macroeconomics - policies

Question 1

types of demand-management policies

Answer 1

fiscal (expansionary/contractionary), interest rate (expansionary/contractionary), exchange rate (expansionary/contractionary)

i/r-centred and e/r-centred are both under monetary policies

Question 2

define fiscal policy

Answer 2

a macroeconomic policy that alters government expenditure and/or tax levels to influence the economy

Question 3

Explain how expansionary fiscal policy works.

Answer 3

1. decrease in personal income tax –> increase in disposable income & pp –> more w&a to consume more g&s, increase in C
2. decrease in corporate income tax –> increase in after-tax profits, firms more w&a to carry out r&d and invest, increase in I
3. increase in government expd –> increase in G

as C, I and G are components of AD, increases in these components will lead to an increase in AD

inventory process, multiplier process

Question 4

limitations of expansionary fiscal policy

Answer 4

crowding effect, small % of AD in C,I & G

1. crowding out effect

• in countries with tight government budget, govts may have to resort to borrowing from central bank to finance their govt proj & expd
• leads to increase in demand of loanable funds, hence driving up i/r

due to increase in i/r…

increase in COB for big-ticket purchases such as cars and houses, households less w&a to consume these g&s, thus decrease in C

firms less incentivised to borrow capital to finance their investments, as it diminishes their ROI + excessive borrowing by govt erodes/decreases investors’ confidence in the country’s fiscal stability

hence decrease in I

AS SUCH, since C & I are components of AD, decrease in C & I will dampen the increase of AD from govt expd, resulting in a muted increase of AD and RNY, hence limiting actual EG

EVAL PT: limitation not sig in SG bc of prudent fiscal policy, no need heavy borrowing

2. small & of C,I & G in AD

e.g. GERMANY: strong manufacturing sector –> export-driven economy, therefore (X-M) makes up a large component of AD, EFP not as effective as a policy that targets (X-M)

e.g. SG: C, I & G approx 20% of AD

Question 5

general limitations of demand-management policies

Answer 5

effectiveness depends on multiplier size, effectiveness is limited by % make-up of AD component, govt info failure (when enacting policies), time lag, unintended consequences & trade-offs with other macro goals (e.g. demand-pull inflation)