Macroeconomic Problems and Mana gement Tutorial Essay Question 2

2b) A government decides that its economy is currently operating with an unacceptably low level of unemployment. Discuss the view that its best option as a method of reducing unemployment is to use discretionary fiscal policy.

This essay will analyse if the discretionary fiscal policy is the most effective way to reduce unemployment as opposed to other alternative policies. Achieving full employment is one of 4 macroeconomic aims of the government. Unemployment refers to a situation where there’re people who are registered as able, willing to work at the going wage rate but cannot find paid employment despite an active search for work. At full employment, there is a base level of unemployment that will always exist in the economy, known as the natural rate of unemployment (2~3%). Types and causes of unemployment include: cyclical (caused by falling AD), structural (caused by mismatch of skills), frictional (imperfect info in job search) and seasonal (changing demands of the changing seasons). In this essay, the main focus will be on reducing cyclical and structural unemployment as frictional and seasonal unemployment do not pose a serious problem due to their low contribution to unemployment rate. Discretionary fiscal policy refers to the government’s deliberate effort to change govt spending, in this case, increase G so that AD increases to increase employment. Note that when AD increases, it implies a higher production of output and hence a higher dd for labour, which means more employment opportunities are available, leading to a higher employment rate.

Fiscal policy encompasses 2 approaches: reduction of taxes and increase in G. Firstly, increasing govt expenditure on public projects will directly lead to an increase in AD since G is a component of AD and hence an increase in employment. It could be spending on infrastructure, training schemes for workers. Secondly, tax rates are reduced. When corporate tax falls, after-tax profits increase, generating more funds for investment in capital goods and attracting FDIs, thus I increase, AD increase and employment rises. [SG corporate tax reduce from 18% to 17% in 09.]When personal income tax falls, after-tax incomes increase, disposable income increase, consumption increase, AD increase and employment rises. Fiscal policy mainly lowers cyclical unemployment.

Increase in AD is illustrated by a rightward shift from AD1 to AD2.

National income increases from Y1 to Y2.

Implies an increase in real GDP. Higher production

of output means greater dd for workers, hence employment rises.

Fiscal policy will work best if the cyclical unemployment is mainly caused by a weak domestic demand. If the main causes of falling AD were due to external factors such as weak global economy, using fiscal policy will not target root cause of unemployment. Fiscal policy will have greater impact on large countries compared to small countries like SG because SG has a small domestic market. It depends on external trade for growth, leaving it vulnerable to external threats. Bulk of AD is due to X-M, so increase in G may not lead to a significant increase in nat.income and a rise in employment.

In view of these limitations, fiscal policy may not be the best option. The govt could try other possible dd management policies to reduce cyclical unemployment. This is especially so in times of global recession when falling AD is due to external causes and for smaller countries with small domestic markets.

Thus, the govt could use the option of depreciating the exchange rate. Px falls(in terms of foreign currencies), QTYddx increase, TRx increase. Pm increase(in terms of domestic currencies), QTYddm decrease, TRm decrease. Hence (X-M) increases, AD increase, more jobs created. This only holds if Marshall-Lerner condition is satisfied(PEDx + PEDm > 1 ). Examples include China undervaluing the Yuan. However, when economies like SG are reliant on imports(due to lack of natural resources), depreciating currency will make imports more expensive and imported inflation occurs, COP rises, workers retrenched due to cost cutting measures, problem of cyclical unemployment worsens.

While we should implement expansionary dd mgmt policies in times of falling AD, we also need to take note of the timing of the implementation of the policies

Evaluate dd-mgmt policies as a whole:

Time lag – the policies could be implemented only when the economy is nearing recovery

Implications: inflationary pressures (increase in GPL leads to fall in purchasing power of money)

Henceforth, dd-mgmt policies cannot be the only option to reduce unN, the govt would also need to implement SS-side policies to expand production capacity keep inflationary pressures in check.

While cyclical unemployment can be solved by dd management policies, what about structural unemployment? Structural unemployment caused by mismatch of skills can be solved through SS side policies.

These policies aim to increase efficiency of labour and goods mkt, increasing labour productivity. This is done through retraining of workers, to upgrade workers and equip them with relevant skills. [Example: CET Masterplan in SG serves as a gateway for workers to access relevant training to stay employable] Labor mobility increases and hence employability increases. Retrenchment is minimized. Higher productivity and skills would increase the LRAS, hence we would be able to achieve sustained growth and employment in the LR. However, employees and employers may not be receptive to the training sessions. Example: Ageing workers in SG, Japan are not adapting to new technology. Also, retraining takes time and the outcome is uncertain, thus structural unemployment can’t be solved quickly.

In conclusion, FP is the best policy to reduce cyclical unemployment in economies suffering from low domestic dd. It’s not the best policy when it comes to solving structural unemployment. Lastly, all govts should be mindful of conflicts between lowering of unemployment rates and inflationary pressures. [If there is an excessive increase in AD without an increase in productive capacity] Hence SS-side policies are needed to not only reduce structural unemployment but also to ensure sustainable growth and hence higher employment over a long period of time.

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2(a) Explain one possible supply-side policy that could be used by a government as a part of its efforts to achieve the macroeconomic policy objective of non-inflationary economic growth. [10]

Introduction:

Definition of non-inflationary ec. growth

- Growth without inflation

- Must achieve both actual and potential growth -> an increase in both AD and AS

Types of SS-side policies: work to expand production capacity of the economy in the LR

Market oriented and interventionist ss-side policies.

Content :

Explanation of ONE example of SS-side policy + how it works to increase both AD and AS

E.g Interventionist policy

Govt incentives: providing training subsidies for firms, reducing corporate tax. Subsidies reduce the cost of training increase the willingness for firms to send

workers for training More trg more skillful workforce higher efficiency and productive increase LRAS (production capacity). The more productive workforce - attracts FDI increase AD

Reducing corporate tax increase after tax profits more funds available for investment for firms I increase OR invest in capital good(machinery, equipment)capital accumulation OR attract FDIs AS increases OR AD increases

Increase in LRAS illustrated by rightward shift of AS1 to AS2.

Productive capacity increases.

Potential growth achieved.

Increase in AD illustrated by rightward shift of AD1 to AD2.

Real NY increases from Y1 to Y3. Real GDP increase.

Actual growth achieved.

Contextualise:

Use SG as an example.

1. CET(Continuing education and training) masterplan. Serves as a gateway for all workers to access relevant training and explore career opportunities.

2. SDF (Skills development Fund). Employers enjoy grants for staff trainings. Firms enjoy 50% subsidy of retraining fees that they undertake to train its employees.

3. Corporate tax reduction. Reduction in corporate tax rate to 17%. SG Corporate tax rates remain one of the lowest in the world.

Conclusion:

To achieve economic growth without inflation, it is important for the government to ensure that there is increase in production capacity alongside with the increase in AD.