Monetary and Fiscal Policy Effectiveness - Coursework Example

?MACROECONOMICS Economic policies are ified into the monetary and fiscal policy in which the overall economic outcome is driven and predicted by the effectiveness of these two factors and the issue of wage price policy. Under a situation of fully flexible prices and wages, this would be the situation in which W/P is the nominal wage, Nd and Ns are labor demand and supply respectively. O is the output is the income and w/p is the real wage. This means that there exists a relationship between prices and wages in determining the economic cycles. O O N Y Nd Ns w/p W/P Ns Nd N Y The IS model for a closed economy is algebraically represented as Y = C(I,Y)+I(i)+G(t),while the LM curve is represented by L(i, Y) = Ms.When the Is curve is vertical the monetary policy tends to be most effective since the key parameters in this case include interest rate and income. 2. (a) In a closed economy, IS curve is the interest rate at which the commodity market is at equilibrium at a given income level. This can be expressed algebraically as Y = C + I + G, where Y is the equilibrium income is the level of consumption, I is the level of investment and G is the government expenditure. It is worth to note that consumption is a function of income while investment is a function of interest rate and government expenditure is a function of tax. Using the equation given above, Y = C + I + G, but C = 100 + 0.4(Y – T) and when this is substituted into the IS equation we obtain Y = 100 + 0.4(Y – T) + I + G, since I = 1000 + 0.1Y – 20i which when replaced to the equation gives Y = 100 + 0.4(Y – T) + 1000 + 0.1Y – 20i + G,note that T= 300 finally the value of G = 100 which when replaced into the equation yield Y = 100 + 0.4(Y – 300) + 1000 + 0.1Y – 20i + 100. When this equation is simplified to give the IS curve we obtain 0.5Y = 1080-20i and the IS curve will be represented by the equation below; Y = 2160 – 40i. LM curve is the interest rate at which the money market is in equilibrium at a given level of income. In this case Money demand equals money supply and this is algebraically presented as L (i, Y) = MS where L is the demand for money which is a function of income and interest rate, MS is money supply. Using the empirical figures given above, 5Y – 10i= 300 and this can be rearranged into 5Y=300+10i, this yields the LM curve of Y=60+ 2i. IS-LM curve can be attained where there is equilibrium in the commodity market and money market. Using the IS and LM equations and combining them we obtain i= 50 and Y = 160.This means that equilibrium income Y=160 and equilibrium interest rate i=50. This can graphically be represented as: I M i 50 L S 160 Y (b) When the G increases by 100, the IS-LM curve equilibrium Y = 170 while the i=55 and this represents an upward shift in the IS curve as shown below: Io I1 i M 55 50 L S1 S0 160 170 Y (c) When the real money supply reduce by 200, the i=51 while Y=122 and this represents an upward shift in the LM curve as shown below. i I I M1 M0 51 50 L1 L0 S 122 160 Y (a)In an open economy, IS curve can be derived by equating Y= C+I+G+X-M, this can be represented as Y = 100+0.8(1-t)Y + 700-50i+900+700-0.2Y: In simple expression the IS curve will be Y=4000-83i. On the other hand the LM curve will be expressed algebraically as Money Demand equals Money Supply and using the data provided this will be 0.25Y – 62.5i = 500. Hence Y= 2000+ 250i (b) The equilibrium income and interest rate in this case will be calculated by equating IS to LM which will be 2000 + 250i =4000-83i and Y= 498 and i= 6. Hence the governments surplus budget will be (X)700- (IM)99 = 600. (c) The equilibrium income Y = 498 therefore, the government expenditure should be increased by 4602 (d)The change in balance of trade will be export less import which is 600 and this is also a government surplus. This employment is sustainable since there is an extra demand for labor to be absorbed in the export sector and this also means that the extra export creates more employment opportunity. (e) The full employment also calls for fiscal policy that would incorporate the tax multiplier in the entire expansionary attempt. f). The increased demand for the products of the country is likely to increase the value of the country’s currency and this is likely to cause deflationary pressure under the flexible exchange regime due to the free forces of demand and supply. g). After joining the one currency agreement, the country is likely to experience acute devaluation of is currency unless the government react through monetization. In this regard it means that fiscal policies need to be blended with monetary policy to achieve desirable economic goals. This must consider foremost the influence of foreign exchange regime that the government monetary authorities choose to use. The most appropriate long run measure against any economic disturbance is adopting the mixed regime. The effect of fiscal stimulus is that it will lead to a shift in IS curve to the right and that can be shown below. i L S1 S0 Y A fiscal stimulus will lead to increase in income and an increasing effect in interest rate. This will be indicated by a shift in IS curve from I0S0 to I1S1. According to the various economic theories on growth and development, it is worth to note that the possibility of economic compatibility among countries of same economic status is easy. This is to say that it is comparatively difficult to find developing countries working towards same economic goals with another one that is developed (Rostow & Kennedy, 1990, 34). One reason for this is the issue of difference in the type of labor applicable in the economy. According to the Harold domer theory, the human capital is the fundamental basis of proper economic prosperity. However, the O-ring theory claims that a given class of workers possessing some equal level of skills will always cluster themselves together. In that respect it would be difficult for the low standard of training acquired in the developing states to be compared with the developed ones. The lag period during the transfer of technology is also likely to be a greater problem for the countries whose economic size gaps are large. In other words, development is directly related to the skills of manpower that a country possess, since even the adoption of a foreign technology demands such a top cream human capital (Salvadori, 2003, 56-9). It is along this line of thinking that it is fairly important to note the interstate development compatibility that is basically pegged on the close economic ability of the concerned nations. The type of input factor combination ratio is also important in determining the ability of two nations to work towards same economic development goals. Section B. Economic growth is the increase in the national income as a result of the country’s increased output level. Many theories have been advanced to explain the trend in economic growth between the developed and developing economies. It is worth to note that various economic models underscore the relative convergence in the rate of growth between economies of similar magnitude. Take the example of the G8 economies; it is not possible for the developing countries to expand their economic bases at the same rate. Various theories of growth and variables are being discussed in regard to the reasons behind the divergence of the economic growth. Exogenous technology growth is one of the theory Solow formulated shows that technological change drives growth. But technological growth is not determined within the model and this means that it is exogenous. It is worth noting that this does not show capital investment as insignificant i.e. better technological advancement raises output besides creating new capital investment opportunities. In regard to this theory, the capital base of the country any country dictates its development rate. In that respect most developed countries have a higher investment in research and development and hence continue to set pace as a group while at the same time the developing economies can grow together. Another concept that needs to be considered is the consumption level between the citizens is similar. This means that the living standards are almost the same between states of same economic level and they tend to move on the same output growth direction (Rostow, W. W., & Kennedy). The labour mobility is equally important in defining the convergence model in economic growth between countries of same social, political and economic characteristics. Monetary policy is always the mode of regulating the economy since it does not add the burden on citizens. Government fiscal policy intervention sometimes works against the reality of the market’s forces of demand and supply and this has always made many nations to sink into economic oblivion. References Rostow, W. W., & Kennedy, M. (1990). Theorists of economic growth from David Hume to the present: with a perspective on the next century. New York, Oxford University Press, p. 34. Salvadori, N. (2003). The theory of economic growth: a 'classical' perspective. Cheltenham [u.a.], Elgar, pp. 56-9. Read More