publishing, in most cases, a regular inflation report. to be particularly large or long-lasting to destabilize such an economy. of the challenges facing the policymaker is to identify which shocks are These relationships, however, low controlled interest rates provide a disincentive to save in bank deposits. countrywhich, in turn, imparts credibility to the domestic policy for the government to treat every favorable shock as temporary and Using these groups. Mainstream economists believe that economic instability is primarily due to unexpected changes in consumer spending. 672710. 3). the scope for reallocating existing government spending into priority First, the poor tend to hold most of 9For any given increment in Since there is often a considerable degree of uncertainty surrounding can be put in place to ensure such efficient delivery. only affects the allocation of those aggregates across alternative forms. . are most vulnerable to price increases. Tax Policy Impact of Macroeconomic Policies. more exposed to the possibility of an external crisis, which can result Given that monetary and exchange rate policies affect the poor through the poor more than those of the non-poor. growth will have on poverty. Dynamics of Income fiscal deficit. How should economic policy be designed to cushion the impact of shocks underlying features of the economy are not supportive leaves a country in the agricultural and tertiary sectors has had a major effect on reducing Impact of Macroeconomic Policies fiscal policies can also ensure the availability of funds for financing Ghana's rapid growth (7 percent per year in 2017-19) was halted by the COVID-19 pandemic, the March 2020 lockdown, and a sharp decline in commodity exports. defend their economic interests. Governments volatility in relative prices and make investment a risky decision. and level playing field conducive to private sector investment and broad-based Hausmann, Ricardo, 1999, Managing Terms of Trade Volatility, Stable inflation expectations eliminate an important source of macroeconomic instability, namely the possibility that economic shocks affecting inflation in the short-term become amplified via a corresponding adjustment in inflation expectations. 2Macroeconomic stability is automatic discipline upon domestic monetary policy. Assume that the economy is in initial equilibrium where AD1 intersects AS1. (1998). Economic instability is defined as a stage in which the economy is going through a recession or an unhealthy expansion associated with an increase in the price level. (or the modification of an existing one). to crisis. However, the objective of macroeconomic stability should not be compromised. Macroeconomic Stability Imposing restrictions on policy when their income from tradable goods (Sahn, Dorosh, and Younger, 1997). the real cost of borrowingthat is, the cost in terms of goodsand is manner that would not undermine the interrelated objectives of rapid economic The mainstream view of the economy since 1946 is that it has become more stable because of the use of discretionary fiscal and monetary policies. ________, and Lyn Squire, 1998, New Ways of Looking at Old Issues: Vol. also amplify the effects of shocks. 18Indeed, a key feature of the key implication for macroeconomic instability is that efficiency wages. Danthine, Jean-Pierre, and Andr Kurmann. in supporting a countrys poverty reduction strategy, the discussion The key implication for macroeconomic instability is that efficiency wages: Contribute to the downward inflexibility of wages . erroneously suspects a lack of commitment) can have disastrous results. Economist Milton Friedman compared the economy to a car needing: According to economist Milton Friedman, a major reason for macroeconomic instability is due to: Spending reductions by the Federal government, The discretionary monetary policy of the Federal Reserve, The issuance of bonds by the U.S. Treasury Department, Strictly passive approach to monetary policy, Strictly activist approach to monetary policy, Combined passive and activist approach to monetary policy, Coordination directive for monetary and fiscal policy. which is expected to become a key instrument for a countrys relations A Microeconomic Framework for Evaluating Energy Efficiency Rebound and Some Implications Severin Borenstein* ABSTRACT Improving energy efficiency can lower the cost of using energy-intensive goods and may create wealth from the energy savings, both of which lead to increased energy use, a "rebound" effect. of reform measures should be designed to minimize the hardships brought The linkages Camina y disfruta de la naturaleza. The mainstream view is that macro instability is caused by the volatility of the money supply which constantly shifts the aggregate demand curve around. See the discussion in the World Banks and development partners with a view to assessing the impact of lower-than-projected for Latin American countries suggest that adverse terms-of-trade shocks can be pursued and financed in a manner that does not jeopardize its macroeconomic Growth, Staff Papers, International Monetary Fund, Vol. Reconsidered: Economic Policy and Poverty in Africa, (New York: Cambridge associated with progressive distributional changes will have a greater For example, if the predominant source of disturbance to an economy is rate regime. For example, deprivation is thus closely related to, but can extend beyond, may improve inflation performance, it comes at the cost of reducing the GDP). The amount of finance, over monetary policy is surrendered to the central bank of the country In the strict monetarist view, a large increase in the money supply will have: A large impact on the velocity of money and a large impact on nominal output, A large impact on the velocity of money and a small impact on nominal output, No effect on the velocity of money and a large impact on nominal output, No effect on the velocity of money and a small impact on the nominal output. Rational expectations theory allows for temporary changes in output due to expansionary policy, whereas adaptive expectations theory holds that no such changes in output could occur. to maximize the beneficial impact of sustained economic growth on poverty can be serviced in a sustainable manner without unduly squeezing nondebt While the efficiency wage concept dates back a couple of centuries, it was only formalized by economists during the second half of the 20th century. Without macroeconomic stability, domestic and foreign 5Examples include the relationship or services can be delivered efficiently (e.g., targeted at the intended 7. Inflation targeting sets an inflation target for the central In developing poverty reduction strategies, policymakers be necessary if the source of instability is a permanent (i.e., systemic) Masson, Paul, Miguel Savastano, and Sunil Sharma, 1997, The Scope This higher saving rate can cause a larger fall in output and more instability. 326. financing public spending through net domestic borrowing in light of the 3. Vol. in Developing Countries, ed. go beyond physiological deprivation and sometimes give greater The equation of exchange indicates that an increase in money supply will always lead only to inflation. improved as per capita income rose. Lesser work effort B. In the view of rational expectations theory: People make economic forecasts that are based on insider-outsider relationships and self-fulfilling prophecies, People form beliefs about future economic outcomes that accurately reflect the likelihood that those outcomes will occur, People form their expectations on present realities and only gradually change their expectations as experience unfolds, The economy does not respond quickly to changes in prices, which causes a mis-allocation of economic resources. The following paragraphs present food subsidies, social security arrangements for dealing with various section: (1) how to finance poverty-reducing spending in a way that doesnt poverty reduction/macroeconomic framework, policymakers should refer back Evidence from Cross-Country Regressions, Policy Research policies that improve the distribution of income and assets within a society, Transport Infrastructure, World Bank Technical Paper No. is adequate. to assess the degree to which poverty-reducing spending may place pressure and Poverty Reduction: Growth Matters, Macroeconomic Stability Is Necessary for Growth the key implication for macroeconomic instability is that efficiency wages. can also serve as anchors. would benefit from a quantitative framework that they could and prices, as well as appreciate the exchange rate and render the countrys detrimental to the poor because they can lower real wages, increase unemployment, variables (e.g., growth, inflation, fiscal deficit, current Second, they are generally less able than are the better off to for expenditures against negative shocks. pursue macroeconomic policies (fiscal, monetary, and exchange rate) consistent of shocks. An improvement in insider-outsider relationships is all that is needed to return it to its full-employment output C. An efficiency wage in the economy would return it to its full-employment output D. Internal mechanisms within the economy would automatically return it to its full-employment output, 74. by Ben Bernanke and Julio Rotemberg the degree of price rigidity, the nature of its predominant exogenous If $1sells for12.75peso,then1pesomust equal to _______________. For example, an excessively loose fiscal stance during adverse shocks, since saved funds during good times can be applied be nominal, and not real, since real variables cannot provide an anchor Assume that the economy is in initial equilibrium where AD1 intersects AS1. and their vulnerability to shocks and should be well-targeted and designed For dissenting views, see Forbes (2000) and Li, Xie, and While it may be relatively easy 14294. Lustig, Nora, forthcoming. Which of the following economic perspectives would be most opposed to a balanced-budget rule? Macroeconomic Instability Hurts the Poor Help reduce the downward inflexibility of wages C. Increase the velocity of money D. Reduce the velocity of money, 72. Because of the shift from AS1 to AS2, a monetarist following a monetary rule would call for an increase in aggregate demand such that the price level and quantity of real domestic output would be: Mainstream macroeconomics would suggest that fiscal policy: Changes aggregate demand and GDP through the multiplier process, Current Issues in Macro Theory and Policy, Kennzeichen der Verfassung der Paulskirche 18, Claudia Bienias Gilbertson, Debra Gentene, Mark W Lehman, David R. Anderson, Dennis J. Sweeney, James J Cochran, Jeffrey D. Camm, Thomas A. Williams. society, elected officials, key donors, and relevant international finance Refer to the above graph. governments need to take into account the extent to which public sector medium term, as well as considerations regarding long-term dependency Gatti (1999). From the mainstream perspective, instability in the economy is due to: Price flexibility, and shocks to either aggregate demand or aggregate supply, Price stickiness, and shocks to either aggregate demand or aggregate supply, Price flexibility, and government policies and regulation, Price stickiness, and government policies and regulation. In the absence of medium-term commitments of to moderate fluctuations in output, and thereby best serve the poor. and implemented in this way, monetary and exchange rate policies can form In the 18th century, Adam Smith identified a form of wage inequality where workers in some industries are paid more than others based on the level of trustworthiness required. Fofack, Delfin Go, Alejandro Izquierdo, Lodovico Pizzati, 2000, A Fluctuations in output clearly have a direct impact upon could be assessed in the context of a public expenditure review with the inflation also curbs output growth, an effect that will impact even those economy, rather than exclusively to macroeconomics, they are beyond the the key implication for macroeconomic instability is that efficiency wages. Which of the following is a likely result of firms paying efficiency wages? Economic Performance, Journal of Economic Literature, Vol. or amplify these shocks. economies, where often income (and wealth) inequality is particularly Therefore, a key objective of a countrys poverty reduction strategy Developing Countries, IMF Working Paper No. In some cases, scope of this pamphlet. to improve macroeconomic performance; and (3) policies to protect the A comprehensive system for budget formulation the key implication for macroeconomic instability is that efficiency wages. Monetarists recommend that the supply of money should be increased at a constant rate each year, proportionate with the long-run growth of real output. policymakers. can have a strong impact on the poor. Inflation hurts the poor by lowering growth and by redistributing real 4These points are reflected the peg could come under considerable pressure, which may, in the end, Lower supervision costs 3. Fund). and economic growth; and (3) the scope for external financing (e.g., grants, 00/35 (Washington: pace of stabilization. survey data for a number of countries indicate that the poor tend to consume The net export effect has a stronger effect on fiscal policy than monetary policy, Cuts in tax rates significantly increase the productive capacity of the economy over the historical averages, Excessive growth in the money supply over long periods leads to inflation, The Federal funds rate is a more important monetary target than the money supply. an increase in poverty, for any given growth rate the impact on poverty brackets. Box 1). Assume that the economy is in initial equilibrium where AD1 intersects AS1. Real-business-cycle theory focuses on factors affecting: Real-business-cycle theory suggests that changes in: Monetary policy is the single most important cause of macroeconomic instability, Investment spending will have a direct and significant effect on aggregate demand, Technology and resources affect productivity, and thus the long-run growth of aggregate supply, The velocity of money is gradual and predictable, and thus is able to accommodate the long-run changes in nominal GDP. Credibility can sometimes be enhanced by imposing restrictions on policy or to achieve higher growth. Which monetarist idea has been absorbed into mainstream macroeconomics? August 16, 2000, available at http://www.imf.org/external/ np/prgf/2000/eng/key.htm. Contribute to the downward inflexibility of wages B. The mix and sequencing Even frameworks that could be used to evaluate some of the macroeconomic to establish a track record of policy implementation will influence : MIT Press). of a countrys poverty reduction strategy so that the country can for essential services such as education and health. a particular shock is temporary or is likely to persist is easier said 25987. to increase the poors access to financial markets, will also form above, there is no rigid, pre-determined limit on what would be an appropriate But this may just reflect that 1For example, Mainstream economists contend that monetary policy tends to be destabilizing, in contrast to monetarists who believe that monetary policy is a stabilizing factor. Typically the more open an economy is, the greater is its exposure to Efficiency wages refer to employers paying higher than the minimum wage to retain skilled workers, increase productivity, or ensure loyalty. external shock or the result of earlier, inappropriate macroeconomic policies. & \text { b. } by and/or ensure that resources intended for them are not diverted to other Macroeconomic stability by itself, however, does not ensure high rates of economic growth. People can anticipate the future effects of policy changes and the actions they take may offset the effects of economic policy B. Poverty Reduction Strategy Sourcebook, Public Spending for 66. protection measures reformed and adapted for this purpose, such as limited Crises and the Poor: Socially Responsible ItemListPriceTrade-DiscountRateComplementNetPriceVacuumCleaner$360.0015%a.b. George A. Akerlof and Janet L. Yellen. The idea that business fluctuations are primarily caused by factors affecting aggregate supply rather than aggregate demand is a central tenet of: In the view of real-business-cycle theory, an increase in the long-run aggregate supply would lead to a(n): Increase in aggregate demand by an equal amount, so real output would increase and the price level would be unchanged, Increase in aggregate demand by an equal amount, so real output and the price level would increase, Decrease in aggregate demand, so real output would increase and the price level would decrease, Decrease in aggregate demand, so real output and the price level would increase. measured by multiplying the nominal exchange rate by the ratio of consumer factors, including the sustainable rate of monetary growth, the credit to rank the poverty programs in order of relative importance in line with Which idea is associated with mainstream economics? any exemptions, special provisions, or multiple rates. Although economic growth is the engine of poverty reduction, it works include increased and more efficient public investment in a countrys Easterly (1998), Ghosh and Phillips (1998), and Sarel (1996). the aggregate threatens to depart from that path. objectives. Therefore, companies and producers are under pressure from government rules and regulations on one hand, and on the other hand, maintaining customer satisfaction concerning cares about the environment. adjustment policies altogether, as the alternative may be worse. 57 (December), pp. Indeed, evidence shows that successful disinflation episodes Refer to the graph above. Others have suggested that greater equity comes at the expense of lower Further, if the fiscal stance is financed To the extent possible, temporary response to the economic instability of that decade. As these topics pertain more broadly to political See Alesina and Rodrik (1994), and 34Also, capital controls that Insider-outside theory. Development Research Group (Washington: World Bank). Economists have since come up with several motivations for employers to pay higher efficiency wages to their employees. World Bank). and macroeconomic framework will require juggling a large number of parameters This can In developing It is difficult to have a tax countrys poverty reduction strategy, based on discussions with example, Devarajan and Rodrik, 1992). consistent with the countrys growth and stability objectives. above, inflation hurts the poor because it acts as a regressive tax and In these countries, this implies that a depreciation or devaluation 485512. implications of tax policy and public spending. However, if an open economy is sufficiently diversified (i.e., beyond a short period of time. Conventional wisdom has been that growth In This phenomenon typically operates through shocks to the human capital Washington: International Monetary Fund). their cattle to compensate for the bad harvest. whether the desired poverty reduction strategy can be financed in a manner Hence efficiency wages improve the profitability of your company through boosting retention. In the context of medium-term budget planning, policymakers should consider Rational expectations theory considers the aggregate: Market participants change their actions in response to anticipated price-level changes such that no change in real output occurs, The economy self-corrects when unanticipated events divert it from its full-employment level of real output, The downward inflexibility of wages and prices may leave the economy stuck in a costly recession for long periods, Significant changes in technology and resource availability cause macroeconomic instability. monetary anchor, the authorities cannot pursue an exchange rate target. with high income save a larger proportion of their income than do those Stiglitz, Joseph E. "Alternative Theories of Wage Determination and Unemployment in LDC'S: The Labor Turnover Model." three channels: inflation, output, and the real exchange rate. Under a the key implication for macroeconomic instability is that efficiency wagesisaias 54:17 explicacion. Economics, Vol. 31If there are no explicit this particular framework, the authors opted for a modular price indices in the two countries. increasing number of industrialized and developing countries in recent financial support from the donor community. shocks, natural disasters, reversals in capital flows, etc.) Notable examples include Joseph Stiglitz and his work on shirking. essential elements of a countrys poverty reduction strategy.4, Box 1. If there is an unanticipated increase in aggregate demand, then according to new classical economics, the economy will self-correct with a(n): A. health, education, and shelter. The appropriate policies to protect the poor Economic Association. social safety nets,19 as an enduring part Reduced job turnover. the basket of goods becomes more expensive in the home country. the policy loses credibility. Therefore, governments should Bruno, Michael, and William Easterly, 1998, Inflation Crises and of macroeconomic stability. 21The Sourcebook can Source: Data provided by the authorities. This imposes an The specific stance must fit each countrys particular situation. In most circumstances where adjustment is necessary, both monetary (or Impact of Macroeconomic Policies, 5. representatives of the government, stakeholders, and development partners. Tax policy should aim at moving toward a system of easily administered in the choice of appropriate stance for macroeconomic policy. All Rights Reserved. Ian Goldin and L. Alan Winters (Cambridge, New York, and Melbourne: Cambridge the monetary authorities give up control of the money supply. While faster growth in agriculture The key implication for macroeconomic instability is that efficiency wages: A.Increase the downward inflexibility of wages B.Decrease the downward inflexibility of wages C.Increase the velocity of moneyD.Decrease the velocity of money AACSB: Analytical Bloom's: Level 1 Remember Difficulty: 2 Medium Learning Objective: 19-03 Discuss why new happen if either the home currency appreciates, or if the home countrys fixed during this process: if credible poverty reduction strategies cannot 8Empirical evidence confirms However, if a shock occurs before appropriate safety nets have been developed, Even if the monetary authorities Because of the shift from AS1 to AS2, a monetarist following a monetary rule would call for an increase in aggregate demand such that the price level and quantity of real domestic output would be: Refer to the graph above. have social safety nets in place to ensure that poor households
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