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12 Macroeconomic Policies (Supply-side: Increase LRAS Increase…
12 Macroeconomic Policies
Demand-side:
Change in AD
Fiscal Policy
Government
spending
Direct Taxes
tax cuts
Advantages
Increases potential output
Indirectly
by creating
stable economic environment
Small inflationary gaps
→ Low inflation rates
Small recessionary gaps → Low unemployment
Encourages investment
and R & D
Encourage increases in
potential output
and
economic growth
Directly
through
government spending
Investments in physical capital
(infrastructure+ R&D)
Increase in quality
and quantity of
physical capital
Investments in human capital
Increase in quality
of human capital
Increased
productivity
Increase in potential output
and economic growth
Effective
in severe
recessions
Government spending is
component of AD
Directly affects AD
Disadvantages
Crowding out
Government with
budget deficit must
borrow money
Demand for money increase
so interest rate increase
Higher cost of borrowing
so firms lower investment spending
Smaller increase in AD
Time lag
Cannot solve
cost-push inflation
Reduces inflation,
Worsens recession
Political constraints (CP)
Government spending not easily cut
Increase in taxes not popular
Eg.
USA
(EP)
2001 recession
George Bush signed an act that provided income tax relief
Ended 2001 recession
Monetary Policy
Advantages
Shorter time lag
than fiscal policies
cos monetary policies are
carried out by the central bank
avoid time lags associated
with the political process
Eg.
USA
FED can quickly decide on
interest rate changes through
meetings held
eight times a year
No political
constraints
Doesn't involve
government spending
change in taxes
Does not affect
government budget
Disadvantages
Cannot solve
cost-push inflation
Reduces inflation,
Worsens recession
Ineffective in
severe recessions (EP)
Manipulation of interest rates to influence consumer and investment spending
Indirectly affects AD
Ineffective if
Banks not willing to lend more money
Firms and consumers not willing to increase spending
Ineffective if interest rate
is low to begin with
Eg.
Japan
Bank of Japan (BOJ) introduced
negative
interest rates in 2016
No effect → consumers not willing to spend
Eg.
USA
(CP)
Hiked Federal Funds rate to 20% in 1979
Ended double digit
inflation
Eg.
USA
(EP)
FED lowered interest rates by 1.5% each month
1.75% in December 2001
Ended 2001 recession
Supply-side:
Increase LRAS
Increase potential growth
Interventionist
Directly increase
productive capacity
of economy by increasing quality and/or quantity of FOP
LRAS curve shifts right
→ Potential output
SRAS increase
Advantages
Increase
aggregate
demand
Downward pressure on inflation
Direct support of areas important for growth
Disadvantages
Severe time lags
Opportunity costs
Budget deficit
Eg.
Korea
(infrastructure)
World's first and largest 5G mobile network
Telecom companies invested
$2.6 billion
63000
5G base stations
Market-based
Institutional changes in economy to develop free competitive market
increase efficiency in production and allocation of resources
LRAS curve shifts right
SRAS increases (pg 257)
LEARN HOW TO LINK ALL THESE TO LRAS INCrEASE
PG 340
Increase
market competitiveness
Disadvantages
Severe time lags
Advantages
Increase
aggregate
demand
Advantages
Downward pressure
on inflation
Reduce natural
rate of unemployment
Disadvantages
NUTSHELL PAGE 57
Trade Strategies
(pg. 85)
Import substitution
Export promotion
Trade liberalisation
SRAS only shifts because of COP or supply shocks