ACJC Macro Policies (1) - Demand Side Policies

©ACJC Econs Dept/2024/Macroeconomic Policies Part 1: Demand Side Policies 1 ANGLO-CHINESE JUNIOR COLLEGE JC2 Economics 2024 H2 MACROECONOMIC POLICIES (1) Demand-Side Policies Section Contents Page 1 Overview of Macroeconomic Policies 3 2 Demand Side Policies 5 2.1 Fiscal Policy 5 2.2 Monetary Policy: Interest Rates 14 2.3 Monetary Policy: Exchange Rates 23 3 Annexes 32 Texts for References: 1. Principles of Economics: Case, Fair & Oster, 10th edition, pages 638-644, 662-663 2. Principles of Economics, Asian Edition: Mankiw, Quah & Wilson, chapter 25 3. Economics: John Sloman & Alison Wilde, 7th edition, chapters 14.4, 14.5, 22 & 23 4. Economics Today: • Volume 21 Issue 1, Pages 10-15 • Volume 24 Number 2, Pages 22-28

©ACJC Econs Dept/2024/Macroeconomic Policies Part 1: Demand Side Policies 2 WHAT IS THIS TOPIC ABOUT? At any time, every country faces a set of macroeconomic problems, such as slow/negative GDP growth, high /negative inflation (deflation) and high unemployment. These problems are caused by a confluence of internal and external factors and the causes of some of these problems are interrelated. For example, a fall in consumer confidence could lead to a country experiencing both negative GDP growth and high unemployment (i.e. causes of macroeconomic problems may be interrelated). Thus, t he complexity of macroeconomic problems makes them difficult to solve and policy decisions will also involve hard choices and constraints. When governments consider the various polic y options, they have to take into account the constraints they face, the cost and benefits of the policies as well as the intended and unintended outcome s of their policy options. For example, to solve the problem of high inflation, policies used may pose the risks of slower growth and rising unemployment. The choice of policies adopted by governments will depend on their economic priorities and the economic characteristics of their countries. LEARNING OUTCOMES Enduring Understanding: • Dealing with macroeconomic problems involves the use of a set of policy instruments which are broadly considered as fiscal policy, monetary policy, and supply-side policies. • Policies chosen by governments are dependent on the causes of macroeconomic problems they are meant to address, the characteristics of the economy as well as the government constraints. • Every policy chosen will have its set of intended consequences and trade- offs, which the government may need to weigh the benefits and costs. Overarching Essential Questions: • Which policy is the most appropriate to solve a country’s macroeconomic problems? • How effectively can government intervention be in solving a country’s macroeconomic problems?

©ACJC Econs Dept/2024/Macroeconomic Policies Part 1: Demand Side Policies 3 1. OVERVIEW: Recall in the previous set of lecture notes, you learnt about government macroeconomic objectives and the macroeconomic problems. And in this set of notes, we will be studying the macroeconomic policies used by governments in addressing the various macroeconomic problems. For each macroeconomic problem, it is important to understand it s causes and consequences before understanding how governments make use of policies to address the problem.

©ACJC Econs Dept/2024/Macroeconomic Policies Part 1: Demand Side Policies 4 Governments could adopt the following policies to address macroeconomic problems and achieve their macroeconomic goals. The previous set of lecture notes on Domestic Macroeconomic Aims and Problems explains the causes and consequences of macroeconomic problems such as negative economic growth, high unemployment, high inflation, and balance of trade deficit. Governments’ macroeconomic intervention for dealing with macroeconomic problems involves the use of a set of policy instruments. These policy instruments can be classified as follows:

©ACJC Econs Dept/2024/Macroeconomic Policies Part 1: Demand Side Policies 5 2. DEMAND SIDE POLICIES: Demand side policies mainly influence the level of AD. These include: a. Fiscal policy b. Monetary policy centred on interest rates and c. Monetary policy centred on exchange rates (for Singapore) These policies can be expansionary or contractionary: Figure 1: Expansionary Demand-Side Policies Figure 2: Contractionary Demand-Side Policies 2.1 Fiscal Policy Discretionary fiscal policy refers to the deliberate changes to the level of government expenditure and/or the direct tax rates to influence the level of aggregate demand. Discretionary fiscal policy is used to achieve various macroeconomic objectives such as sustained economic growth, low inflation, and low unemployment. 2.1.1 Expansionary Fiscal Policy The expansionary fiscal policy increases AD via the increase in government expenditure and/or lowering of direct tax rates aim to: • Promote real / actual economic growth by increasing real national output. • Purpose: to increase AD to promote economic growth, reduce unemployment, and achieve a healthy rate of inflation. • Impact on real national income and general price level is shown in Figure 1 Expansionary Policies • Purpose: to decrease AD in order to reduce pressure on general price level any prevent demand-pull inflation, or to correct a persistent balance of trade deficit. • Impact on real national income and general price level is shown in Figure 2 Contractionary Policies

©ACJC Econs Dept/2024/Macroeconomic Policies Part 1: Demand Side Policies 6 • Reduce demand-deficient unemployment. • Fight deflation by increasing the general price level. Primary effects: Under expansionary fiscal policy , governments could increase government expenditure and/or decrease direct tax rates to increase AD to achieve the above-mentioned macroeconomic objectives. Note that only government spending in form of development expenditure (where the government spend s on infrastructures for the purpose of economic and social development ) will increase the G component of AD . Transfer payments, for example subsidies to households and firms, can also increase the AD, but via the increase in C and I when households and firms increase their spending. 1. Increasing government spending (G) • Given that G is a component AD, ceteris paribus, this increases AD directly. Governments may spend on, for example, infrastructure such as roads and public transport systems. 2. Reducing personal income and/or corporate income tax rates • Reduction in personal income tax → increases households’ disposable income → higher purchasing power → increasing household consumption expenditure → increase in AD. • Reduction in corporate income tax → increases firms’ after-tax profits and encourages investment expenditure → increases AD. Governments typically implement expansionary fiscal policy during a recession / economic downturn. This helps to: • Achieve / increase actual economic growth. o Recall the multiplier process : AD rise → this results in an unplanned fall in inventory spending, signalling to firms to increase output → allows firms to employ more factors of production to increase output → RNY increases. o the higher derived demand for factors of production also imply greater factor payments such as wages → higher household disposable income → induced consumption increases. o This increase in induced consumption → increase AD → increasing RNY again → this process repeats itself until RN Y ultimately increases by a multiplied magnitude, equivalent the original increase in AD x 1 / (1 – MPC). • Reduce demand-deficient unemployment. o Furthermore, since more factors of production are needed to increase output → the derived demand for factors of production increase