"The road to success comes through hard work, determination, and personal sacrifice."

1. "The road to success comes through hard work,determination, and personal sacrifice."

2. Low inflation to keep value of money under control Low unemployment to make full use of country’s resources Macroeconomics Objectives A sound balance of payment for exports & imports A good rate of growth to raise standard of living

3. Macroeconomics Objectives Internal Balance vs External Balance Sustained EG Low UnN+ Low Inflation Stable Exchange Rate Healthy BOP

4. Macroeconomics Problems Internal Balance vs External Balance Economic Growth Employmt Price Level Exchange Rate BOP Persistent Disequilibrium (deficit) Low growth/ recession High UnN+ Serious inflation Fluctuating Exchange Rate To achieve BOTH internal & external balance, the choiceof policy instrument is very important.

5. The next few slides are recap of what you have learnt last term… Please do not get into a state of panic There is no need to copy anything…… Just listen and try to recall all that you have learnt last term….

6. PROBLEM : INFLATION- Sustained and inordinate general price increase Demand-pull Cost-push Demand-mgmt polices –AD: • Contractionary fiscal policy • direct taxes • G • Contractionary monetary policy • interest rate • Supply-side policy • Income policy

7. PROBLEM : UNEMPLOYMENT- workers are able and willing to work but cannot find jobs Cyclical Classical (real-wage) Structural Demand-mgmt polices –AD: • Expansionary fiscal policy •  G •  direct taxes • Expansionary monetary policy •  interest rate Supply-side policies - • Reduce minimum wage • Training/ • Retraining

8. PROBLEM : LOW ECONOMIC GROWTH/ RECESSION SR: Demand-mgmt polices –AD: • Expansionary fiscal policy •  G •  direct taxes • Expansionary monetary policy •  interest rate LR: Supply-side policy

9. PROBLEM : PERSISTENT BOP DISEQUILIBRIUM Disequilibrium • Surplus • Deficit Current Account Deficit Capital Account Deficit

10. PROBLEM :CURRENT ACCOUNT DEFICIT - imports exceed exports Demand-mgmt polices AD & DD for imports: • Contractionary fiscal policy • Contractionary monetary policy Exchange Rate policy: Depreciate homecurrency to makeexports more competitive (increase Xs)

11. PROBLEM :EXCHANGE RATE FLUCTUATION Exchange Rate policy

12. Macro Policy Instruments • Supply-side Policies • Pro-biz policy (fiscal incentives -> reduce COP • R & D • Training & upgrading of labour skills • Influence AS • Demand-mgmt Policies • Fiscal tools • - G, T • Monetary tools • - i/r, money supply • Influence AD • Trade Policies • Import Restrictions • Export Promotions Exchange Rate Policy

13. Expenditure-Changing Policies targeting at increasing/decreasing level of AD Expenditure Switching Policies which aim to switch imports to home-produced goods • Fiscal and • Monetary Policy • ER Policy • Trade Policies

14. Economic Policy Trade offs • What are the conflicts b/w Internal balance objectives? • What are the conflicts b/w Internal & External balance objectives?

15. Policy Trade-offs? Trade-off implies • choices might have to be made between different macroeconomics objectives. Decisions have to be made • about the relative importance of each policy objective. • when to change economic policy instruments to meet a particular objective.

16. A Question of Priorities! Could economic growth be maintained without eventually causing a rise in inflation? Which objectives should have the highest priority? Should government have as its main aim the control of inflation? Is a period of faster economic growth always a bad news for the balance of payments?

17. No need to copy the next four slides….. Just sit back, listen & THINK…..

18. Balance of Payments • In the 1960s, the Balance of Payments was considered very important. • A deficit was considered highly embarrassing, a big problem in the days of the fixed exchange rate system. • Nowadays, with a floating ER, many economists believe that BOP deficits or surpluses simply do not matter.

19. Employment • Full employment was considered very important after the Second World War. • The number one objective and continued to be for the next three decades. • Unemployment exploded under Thatcher in the 80s, due to structural changes in industry. • The lower levels of unemployment today

20. EG & Low Inflation • Growth and low inflation have always been important. • Without growth, standard of living will not increase • If inflation is too high, value of money falls negating any increase in living standards. • Nowadays, the two most important objectives of UK macroeconomic policy  'sustainable growth‘ (growth without inflation)

21. Have you heard of the “Goldilocks Economy”?

22. What are the conflicts between internal balance objectives?

23. Low inflation vs Economic Growth Internal Balance – Conflict? Is there a conflict in objectives? Consider: To achieve EG by increasing AD • Fast growth can lead to an acceleration in inflation • The economy uses up scarce resources and SRAS becomes inelastic which worsens the trade-off. • An increase in AD leads to higher prices than increased output and employment

24. Low inflation vs Economic Growth Internal Balance – Conflict? How can the conflict be resolved? • Fast growth does not necessarily lead to rise in inflation. • The trade-off can be avoided if an economy can increase its potential output (rightward shift of AS via supply-side policies) • Rightward shift in AS  economy can meet higher level of AD without putting upward pressure on general price level (LR growth)

25. Low inflation vs Low unemployment Internal Balance – Conflict? Is there a conflict in objectives? Consider: Government tries to reduce unemployment through expansionary MP or FP, such as lower interest rates or increased public spending: • Resulting reduction in unemployment leads to increase in AD, causing demand-pull inflation if AS is inelastic.

26. Low inflation vs Low unemployment Internal Balance – Conflict? How can the conflict be resolved? • The trade-off can be avoided by using supply-side policies which are effective in reducing unemployment.

27. Economic Growth vs BOP equilibrium (trade balance) Internal vs External Balance – Conflict? Is there a conflict in objectives? Consider: To achieve EG by increasing AD • When AD is high & domestic producers unable to meet all of this demand, demand for imported goods will increase  increase trade deficit. • With EG, consumers tend to buy goods from abroad (imports) in preference to home produced goods  increase trade deficit.

28. US Deficit Headaches The Bush administration also faces the twin problems of a rising budget deficit and a trade imbalance which continues to set new records. Iraq-related expenditure, allied to significant tax cuts, have pushed the budget even further into the red, rising above $400bn. The trade deficit - the difference between what the US exports and imports - rose to $742bn last year, equivalent to 7% of total economic output. The US trade gap has been fuelled by a sharp rise in imports from China and other Asian countries, which continue to outpace exports. Fears about the widening deficit have contributed to a significant fall in the value of the US dollar over the past month.(BBC, May 2006)

29. More Challenging Tasks: What happens when an economy suffers from twin problems? How will the choice of policies determine if there is a conflict in aims?

30. Eg. Expansionary FP or MP • AD • NY ,N+ • Purchasing Power • Dd for M • BOP surplus UN BOP Surplus Internal vs External Balance - Case 1 Twin Problems Policy Outcome • Cyclical UnN+ • BOP surplus • (CA surplus: • Xs>Ms) • Expenditure • Increasing • Policy resolves • both problems • HARMONY

31. Px ,Pm • X , M • BOP surplus (Marshall-Lerner condition holds) • AD • NY ,N+ UN Internal vs External Balance - Case 2 Twin Problems Policy Outcome • Cyclical UnN+ • BOP surplus • (CA surplus: • Xs>Ms) • Appreciation • of currency • Policy resolves • one problem • but aggravates • the other • CONFLICT Fall in (X-M)

32. Internal vs External Balance - Case 3 Twin Problems Policy Outcome • Dd- pull inflation • Current a/c deficit • Expenditure • decreasing • Policy resolves • both problems • HARMONY • Contractionary FP/MP => fall in AD=> multiple fall in NY Solves inflation problem • And falling NY => less purchase of imports Reduces current a/c deficit

33. Internal vs External Balance - Case 4 Twin Problems Policy Outcome • Dd- pull inflation • Current a/c deficit • Depreciation • of currency • Policy resolves • one problem • but aggravates • the other • CONFLICT => X relatively cheaper & M dearer => rise in X and fall in M (Marshall-Lerner condition holds) Solves current a/c Deficit • But as (X-M) rises => AD rises Worsens inflation problem

34. Internal vs External Balance - Other Cases Conflict/ Harmony Case Int. Prob Ext. Prob Govt Policy Cyclical UnN+ Expenditure increasing 5 CA Deficit Cyclical UnN+ 6 CA Deficit Depreciation Expenditure decreasing 7 Inflation CA Surplus 8 Inflation CA Surplus Appreciation

35. Internal vs External Balance - Case 5 Twin Problems Policy Outcome • Cyclical UnN+ • Current a/c deficit • Expenditure • increasing • Policy resolves • one problem • but aggravates • the other • CONFLICT • Expansionary FP/MP => increase in AD => multiple increase in NY Solves UnN+ problem • But increasing NY => increase in purchase of imports Worsen current a/c deficit

36. Internal vs External Balance - Case 6 Twin Problems Policy Outcome • Cyclical UnN+ • Current a/c deficit • Depreciation • of currency • Policy resolves • both problems • HARMONY => X relatively cheaper & M dearer => rise in X and fall in M (Marshall-Lerner condition holds) Solves current a/c deficit • And as (X-M) rises => AD rises Solves UnN+ problem

37. Internal vs External Balance - Other Cases Conflict/ Harmony Case Int. Prob Ext. Prob Govt Policy Cyclical UnN+ Expenditure changing 5 CA Deficit Conflict Cyclical UnN+ 6 CA Deficit Depreciation Harmony Expenditure changing 7 Conflict Inflation CA Surplus 8 Inflation CA Surplus Appreciation Harmony

38. Summary Problems Macro aims Policies Limitations Twin Problems- Policy Outcome: Harmony or Conflict ? Conflict of aims?

39. US Deficit Headaches Think about this: How might US solve its twin problems? The Bush administration also faces the twin problems of a rising budget deficit and a trade imbalance which continues to set new records. Iraq-related expenditure, allied to significant tax cuts, have pushed the budget even further into the red, rising above $400bn. The trade deficit - the difference between what the US exports and imports - rose to $742bn last year, equivalent to 7% of total economic output. The US trade gap has been fuelled by a sharp rise in imports from China and other Asian countries, which continue to outpace exports. Fears about the widening deficit have contributed to a significant fall in the value of the US dollar over the past month.(BBC, May 2006)