Macroeconomic Policies Flashcards
Functions of taxes -
correct market failure due to negative externalities
reduce income inequality
promote actual and potential growth
improve BOT position
Types of taxation -
Progressive Tax System (Singapore’s personal income tax)
Regressive Tax System (GST)
Proportional Tax System (corporate tax)
Impact of taxation: -
on productivity:
those who want to maintain their current SOL will work harder as the higher taxes will reduce their disposable income, reducing their ability to consume at the same level as they did before the higher taxes.
those who have less commitments will work less as they trade the opportunity cost of a higher disposable income with additional leisure time.
ability and incentive to invest:
the higher the tax rate, the lower the investments. The increase in taxes 1. reduces the firms ability to save and 2. decrease the after-tax profits.
Aim of austerity measures
aim: to improve the situation with the depleted government reserves, in hopes that in the long run, confidence will be restored on the economy and foreign investments will be attracted, improving economic growth
vG ^T
unintended consequences of austerity measures
further contraction of the economy and lower standard of living (M and NM)
the SR impact of austerity measures may lead to a contractionary effect on the economy due to the decrease in G (decrease in welfare benefits and reduction in infrastructure) and the higher taxes discourages consumption, hence decreasing AD
the decrease in AD leads to a multiplier effect, hence leading to a higher cyclical unemployment
definition of fiscal policy
defined as the use of government expenditure to influence the level of economic activities through AD
suitable for China and America
limitations of fiscal policy
nature of economy: if the economy is export-driven (X-M), a larger amount of G has to be pumped in to offset the drop in AD.
small k: multiplier process, increase in NI is relatively lower than countries with a large k value. *In the context of Singapore, we have a higher MPS, hence the smaller k value.
time lags: the fiscal policy may be implemented too late due to the time lag between the identification of the problem and the implementation of the policy.
monetary policy definition
instruments used by The Central bank to influence economic activity levels
aim of quantitative easing
inject more cash to boost the liquidity in banks, and is used when interest rates are slashed to 0.
implications of quantitative easing
- could be highly inflationary in the long run
- low interest rates causes capital outflow to other countries
- which creates asset bubbles (ie higher prices of assets) as FI prefer to invest in properties that will give them a higher return. The purchase of properties by these FIs contribute to the economic boom due to the increase in I.
how interest rate policy works:
v i/r –> ^I + ^C + ^(X-M) –> ^AD
I: the cost of borrowing(r) of firms will be reduced, hence the MEI, marginal efficiency of investment, is MEI>r, where the rate of return is higher than the rate of borrowing, encouraging increased investment from the firms
C: the cost of borrowing for households also decrease, causing an increase in demand of those consumer goods, causing the autonomous consumption to increase.
(X-M): when the interest rates are low, hot money flows out of the country to other countries with a higher interest rate, causing the supply of the local currency to increase in the f exchange market. The increase in supply of the local currency in the f x m causes the country’s net exports to increase as the local currency depreciates and the price of the country’s exports decrease in terms of foreign currencies.
limitations of interest rate policy:
- Poor economic outlook (pessimism): expansionary monetary policy is ineffective during poor economic outlook as investors and households cannot be coerced to borrow even if the ir is lowered.
Some firms will not borrow to expand and may even downsize due to weak demand of their goods. Consumers may reduce spending due to fear of retrenchment. - Interest rate is already close to 0, and the government may not be able to further reduce it. –> QE
usage of contractionary monetary policy to reduce demand pull inflation
rising of ir to reduce AD in order to decrease inflation.
when the ir is raised by central bank and hence commercial banks, the cost of borrowing from firms and households will increase, discouraging investment and consumption, I and C, hence, AD will decrease.
aim of exchange rate
promotes price stability as a sound basis for sustained economic growth
why does Singapore use exchange rate policy?
Since our resources are scarce and the nature of our economy is mall and open, we are especially susceptible to the price changes of the imports from other countries. Hence the use of exchange rate policy counters import inflation so that the exports have price competitiveness through gradual and modest appreciation of our currency.
the appreciation of Singapore’s currency makes it cheaper to import raw materials, which Singapore lacks, to produce exports that are sold for a higher price in terms of foreign currency.
also keeps the prices of imports low in domestic currency.
