topic 15,16,17: fiscal policy, monetary policy, SS-side policy Flashcards Preview

A-level H2 Economics > topic 15,16,17: fiscal policy, monetary policy, SS-side policy > Flashcards

Flashcards in topic 15,16,17: fiscal policy, monetary policy, SS-side policy Deck (34)
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expansionary fiscal policy


address slow econ. growth, -ve econ. growth, deflation and dd-deficient UN
- increase G (component of AD)
- reduce T
reduce income tax will increase household level of disposable income which increases PP and translate to increase in autonomous consumption
decrease corporate taxes will increase post-tax profits and encourage firms to invest

+ increase G more effective.
income tax - only some of increase in disposable income will be spent on dom-produced G&S. this is due to leakages in form of S,T,M


fiscal policy


demand-management policy that works through G and T to influence AD


H(AL) of expansionary FP

  • not feasible for govt with large debt or lack of fiscal reserves
  • small multiplier size: effects on EFP on RNY is smaller
    SG: small consumer base and reliant on imports, large MPM, high MPS and low MPT. limit effectiveness of EFP in increasing RNY
  • crowding-out effect: increase in G divert resources away from private expenditure; govt uses resources [if economy operating near full capacity] and borrow from bank (deprives private sector firms of finance necessary for investment)
  • pessimistic outlook: irresponsive to tax cuts
  • conflict of macroecon objectives - if AD continues to increase even aft economy reaches full employment -> trade off btn low UN and low inflation

contractionary FP


address high rates of inflation, excessively high econ. growth
- reduction in G
- rise in personal income tax, rise in corporate tax
GPL falls from P1 to P2, alleviating DD-pull inflation as economy returns to a state with more spare capacity, ensure resources are being utilised at a more sustainable rate since fewer resources being used to produce lower national output


H(AL) of contractionary FP


^advantage as compared to EFP: allow more tax revenue to be collected. more feasible if govt is in debt

  • inability to address root cause of a lack of spare capacity in the economy
  • unintended side effect of reducing RNY, if govt too hard handed due to inaccurate data and info, govt may end up with situation of recession and leads to dd-deficient unemployment
  • unintended effect of reduced PG since investment is reduced

expenditure-reducing policy


FP can be used to carry out an expenditure reducing policy to address BOT deficit

  • decrease in G or increasing T, leading to multiplied fall in RNY via multiplier effect. PP power fall and M fall
  • inflation also falls, exports are more price competitive, increase in X

H(AL) of expenditure-reducing policy

  • not feasible if economy at brink of recession
  • if dd for imports income inelastic, there must be large fall in income
  • does not address if root cause due to appreciating currency
  • high MPM means the fall in AD will be great due to fall in imports
  • economy have to suffer high unemployment and slower econ growth

non-discretionary FP


automatic changes in tax revenue and govt expenditure w/o any deliberate govt intervention. to moderate changes in AD
1. govt spending in form of transfer payments
during recession, more are unemployed and receive more un benefits. decrease in income partially offset by UN benefits, consumption fall by smaller extent
- decrease in AD and resultant multiplied fall in RNY will be smaller, moderate effects of recession
2. progressive tax
- during recession, more people move into lower income tax brackets, need to pay lower proportion of income as income tax, decrease in withdrawals.
- disposable income does not fall as much, consumption and AD fall by smaller extent
conversely: during recovery -> non-inflationary and sustained rates of growth


H(AL) of automatic stabilisers


A: progressive tax system also helps economy achieve inclusive econ. growth, little time lag
- fiscal drag during periods of recession. when economy in deep recession and begin to recover, automatic stabilizers will act as drag on expansion by reducing size of multiplier.
- merely reduce full effects of recession and high rates of inflationary& unsustainable growth, but unable to completely fully address these econ issues. still req discretionary FP
- high UN benefits may worsen frictional UN, while income tax creates disincentive to work (substitution effect)


monetary policy (MP)


demand-management policy that works through tools of i/r or exchange rate to influence AD
managed by central bank thru
i/r: to influence DD and SS of money
exchange rate: to influence DD and SS of currencies


expansionary MP


to address slow growth, recession, deflation and UN
decrease i/r
- lowers cost of borrowing for firms, hence increase borrowing by firms for investment
- cost of borrowing for average household falls. increase in consumption on goods bought on hire purchase or bought using loans on big-ticket items as well as an increase in credit-card spending -> cause autonomous consumption to increase
- lead to hot money outflows: speculators will seek overseas banks with higher i/r -> cause an increase in SS of domestic currency in the foreign exchange mkt as short-term speculators convert it for foreign currency. domestic currency depreciates and net exports increase, DD for exports is price elastic.
-> increase in C,I, (X-M) -> increase in AD, firms hire more FOP, multiplied increase in national income, higher AG


H(AL) of expansionary MP

  • liquidity trap - if i/r already near 0, little room for govt to reduce i/r [occurs when economy is in deep recession]
  • poor econ. outlook -> LTP increase in I and C
  • size of domestic C and I (out of GDP) -> if C and I are small relative to export sector, i/r aimed at increasing C and I might not have much impact on the economy. small domestic size. sg investment mostly comprises of FDI financed by funds in foreign country, changes in i/r unlikely to have large impact on I
  • macroecon. trade off: if AD increase excessively, this could fuel inflationary pressures

contractionary MP


address excessively high rates of growth/ high rates of inflation
- increase i/r
cost of borrowing increases, reduces C
investments become more less profitable
hot money inflow as returns on savings increases -> increase DD for domestic currency, causing currency to appreciate, if DD for imports is price elastic, fall in domestic price of imports cause qty dd for M to increase, fall in net exports
^fall in C, M, (X-M) alleviate DD-pull inflation as economy returns to state with more spare capacity


H(AL) contractionary MP


lack of responsiveness to increase i/r -> overly optimistic
inability to address SS-side constraints of economy, large part of reason for DD-pull inflation due to lack of spare capacity
side effect: unintended effect of reducing RNY, adversely affecting potential growth as fall in I reduces productive capacity


MP as a expenditure-reducing policy


reduces DD and spending on imports, addressing BOT deficit.
increase i/r -> fall in C and I -> fall in AD -> fall in RNY
induce fall in DD for imports, leading to fall in M, BOT deficit will be reduced, improving BOT position
also help to reduce AD such that country inflation rate ends up lower than other countries, exports become relatively cheaper, increases X


H(AL) MP as a expenditure-reducing policy

  • unintended side effect of dd-deficient UN
  • less effective if country’s DD for imports is income inelastic -> must be large fall in income to induce given fall in imports
  • low MPM will be a impediment as it would require large increase in i/r to bring down RNY to decrease M to desired level
  • does not address root cause if BOT deficit due to rising strong currency or import of capital goods (could potentially lead to rise in welfare)

managed float exchange rate system


used by SG

  • allows for value of country’s exchange rate to be flexible within a range so currency is responsive to mkt forces within a band
  • central bank only intervenes to prevent excessive fluctuations outside the ban


tackle import and dd-pull inflation
- on X: increase in prices of exports in foreign currency, less price competitive.
- on M: fall in prices of imports in domestic currency
fall in (X-M), fall in AD -> fall in RNY, decrease in AG [alleviate inflationary pressures]

H(AL) of appreciation


availability of foreign reserves -> govt need to purchase domestic currency in foreign exchange mkt to increase dd for currency
- does not tackle root cause if inflation is due to domestic issues such as higher labour costs
side effects: dd-deficient UN and slower econ. growth




to tackle slow growth, recession, deflation and high UN
impact on AD:
- fall in prices of exports in foreign currency, exports more price competitive
- increase in price of imports in domestic currency, assuming demand for imports is price inelastic, qty dd for imports fall mtp, fall in import expenditure
-> AD increase, increase in RNY, fall in dd-def UN and alleviate deflationary pressures


H(AL) of depreciation

  • short term policy: limited in its ability to ensure long-term sustainable growth e.g. due to loss of export competitiveness due to quality/unrelated to exports
  • at the same time: cop increases due to increase in price of imported raw materials, SRAS falls, dampens increase in RNY. impediment for countries like SG that rely heavily on imported raw materials
  • sufficient spare capacity: following depreciation, dom. production can be sufficiently increase to meet increase dd for exports and dom-produced G&S, otherwise there will be dd-pull inflation
  • demand for exports and imports are price inelastic, there will be LTP decrease in qty dd for imports

marshall lerner condition


PEDx + PEDm >1
(X-M) will still increase even if dd for imports is price inelastic (LTP fall in qty dd for imports)
- trigger retaliatory actions


exchange rate policy - expenditure switching


reduce relative price of dom. goods to imports so people will switch to consume dom.produced goods so as to correct BOT deficit
depreciation -> rise in X, fall in M -> improves BOT position


H(AL) of expenditure switching policy

  • retaliation: other countries devalue currency to maintain relative competitiveness
  • marshall-lerner condition
  • beggar-thy neighbour side effect: trading partner suffer fall in RNY and reduce M, causing country’s exports to fall, offset initial improvement of BOT
  • cost-push inflation: increase in import price -> increase COP -> offset initial improvement in BOT
  • sufficient spare capacity

sg gradual and modest -> zero appreciation


curb import cost-push inflation (raw materials)
alleviate import price-push inflation (finished G&S), consumer goods
- exports have high import content -> fall in cop increase export price competitiveness

-> allows more room for SGD to depreciate


supply side policies - to improve qty, quality and mobility of FOPs


a. govt spending on R&D -> increases factor productivity
b. govt spending on improving human capital
c. govt spending on improving infrastructure -> reduce geographical immobility, labour allocated more efficiency to production of goods and services
cross island line
d. reduction in welfare benefits -> increase opt cost of being unemployed -> increase qty of labour
workfare - wage supplement paid out to employed low-wage workers - benefits contingent upon work


supply side policies - to increase efficiency and remove barriers to competition and trade in global mkts


a. reduce red tape and other obstacles for business start-up and risk taking -> reduces cost and uncertainty, encourage firms to engage in I
SG: one of the easiest countries to start up
b. pro-comp policies (deregulation, strict comp. regulations) -> remove barriers to entry -> easier, less costly for new firms to operate in the mkt against existing firms; monopolist incentivised to be more efficient in production/engage in R&D
e.g. SG open up household electricity retailing mkt
c. privatisation -> increases productive efficiency -> increases productive capacity
d. to reduce the power of trade unions
- reduce bargaining power reduces COP
e. reduction in welfare benefits


supply side policies - give incentives and encourage enterprises


a. grants and initiative to encourage entrepreneurship -> reduce cost and barriers to start up -> increase qty of entrepreneurs
Startup SG Founder Grant
b. tax incentives -> higher post-tax profits to invest -> increase in qty and quality of capital
- cut in income/corporate taxes
- tax rebates/ allowances


H(AL) of SS-side policies

  • req. extensive govt spending
  • diff to change attitudes and mindsets towards retraining/switching jobs
  • effects take a long time to take effect as policies involve structural changes to economy
  • when AD is low, increase in capacity of economy does not address slow growth. effective if it is due to fall in non-price competitiveness

SS-side policies to address dd-deficient UN

  • reduces COP -> firms less incentivised to lay off workers when AD falls
  • SG has flexibility to adjust employers CPF contributions downwards during a recession -> lower COP -> increase SRAS
    cushion effects of falling AD on DD-def UN
    Jobs Support Scheme (govt pay 25% of monthly wage for every local worker in employment)
    flexible wage policies:
  • wages tend to be inflexible downwards due to existing contractual agreement -> set variable wage components relating to performance of workers and economy, wages can fall in response to fall in AD -> increase in qty dd for labour and fall in qty supplied of labour -> reach new eqm where labour mkt clears and dd-def UN eliminated
    e.g. sg adopts flexible wage system where there is a monthly variable components which varies with econ perf and perf of firm

(-) DD-def UN primarily caused by fall in AD, policies to increase SRAS can only mitigate


SS-side policies to address structural UN


improve occupational immobility, reduces mismatch of skills
- enable firms to capitalise on spare capacity (more time, excess manpower) to upgrade and build capabilities to better position SG workforce


SS-side policies to address frictional UN


improve labour mkt info -> increase efficiency -> reduce time needed for jobseekers to be matched to job vacancies
e.g. job matching websites


SS-side policies to address inflation, BOT

  1. cost-push inflation [regulate monopoly, competition act]
  2. dd-pull inflation [increase productive capacity]
  3. BOT deficit
    increase quality of exports by giving tax incentives to encourage innovation

Other SS-side policies

  1. price ceiling
    - on essential items to address imported inflation, mitigate cost-push inflation
    - cap prices of factor imports (oil, fuel) to improve price competitiveness of exports
    x black mkts
    x price control remove, inflation will accelerate
  2. income policy
    - limit extent to which wages can rise
    - legislate wage freeze, wage reduction -> alleviate cost push inflation
    x distort mkt mechanism - inefficient allocation of resources as emerging industries unable to attract labour
    x lack of political acceptability