GOVERNMENT MACRO INTERVENTION Broad topic objectives: To explain The aims of macro policy Fiscal, monetary & supply side policies. Effectiveness of macro policies

Aims of macroeconomic policy 1. Sustainable economic growth 2. Low & stable price inflation 3. Equilibrium or stable BOP position 4.Full employment/low unemployment . 5.Minimal exchange rate fluctuations

6. sustainable economic development Macro econ goals of govts. video. Types of macro econ policy:. There are 3 policies used to achieve macro econ objectives; Fiscal policy

Monetary policy Supply side policy Give mind map from page 118: 1.FISCAL POLICY (FP): It’s a dd side policy that uses taxation & government spending to manage AD so as to attain macro econ aims.

Tools of fiscal policy Taxation Government spending

Types of fiscal policy: 1. Expansionary FP AKA reflationary FP. Designed to raise AD thru cutting tax rates & raising Government spending on investment projects. Aim: expand the economy so as to create more jobs and income.

2. Contractionary FP AKA deflationary FP Designed to lower AD thru raising tax rates & cutting Government spending on investment projects. Aim: solve inflation by reducing disposable income.

Top tip A deliberate change in taxation(T) & government spending(G) to affect the AD is called Discretionary FP. Forms of G & T that change without deliberate govt action are called automatic stabilizers.

Examples of automatic stabiliers During a recession, govt spending on unemployment benefits increases automatically due to rises in unemployment. During a boom, higher incomes drags people in to higher tax brackets. Diagram : page 115

Observations Y is the initial equilibrium which is below full employment. As GDP rises Taxes increases and govt spending falls automatically. The Budget It’s a government annual fiscal plan outlining the govt revenue and spending sources.

Types of budgets  1. Balanced budget: Occurs when tax revenues = govt expenditures. 2. Surplus budget: Occurs when tax revenues > govt expenditures 3. Deficit budget: Occurs when govt expenditures > tax revenues

Top tip Copy the cyclical & structural budget deficits from page 116. 2. MONETARY POLICY(MP): It’s dd side policy thru’ the central bank/Fed to alter AD so as to regulate the macro economy.

Tools of monetary policy Interest rates Money supply Exchange rates

Types of monetary policy(MP) 1. Expansionary MP AKA reflationary MP: Occurs to raise money supply & AD thru a cut in interest rates, increases in money ss and reduction in exchange rates

2. Contractionary MP AKA deflationary MP. Occurs to lower money supply & AD thru an increase in interest rates, reduction in money ss and rises in exchange rates

3. Supply side policy Designed to increase the LRAS or the economies productive capacity thru the product & factor markets. Draw the diagram:

Tools of MP 1. Deregulation. These are policies that encourage competition in the economy. They reduce barriers to entry in various markets This enables business growth while increasing investor confidence E.g. Liberalisation of power generation & supply in Kenya

2. Tax & welfare benefits reductions This causes pple to have high disposable incomes by increasing incentive to work. They also reduce the firms prodn costs leading to prodn of high output Lower benefits reduces the return of not working hence more incentive to work.

3. Education & training This makes workers more skilled, flexible, mobile and more productive. It can be continuous staff devpt thru on or off the job training 4 Trade union reform These are labour associations that represent workers before employers

Reform means making them comply with labour laws. It increases worker motivation due to proper representation leading to higher productivity. 5. Privatization This involves converting state enterprises in to private sector businesses.

It helps to improve efficiency & productivity. 6. Subsidies: These are govt financial grants to help firms. This is to increase productive efficiency and capacity.

Tasks Self assessment task page 118. Policies to correct BOP disequilibrium: They are of 2 types Expenditure switching policies Expenditure dampening policies

1.Expenditure switching policies Policies used to encourage the purchase of local products and less of imports. Both locals and foreigners are encouraged to buy local goods & services.

They help reduce the amount of spending on imports and to redirect/switch the spending on local goods and services. Their impact is a fall on import expenditure and a rise on export earnings.

They are the trade barriers or methods of trade protection described in topic 4. List them down here….. 1. Tariffs 2. 3. 4.

2. Expenditure dampening policies They help to reduce the amount of spending in the country Their effect on the economy is 2 fold: Few products will be imported Dampening of the domestic market demand . They include; Deflationary fiscal policy Deflationary monetary policy

Effectiveness of policy framework to solve a current account deficit 1. Effectiveness of fiscal policy: Current account deficit occurs when imports > exports. Deflationary FP may help to reduce import demand. It involves raising taxes on all economic agents.

High taxes reduce disposable incomes and possibly import dd. However, high taxes may cause disincentive to work, unemployment, slow econ growth & low AS. Imports may not reduce as much if PED for imports is inelastic.

FP should be used in conjunction with expenditure switching policies e FP should be used in conjunction with expenditure switching policies e.g. tariffs * quotas though they may provoke retaliation. 2. Effectiveness of monetary policy; MP can be used to reduce growth of money ss to correct a current account deficit

High interest rates may reduce incomes and imports dd. However, they may cause capital inflows and a rise in the floating exchange rates making imports cheaper. Changing interest rates is not automatic & may take like 18 months to effect them

Again, high rates will harm borrowers & benefit savers/investors. It may reduce investments, raise unemployment and cause a slow down in econ growth. Devaluation of exchange rates will make exports cheaper & imports

Expensive thereby reducing import dd. However, effectiveness depends of PED of X & M as implied by the Marshal Lerner condition & |J curve effect. Like fiscal policy, MP wont be effective on its own.

3. Effectiveness of supply side policy Deregulation & privatization may increase competitiveness of domestic markets. This leads to low prices and high quality products that may encouraging expenditure switching. However, privatized firms may become inefficient if they turn out

to be monopolies. They may also lay off staff so to maximize profits. Deregulation & trade union reform may increase inefficiencies especially where market failure exists. Education & training of labour force improves productivity & may attract more FDI’s.

However, benefits of education & training are only feasible in the LR and may constitute a huge opportunity cost. Subsidizing local firms may also raise output and possibly check on import dd.

However, subsidies are costly to the taxpayers. They may have high opportunity costs, provoke retaliation & subsidized firms may not pass entire benefits to consumers.

Polices to correct inflation & deflation Policies to correct demand pull inflation: Deflationary FP & MP policies are used. This deals with raising tax rates & cutting govt spending hence cutting back on AD & spending.

The Fed/central bank may also raise interest rates hence raising the cost of borrowing. Large scale purchases e.g. mortgages will be reduced. High rates also cause more savings hence reducing present consumption

Again high rates may attract hot money investments which may raise the exchange rates. High exchange rates makes imports more expensive. Supply side policies are also used to check on dd pull inflation.

Task: Make short notes on the effectiveness of policies to correct demand pull inflation. Page123-4 Policies to reduce cost push inflation: Cost push inflation occurs from the supply side due to high costs of production.

Supply side policies are used e. g Supply side policies are used e.g. training of labor force to increase productivity & to reduce labor costs. Lower corporate taxes may encourage firms to buy more efficient capital equipment.

Subsidizing firms with high production costs may help firms to lower prodn costs & prices. Evaluation of supply side policies: Training workers may raise their productivity but make them more expensive to hire.

Low corporation taxes may not lead to more investments if firms are pessimistic about the future. Lastly subsidies may raise AD but firms may not use them efficiently to raise output.

Policies to correct deflation Deflation is the fall in the rate of inflation. Reflationary FP & MP are used e.g. cutting tax, interest rates & increases in MS. However, rise in govt spending may be better since it will stimulate AD causes more spending.

Again, if interest rates are already low, cutting them again would not help much. Lastly even though CBK raise money supply, banks may not lend more if borrowers aren’t credit worthy.

The end Prep – page 126 Revision summary and questions- page 127  