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Economic Growth and Policy, Aims of MP and FP, EMP, EFP, SS policies -…
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Aims of MP and FP
Low and stable rate of inflation
- high inflation has harmful impacts to the economy
Low unemployment
- High unemployment also has negative impacts on the economy
- reducing cyclical unemployment (caused by insufficient AD)
Reduce business cycle fluctuation
- real GDP growth can be uneven and irregular, which is disruptive to the normal functioning of the economy (causes inflation when output is at full employment -- the peak of the graph -- and causing cyclical unemployment when it is below full employment -- at the trough)
Creating a stable economic environment
- firms require a stable economic environment to plan and carry out their economic activities and also to avoid sharp economic downturns and upturns
- central bank helps to create a stable macroeconomic environment that encourages economic activities
Achieve external balance (balance of import spending and export earning)
- by influencing exchange rates, the central bank can achieve external balance
MP only: achieving an equitable distribution in income
- by manipulating tax policies and spendings --> the government can choose to increase the production and provision of merit goods (long term: increase productivity and skill of labour force
--> higher income)
EMP
Strengths of the policy
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Fine tuning the economy
Interest rates can be incrementally adjusted which makes it a better policy for fine tuning the economy as compared to FP (the government is liable to commit to changes that they have announced -- not as easy to retract decisions)
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Shorter time lags
Central bank faces shorter time lag as compared to FP as
- it doesn't go through the long and cumbersome bureaucratic / politcal process (still faces time lags as it takes time for interest rate changes to take effect)
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How does it work:
Increasing money supply
- greater availability of credit for firms and consumers to borrow
--> interest rates fall --> C and I increases --> AD increases
Reducing interest rates
- fall in interest rates --> fall in cost of borrowing --> more borrowing for C and I purposes --> increase AD
EFP
Weaknesses of the policy
Time lags
cumbersome and time consuming bureaucratic process and excessive formalities hinders decision making
if time lag is too long, overall expansionary effect may be too little (as the economy would have worsened) -- or the other way
G as a ratio of GDP
if G as a ratio of GDP is low --> increase in G does not increase AD significantly --> policy is less effective
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How it works:
Increase in G
- directly affects AD --> increase in G --> increase in AD
Reduction in taxes (corporate and income)
- increase post-tax profits of firms and disposable income of consumers --> increase in I and C --> increase in AD
SS policies
Strengths of the policy
Interventionist
Reduce income inequality
- Investment in human capital --> increases skills and education of future labour force --> more productive, skilled and healthy workforce --> more likely to be employed and become a productive and active contributor to economy --> income distribution becomes more equal
- lowers the natural rate of unemployment
Targetted
- government can target specific sectors that may be more important for growth
Market based
No burden on government budget:
- government does not provide funds, it is done through private firms initiative (except for incentives based policies -- tax cuts --> fall in government revenue)
Improved resource allocation:
- improves the working of the market system (through the freer play of market forces of demand and supply) --> increasing efficiency in resource allocation
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Weaknesses of the policy
Market based
Time lags
- long run policies that take time to materialise and cause a change in potential output
Vested interests: strong personal interest in something
- firm's vested interest may be affected negatively (policy is not in their best interest) --> rejection and oppose policies --> may even prevent enactment of the policy
Increase income inequality
- greater competition may cause unemployment --> loss in income --> labour market policies (which are there to support the lower incomed) is being reduced --> reduction in the protection of the lower income who face higher job insecurity --> increased income inequality
- tax cuts are designed to impact the post tax incomes of higher income groups (to increase their income) --> tax system is thus less progressive --> redistributive effects of national income is reduced (since the wealthy are the ones who enjoy capital gains and earn interest income --> tax cuts increase incomes even more --> widening income gap)
Environmental impact
- by encouraging competition --> increased scope for economic activities --> negative externalities on the environment
Interventionist
Time lags
- takes time to persuade workers of the need to undergo training and learn new skills
Costs to government
- policies require government spending and investment (in physical, human capital and state of technology by supporting R&D) --> burden government budget and drain scarce resources --> opportunity costs incurred
Firm's unwillingness to send workers for skills training
- reluctant because during the duration of the training there will be a loss in output
- it has positive consumption externalities and may be undervalued and hence under-consumed
- workers may face difficulties learning new skills, esp those who are older