“Governments should focus primarily on a low and stable rate of inflation.” Discuss. [15]

(b) “Governments should focus primarily on a low and stable rate of inflation.” Discuss. [15]

This essay discusses the macroeconomic aims of governments. This essay argues that, while low inflation is an important macroeconomic aim, governments should also focus equally on other macroeconomic aims such as low unemployment, economic growth, and a stable balance of payments. There are a few types of policies that governments can use to achieve their aims. First, monetary policy is the manipulation of monetary variables such as money supply, interest rate and the exchange rate. Second, fiscal policy refers to the use of government spending and taxation to achieve macroeconomic objectives. However, other than such demand-side policies, governments can also use supply-side policies, which increase the quantity and quality of resources, and improving technology.

Targeting Inflation

First and foremost, clearly there are good reasons for governments to use demand-management or supply-side policies to tackle inflation. This is because a persistent and sustained increase in the general price level hurts fixed-income wage earners and retirees on pensions, as well as consumers of goods and services, who find that their incomes buy fewer goods and services. Inflation reduces the real value of their incomes. In addition, inflation makes it difficult for trading and exchanges within an economy, for instance due to menu costs – the costs of constantly updating prices. Furthermore, inflation makes it difficult for a country to engage in international trade. This is because cost-push inflation reduces the competitiveness of a country that depends on exports, for instance, Singapore, which might suffer from imported inflation. These culminate in a wider socio-political impact: for instance, the hyperinflation in Weimar Germany in 1923 led to socio-political unrest and the collapse of the Weimar government.

Targeting Unemployment

Yet, inflation is not the main goal or the only focus of government policies. Another important goal of government can be to increase employment, or lower unemployment. Unemployment refers to the situation where people able and willing to work are unable to find jobs, and can be structural, demand-deficient, frictional, or seasonal. Being unemployed causes financial hardships for citizens, therefore governments have to ensure that there is job creation for citizens. For example, during 2008-2010, in the depths of the financial crisis and economic recession, there was massive unemployment in many developed economies, especially in the West. Governments can also tackle structural, frictional, and seasonal unemployment by focusing on these problems rather than concentrating their efforts on inflation.

In fact, reducing inflation sometimes leads to increased unemployment. This is because if the inflation comes from demand pressures, policies that lower AD might inadvertently cause demand-deficient unemployment. In a similar vein, focusing on solving unemployment might lead to higher inflation. This is because of government failure – governments do not always know where the AD and AS curves of the economy are, and their actions suffer from time lags and delays, due to imperfect information. If governments use demand side policies such as Keynesian fiscal policy, and the economy is near the full employment level, then an overshooting AD might lead to inflation. Therefore, there is a trade-off between inflation and unemployment.

Targeting Economic Growth

Another goal of government can be to raise economic growth, which leads to a rise of the standards of living in a country, which will generally make citizens better off. Economic growth is measured by percentage increases in real Gross Domestic Product (GDP), which measures the production of an economy. Generally, a higher real GDP per capita means a higher standard of living for the people of that country. There are two aspects to growth: actual growth measures the rate of change in the volume of output produced within the country in a year, and increases mean increased employment, another of the government’s goals. Potential growth is the percentage annual increase in the economy’s capacity to produce. Economic growth can be increased via increasing aggregate demand and increasing aggregate supply. Thus, the government may introduce demand management policies, such as monetary and fiscal policy, as well as supply-side policies in order to aid actual and potential economic growth respectively. Supply-side policies generally lower inflation by shifting LRAS to the right, and therefore it would seem that there is no trade-off.

However, increasing actual economic growth sometimes results in more inflation, because the AD shifts rightwards, and there might be a trade-off to be made between economic growth and a low rate of inflation; higher rates of economic growth are generally accompanied by higher rates of inflation, ceteris paribus.

Targeting the BOP

Another possible macroeconomic aim of government is to maintain a balance of payments (BOP) surplus. Generally, some governments like Singapore run BOP surpluses for most years, where export values exceed import values. For example, Asian countries such as China have been running huge BOP surpluses, vis-à-vis their trading counterparts, mainly western countries; they have been selling more exports than imports they buy, and this provides a net inflow of capital into their countries rather than an outflow.

However, running a current account surplus might lead to demand-pull inflation because exports (X) exceed imports (M), if the economy is already near or at the full employment level. Therefore there is a trade-off decision to be made between a current account surplus and demand-pull inflation.

Conclusions

In conclusion, one disagrees with the statement posed. All the macroeconomic aims of government are important and the government has to maintain a balancing act, considering various trade-offs. Also, governments may have to tackle different problems at different time periods, and thus inflation should not be the primary focus. In the final analysis, governments should use a combination of demand-management and supply-side policies to manage society’s macroeconomic aims, and not merely focus primarily on inflation, because it is one problem among many.

JC Economics Essay - Tutor's Comments: This is the second part to a question on inflation. There are many relevant real life examples in this essay, and this "A" grade essay also tackles a wide range of macroeconomic aims and  policies, which makes it a balanced, sound, and well-written Economics paper. In addition, the conclusion is considered, evaluative, and generally quite interesting to read. Overall, it is very well done! However, the usual question applies: if you were an Economics tutor, what would you do to make this Economics paper better? How would you improve on it? To take a specific case: if you were going to edit or correct the conclusion, what better conclusion, or what alternative conclusion to this Economics essay could you come up with? Think, think, think; thanks for reading and cheers!

(b) Discuss what influence the rate of interest might have on the level of investment in an economy [15]

(b) Discuss what influence the rate of interest might have on the level of investment in an economy [15]

This paper discusses the influence the rate of interest might have on the level of investment in an economy. Investment refers to a process of accumulating capital, where goods are used in the production of other goods. There are two types of investment, the first being fixed capital such as machineries, plants and equipment, and second type of investments includes inventories such as raw materials and unsold goods. The cost of borrowing money or the cost of credit is important for businesses that depend on borrowed capital. The decision to invest depends on the expected returns on investment (MEI) and cost of investment (i/r). Investments will be profitable as long as MEI is more than interest rate. Hence the rate of interest definitely has an impact on investment, although there are some limitations and other factors that need to be considered in this paper.

There exists an inverse relationship between interest rates and investments. If the rate of interest decreases, then investment will increase, ceteris peribus. Projects with lower expected returns will now appear profitable and so more investments will occur. When interest rates are at 4%, projects with returns of 2% and below appears unprofitable I*, and will not be undertaken. If it falls to 2%, these projects will now become profitable, thus investments increase.

THINK: Insert theoretical diagram. What economics diagram do you think this will be?

Also, when rates of interest falls, people may save less but can consume more. This may increase production and employment and national income in the economy. Producers that need to meet higher consumption will invest more.

The extent of increase in the level of investment due to a fall in interest rates depend on the responsiveness of investment decisions to interest rate changes which in turn depends on economic conditions, business confidence and source of investment. Keynes suggested the interest elasticity of demand for capital goods – during a recession – businesses are pessimistic, and even decreases in interest rates may fail to stimulate investments.

Interest rates alone are also insufficient to influence the level of investment, but the expected yield is also crucial in determining investments. The expected returns are important in that a fall in interest rates that is accompanied by a fall in expected returns may not result in greater investment. Even without any increases in interest rates, if the MEI curve shifts up, there will be more investment at each interest rate than before. The increase in expected returns could result from either a fall in the cost of capital goods, increased efficiency of machines due to technological advancement or favourable changes in government policy such as decreases in profit taxes or any increase in business confidence.

Expected yield may end up being more important in certain circumstances – for example in Singapore, where investment is largely foreign. Most investments take place when businesses are optimistic about the profitability of their projects. The reduction in corporate tax for example, will increase the expected yield of business projects and encourage greater investment expenditures.

Therefore, the rate of interest is only one of many factors that affect the level of investment in an economy. Its impact depends on the responsiveness of the investment to interest rates. If the elasticity of investments to interest rates is elastic than an increase in interest rates will lead to more than proportionate increase in investments and vice versa.

JC Economics Essays - Economics Tutor's Comment: This economics paper could be improved. However, this is quite a good approach, although many relevant real life, real world examples are lacking and more details could be further added. This economics paper is quite strong in theory and the candidate clearly knows her work. Although it was written under model "A" level examination conditions, still think - how could this economics paper be further improved and made better? How could the conclusion be made more argumentative, more evaluative, more considered and better nuanced? Remember that an evaluative conclusion that gives a susbstantiated, justified, and nuanced opinion can score high, good marks. Suggested possible exam grade: 11.5 / 15.  

(a) Discuss the likely causes of a rise in consumer spending in Singapore [10]

(a) Discuss the likely causes of a rise in consumer spending in Singapore [10]

This paper discusses the likely causes of a rise in consumer spending in Singapore. Consumption refers to the planned spending on consumer goods and consists of both autonomous and induced consumption. There are several factors that can cause a rise in consumer spending in Singapore.

Firstly, induced consumption could be due to national income changes. Singapore may experience high economic growth rates in recent years which led to the growing affluence of Singaporeans. This rise in national income translates into an increase in purchasing power which would mean that households would be able to spend more on consumer goods and services. Eventually, there will be a rise in consumption indicated by a shift of the curve. However, the extent of the rise in consumption depends on the value of the MPC and whether the rise in national income is permanent.

Apart from this, autonomous consumption also increases. This could be done to firstly, consumers expectations. Strong economic forecasts and stability in both internal and external environment would lead to an optimistic outlook on the economy. Therefore, there will be strong consumer confidence as people tend to save less for rainy days and expect future increase in income, leading to a rise in consumption. However, the extent of the rise depends on how optimistic consumers are judging from the outlook and whether this outlook is a temporary or permanent phenomena.

Secondly, consumption increase may be due to government policies or disposable income rise. A fall in income tax rates (which reduces the reliance on direct taxes) and the increase in transfer payments in recent years have led to an increase in the disposable income. Households are likely to down more due to the increase in purchasing power. However, the extent of increase in consumption depends on the propensity to consume and other factors - for example, a rise in GST from 5% to 7%

Lastly, interest rates and credit availability also affect consumption. Lower cost of borrowing and loosening of credit facilities as seen by growing varieties of credit cards available in the market and the aggressive advertising tactics that follow show an encouragement on the bank's part to consume. It is now cheaper and easier to borrow in order to purchase consumer durables and there is a reduced incentive to save due to lower returns, therefore leading to a rise in consumption.

The extent of the rise, however, depends on the interest elasticity of consumption, the economic outlook and availability of past savings.

JC Economics Essays - Economics Tutor's Comment: This response is quite a good attempt at answering the economics question posed, especially during examination conditions. Fair work, and a good effort, given that this was done under "A" level Economics examination conditions. However, there are some possible areas of improvement - putting yourself into the shoes of an Economics tutor or examiner, what would you do to improve this economics paper, other than drawing in the correct Economics diagram and then explaining it carefully? What other economics details should have brought into this paper in order to improve it? Thanks for reading and cheers. Suggested grade: 8/10.