Section 10-Government Macro
Intervention
Interconnectedness of Macro-economic Problems
• The internal value of money is the value of money when buying goods and services.
This is the real value of money and it is measured by the purchasing power of money.
• Inflation reduces internal value of money.
• Exports become dearer and imports cheaper.
• Current account deficit occurs if ML-condition met.
• Exchange rate falls due to reduced demand and increased supply of currency.
• Fall in unemployment increases AD AD, thus causes inflation.
• Timbergen’s rule: is that there must be at least one policy measure for every
macroeconomic objective**.**
• Refer to AS section 5 for more.
• Counter-cyclical fiscal measures are policy measures which counteract the effects
of the economic cycle. For example, counter-cyclical fiscal policy actions when the
economy is slowing would include increasing government spending or cutting taxes to
help stimulate economic recovery.
• Macroeconomics problems arise when the economy does not adequately achieve
the goals of full employment, stability, and economic growth this is why
macroeconomic failure occurs.
Macroeconomic conflicts
• Economic growth vs Inflation: One macro-economic conflict can come between
economic growth and inflation (which leads to a similar conflict between unemployment
and inflation). If there is rapid economic growth, it is more likely that inflationary
pressures will increase.
• Economic growth vs Balance of payments: When economic growth is led by consumer
spending, it tends to cause a deficit in the current account. This is because as
consumer spending rises, there will be a rise in import spending.
• Economic growth vs budget deficit: If government wants to reduce budget deficit this will
require higher taxes and lower spending. However, this tightening of fiscal policy will
lead to a fall in AD and lead to lower economic growth.
Similarly, if the government wants to boost the rate of economic growth it could pursue
expansionary fiscal policy (tax cuts/spending rises). This should increase aggregate
demand and help economic growth – but there will be a side effect, the budget deficit
will rise.
Inflation
• Government wants high employment with low inflation
• Internal and external value of money: The internal value of a country’s currency and its
external value may be closely connected. Th e internal value will fall as a result of
inflation. Each unit of the currency will buy less in the domestic market.
• Balance of payment and inflation: if a country’s inflation rate rises above that of its main
competitors, its price competitiveness will fall. Export revenue will decline while import
expenditure rises and the current account balance will deteriorate.
• Unemployment and inflation:
• Phillips curve: a curve that shows the relationship between the unemployment rate and
the inflation rate over a period of time.
• Expectations-augmented Phillips curve: a diagram that shows that while there may be a
trade-off between unemployment and inflation in the short run, there is no trade-off in
the long run.
Tax
• Tinbergen’s rule: for every policy aim there must be at least one policy measure.
• Government macroeconomic failure: government intervention reducing rather than
increasing economic performance.
• Counter-cyclically: going against the fluctuations in economic activity
• Laffer curve: a curve showing tax revenue rising at first as the tax rate is increasing and
then falling beyond a certain rate
The Macro Economy
