the economy is operating below full employment
budget deficit

Question 18

tools of expansionary fiscal policy

Answer 18

increasing G -> multiplier -> rny increases more than proportionately to increase in G
reducing T -> increase disposable income -> save some, but also spend some on consumer goods -> c, ad increase -> multiplier
use numerical illustrations (MPC, k)

G has greater impact on raising AD as T is indirect and a portion of the tax cuts could be saved instead of spent

Question 19

contractionary fiscal policy

Answer 19

aims to curb excessively high aggregate demand that brings about inflationary pressures in the economy
budget surplus

Question 20

automatic stabilisers

Answer 20

make fiscal policy automatically expansionary during recessions
and contractionary during economic booms

Question 21

types of built in stabilisers

Answer 21

progressive tax structure: tax payments increase/decrease faster than the increase/decrease in incomes
unemployment compensation: offsets loss in earned income of the unemployed, less unemployment benefits are paid out as the economy expands -> slows down rate of economic growth
family assistance programmes
larger in advanced economies
not susceptible to time lags
but cannot eliminate fluctuations completely, should not be completely relied upon

Question 22

effects of fiscal policy on actual growth and employment

Answer 22

expansionary fiscal policy in times of a recession -> raise firm’s profits and employment -> increase workers’ consumption -> sellers earn higher profits, hiring more workers -> stimulate consumer spending again -> rny rise at each successive round of spending but in smaller amounts due to the presence of withdrawals -> draw graph

Question 23

effects of fiscal policy on potential growth

Answer 23

fiscal measures with supply side effects, increase the productive capacity of the economy

Question 24

effects of fiscal policy on inclusive economic growth

Answer 24

through government spending on social services or a progressive tax system + lt infrastructural improvement (healthcare/education)
direct transfer payments are more effective as it directly raises the disposable income of lower income households but require a well-designed mechanism to ensure that the poor are the largest beneficiaries of this transfer
heavy spending on regressive price subsidies limits economic growth -> must be well-targeted

Question 25

effects of fiscal policy on sustainable growth

Answer 25

create a set of policy instruments for building a green economy (carbon taxes which price environment externalities)
investment in green energy/technology (sg $180 million enterprise sustainability programme)
cut back on inefficient government spending on environmentally harmful subsidies (fossil fuels) -> open up new methods of production

Question 26

effects of fiscal policy on SoL

Answer 26

mSoL: tax -> disposable income -> purchasing power
- cuts in taxes tend to disproportionately benefit the middle/high-income households
transfer payments
nmSoL: government expenditure on education, healthcare and public infrastructure + higher real per capita income would give the average person access to higher quality education and healthcare + lower unemployment-> less stress from searching for a job

Question 27

effects of fiscal policy on inflation

Answer 27

contractionary fiscal policy can control demand-pull inflation
fiscal policy that targets aggregate supply in the economy dampens inflationary pressures by expanding the economy’s productive capacity (lowering corporate taxes -> greater accumulation of fixed capital assets) + reduce unit labour cop (assuming productivity growth > wage growth) -> moderates wage-push inflation in the LR / BUT may worsen inflation in the SR

Question 28

effects of fiscal policy on balance of trade

Answer 28

contractionary fiscal policy would deflate ad in the economy (reverse multiplier) -> fall in import expenditure + reduce gpl -> foreigners and locals substitute foreign goods for cheaper local ones -> reduce m and increase x -> improve trade balance
dependent on mpm
conflict with internal objectives

Question 29

limitations of expansionary discretionary fiscal policy

Answer 29

small k (high MPW) - funds required to stimulate the economy are high
economy operating near full capacity
if firms and consumers have a persistently pessimistic outlook on the economy
time lags: effects may come after the economy has recovered and worsen inflationary effects (recognition, administrative, operational) + inflexibility
crowding out effect
Ricardian Equivalence Theory: rational households see current measures which increase their disposable income as temporary and eventually offset by tax increases in the future -> don’t change consumption

Question 30

crowding out effect

Answer 30

if the government finances its budget deficit by borrowing from the private sector, the increase in competition for loanable funds would raise i/r, causing less investment spending by private firms, draw graph – effect of government spending depends on whether the multiplier or crowding out effect is larger
- domestic firms can borrow from external sources
- crowding out effect tends to be smaller during a recession due to the already subdued investment
- sg government uses reserves from the past to finance its deficit spending

Question 31

cost of running a budget deficit (measured using the public debt ratio, debt:GDP)

Answer 31

structural (large and persistent) or cyclical deficit
default on loans -> forced to impose austerity measures -> losing credibility
debt holders would require higher interest payments to compensate for the heightening risk that they will not be repaid
intergenerational inequity
if tax reduction is used, it could lower the willingness of individuals to work, causing the ss of labour to fall and as to fall as well

Question 32

relationship between expansionary fiscal policy and macroeconomic objectives

Answer 32

promote eg and reduce cyclical unemployment at the expense of demand-pull inflationary pressures if sustained for a long period of time
target of government expenditure: inclusive economic growth vs creating more jobs by supporting private investment
higher domestic i/r caused by expansionary fiscal policy may erode the competitiveness of the country’s goods if i/r is higher than foreign countries, assuming demand for exports in price elastic, qty of x will fall (price elastic) + qty of m will fall (ced) -> nx fall -> bot position worsened

Question 33

limitations of contractionary discretionary fiscal policy

Answer 33

if households and firms remain confident about the economy, I and C may continue to rise
cause higher cyclical unemployment due to a lower derived demand for labour
fiscal policy is inflexible downwards as projects are long-term and cannot easily be cancelled
if substitution effect outweighs the income effect, labour supply and thus as would decrease in the LR

Question 34

limitations of non-discretionary fiscal policy

Answer 34

steeply progressive tax rates may discourage workers from taking overtime/seeking promotion and discourage firms from taking risks -> decrease AS
increase the rate of inflation as AS grows at a slower rate relative to AD
reduces opportunity costs of being unemployed -> encourages frictional unemployment
fiscal drag (reduce the recovery of an economy from a recession)
- can be explicitly linked to triggers in the labour market

Question 35

singapore’s fiscal policy

Answer 35

directed at promoting LT economic growth and promoting essential public goods and services to sgeans
tax rates are low to attract foreign investment to Singapore
high mpm -> limited counter-cyclical role of fiscal policy
consistent budget surplus -> investment to grow reserves (boosts investor confidence, buffer against economic shocks)

Question 36

monetary policy

Answer 36

the actions of a central bank to influence the availability of credit (ss of money), cost of credit (i/r), or value of currency in the foreign exchange market (e/r) to achieve macroeconomic goals

Question 37

conventional monetary policy

Answer 37

i/r or money supply is used as the main tool of monetary policy in large economies where C and I make up a large part of AD

Question 38

interest rates (loanable funds theory)

Answer 38

market for loanable funds is an interaction between borrowers (households , firms, governments) and lenders (national savings) that determines the equilibrium i/r
i/r represent the cost of borrowing and return on savings

Question 39

monetary policy stances

Answer 39

expansionary mp: increasing money ss to lower i/r to make credit more available during economic slowdowns to increase rny and lower cyclical unemployment
contractionary mp: reducing money ss to increase i/r to limit the availability of credit to lower the rate of inflation

Question 40

effects of expansionary monetary policy

Answer 40

internal: lowered cost of borrowing -> households borrow to purchase big-ticket items and are less incentivised to save -> c rises + firms have more profitable projects due to the lowered cost of financing the projects -> i rises
external: fall in domestic i/r, ceteris paribus, means that the i/r falls relative to that of other countries -> outflow of hot money -> increases ss of country’s currency in forex -> free/managed float e/r, depreciation of country’s currency against other currencies -> cheaper x + more expensive m -> increase in nx
=> increase in AD (multiplier, draw graph)

Question 41

limitations of expansionary monetary policy

Answer 41

interest elasticity of dd for investment (monetarists vs keynesians) - proportion of economy’s investments that are funded by FDI (foreign companies are less likely to be funded by local banks)
business pessimism may render monetary policy ineffective in stimulating the economy (shift in graph to the left, even if r rises i could still fall)
when i/r is low, the demand for money becomes perfectly interest elastic -> an increase in the ss of money will not have any effect i/r -> liquidity trap and monetary policy of increasing money ss will be ineffective
time lags -> contribute to demand-pull inflation after economic recovery is underway
cannot tackle supply-side macroeconomic problems
increase in inflation
asset price inflation -> benefit the rich

Question 42

quantitative easing

Answer 42

a monetary policy strategy where the central bank makes large-scale purchases of financial assets, crediting the accounts of financial institutions, which now hold more reserves -> increase in loans + strong message to markets that the government seeks to stimulate economic growth, increasing business confidence
causes inflationary pressures on the economy and creates asset bubbles (money value of assets is disconnected from their intrinsic worth)

Question 43

effects of contractionary monetary policy

Answer 43

internal: higher i/r -> it is more costly for households to obtain loans to finance the purchase of big-ticket items + firms are left with fewer investment projects with expected rates of return high enough to cover the increased cost of borrowing -> less I and C
external: in an open economy, hot money will flow into the country to take advantage of high interest returns -> increase dd for country’s currency -> appreciation of its e/r -> less price competitive -> fall in exports + imports increase -> fall in nx
=> fall in AD, inflationary presence dampened, lower RNY + higher cyclical unemployment

Question 44

limitations of contractionary monetary policy

Answer 44

firms’ lt projects cannot be abandoned easily without incurring greater losses -> high investment persists even as i/r increases
inflation-unemployment trade off

Question 45

limitations of monetary policy

Answer 45

time lag, but shorter than fiscal policy as decisions do not require parliamentary approval -> i/r policy has to be conducted in a forward-looking manner
imperfect information on the state of the economy or how it works and its future

Question 46

exchange rate centred monetary policy

Answer 46

primary objective is to promote price stability (low and stable inflation) as a basis for sustained economic growth in the LR

Question 47

reasons to use e/r instead of i/r

Answer 47

small size and high degree of openness to trade and capital flows
high dependence on external sector: m and x each amount to more than 100% of Singapore’s GDP, and total trade is around 400% of its GDP -> e/r directly affects the largest component of SG’s AD, NX
SG is a financial centre and maintains free movement of financial capital, open economy -> any attempt to change i/r would be thwarted by a movement of funds in/out of Singapore -> SG’s i/r is largely determined by foreign i/r
dependence on imported consumer goods + price-taker in the global market as it is a small economy -> reliance on imports and heavily affected by imported inflation -> appreciation of SGD against foreign currencies lowers the domestic price of its imports + CoP of SG firms -> rise in AS, reduces GPL

Question 48

Singapore’s monetary policy

Answer 48

S$ is managed against a trade-weighted basket of currencies, and is valued using the Real Effective Exchange Rate (S$REER) + slope, width, and centre of policy band is announced by MAS (managed floating e/r)
draw graph and assume increase in S$ -if left to free market forces, the value of S$ will rise beyond the upper limit of the band but MAS will sell more S$ in the forex market to keep the value within the band -> slight revaluation of the S$ but the value of S$ remains within the band

Question 49

effect of appreciation of e/r

Answer 49

AS: prices of imported raw materials used by SG’s firms in the production of G&S falls -> CoP falls -> downward shift of AS curve
AD: appreciation of currency -> less competitively priced, price of Singaporean x increases and x falls, price of imports to Singapore decreases and m increases. nx falls -> AD falls
=> lower rate of inflation, fall in RNY -> lower derived dd for labour -> cyclical unemployment increases + assuming marshall lerner conditions holds, BOT worsens

Question 50

limitations of appreciation of S$ policy

Answer 50

st conflict between BOT, economic growth, unemployment vs inflation BUT in the LT SG can gain export competitiveness by keeping inflation low and stable
relies on the country’s availability of forex reserves – insufficient reserves -> speculators sell the currency -> currency crash

Question 51

effects of depreciation of e/r

Answer 51

price of Singapore imports increases -> directly raises prices that an average Singaporean household has to pay for imported g&s -> CPI increases, cost of living increases
AS: price of imported raw materials used by SGean firms in the production of G&S increase -> CoP increases -> upward shift of AS curve
AD: increase in x, decrease in m and shift to domestic goods and services -> increase in NX -> increase in AD – could overheat the economy, which would offset the gains in export competitiveness provided by a depreciation of the S$
devaluation of the S$ e/r could be used in times of deep economic recession
=> dampened increase in RNY, lower unemployment, higher GPL, improved BOT position assuming Marshall-Lerner condition holds (but only a temporary solution if deficit is due to technological backwardness)
j-curve effect: consumers take time to change their consumption patterns and find substitutes -> demand for x and m are relatively price inelastic initially and the Marshall-Lerner Condition does not hold, BOT position worsens in the SR -> improvement over time

Question 52

limitations of devaluation of S$ policy

Answer 52

ST tradeoff between economic growth and lower unemployment vs imported inflation – in the LT, poor management of inflation leads to a wage-price spiral which can cause SG to lose its export competitiveness
time lag
imperfect information

Question 53

supply-side policies

Answer 53

designed to improve the structural long term performance of an economy, improving its productive capacity by increasing the qty, qly and mobility of FoP in an economy
- dd side policies are ineffective in combating stagflation

Question 54

market-oriented supply-side policies

Answer 54

aim to reduce the role of the government and enable the market to work more freely by putting more emphasis on market incentives and competition

Question 55

market-oriented supply-side policies for product markets

Answer 55

product markets: manufacturing and trade, increase degree of competition and efficiency
privatisation: the sale of public enterprises to the private sector -> removal of government funding gives businesses the profit incentive for them to be run efficiently -> drive competition, reduce x-inefficiency and improve dynamic efficiency at the cost of decrease in investment and large-scale reductions in employment
pro-competition policies: promote greater freedom and competition in the private sector, forcing firms to be more efficient in the way they use scarce resources and reduce CoP to maintain their market share -> more x efficient, encourages innovation to gain a competitive edge
- tougher competition policy regime designed to curb anti-competitive practices
- liberalisation removes bte to new firms, encouraging greater levels of entrepreneurship
- promoting freer trade between nations by reducing tariffs creates competition for domestic products
=> in the LR, may be a reconcentration of the market as uncompetitive firms leave the industry + danger of larger firms gaining at the expense of smaller firms

Question 56

market oriented supply side policies for labour market

Answer 56

aim to increase labour market flexibility and improve the quality and quantity of labour
reducing the ability of trade unions to unilaterally raise wages, lowering labour costs for firms and increasing profits and reducing the incidence of work stoppages so loss of output is prevented
tax cuts: encourage workers to work and save by increasing the opportunity cost of leisure -> increase labour supply + incentivises investment, increasing capital stock in the economy and the economy’s productive capacity
- tax incentive wars might be created, other incentives (political stability and a conducive business environment)
cuts in welfare benefits would increase the incentive of unemployed labour to rejoin the workforce and become economically active again by making them mere willing to accept jobs of lower wages, increasing the overall labour supply BUT a dramatic solution which might not be well-received by the population

Question 57

definition of interventionist supply-side policies

Answer 57

direct government intervention in markets, based on the view that the free market fails to achieve certain desirable outcomes such as a low unemployment rate, adequate incentive for education and training, investment and r&d

Question 58

interventionist supply-side policies

Answer 58

government investment in human capital via education and training, as firms may be unwilling to invest in training their workers as the benefits will be lost to them when workers leave their firms but education and training would improve the quality of the workforce, benefitting society as a whole (improve occupational mobility of workers and reduce structural unemployment)
- depends on the receptivity of workers (opportunity cost of retraining, older workers have less incentive to retrain as they have fewer working years)
- LT in nature as it takes time to acquire new skills, and may not be effective in addressing issues in the SR + issue of a loss of productivity of workers during training
- burden of financing courses falls on the government
R&D grants to improve technology (increase productive capacity and reduce unit cop) in areas where there are potentially large external benefits as firms might be unwilling to take on the risk of financing R&D
- risky for the government as well
- long gestation period before R&D efforts are able to yield tangible results
encourage small business start-ups by extending loans, providing technical expertise and support for new start-ups and removing bureaucratic red tape to increase the ease of doing business -> inject more competition into the industry with new technology and new methods of production
- expense, effort and risk of starting a business is still high
the government could nationalise strategic industries, resulting in higher investment and greater internal economies of scale funded by the government’s greater financial ability and better coordination
- opportunity cost of spending tax revenue on the nationalised industry
- inefficiency that results from a lack of incentive to reduce costs
wage subsidies reduce the cost of labour and increase take-home pay -> increases the demand and supply of labour
- give wage subsidies to groups of workers who would otherwise be unemployed -> increase their employability in the future -> increase labour supply in the LR

Question 59

effects of supply-side policies on the ceonomy

Answer 59

growth of an economy in the long run is determined by supply-side factors (technological progress, capital accumulation and quality of labour force): avoids demand-pull inflation caused by a lack of spare capacity (draw graph of both as and ad shifting) + can restrain cost-push pressures by increasing competition in the supply of labour or goods and encouraging increases in productivity
improved training opportunities tend to more greatly increase the skills of low-skilled workers -> wages of low-skilled workers will grow faster according to the marginal productivity theory of wage determination -> smaller wage gap + universal access to good-quality education can reduce educational inequalities which inevitably result in income inequalities => inclusive economic growth
grants for R&D to switch to cleaner methods of production -> more sustainable growth
successful supply-side policies that lower the unit labour cost and increase the productivity of labour boost export competitiveness and attract FDI, improving both the CA and KFA thus improving the BoP
improve nmSoL in societies with ageing populations by slowing the decline in older workers’ skill relevance and cognitive abilities, allowing them to continue to earn a steady stream of income

Question 60

limitations of supply-side policies

Answer 60

are insufficient to help an economy achieve sustained growth on their own, also require a high level of aggregate demand so shifts in the LRAS would cause actual economic growth
depends on the accuracy and availability of information to the government, especially because its effects are only felt in the long run