Lecture 11: Government Policies: Macro Perspective (WS2024) - PDF

Introduction to Economics Lecture Eleven: Government Policies: Macro Perspective WS2024 Assoc. Prof. Dr. Hebatallah Ghoneim 12/30/2024 1 Government Policies: Fiscal Policy...

Introduction to Economics Lecture Eleven: Government Policies: Macro Perspective WS2024 Assoc. Prof. Dr. Hebatallah Ghoneim 12/30/2024 1 Government Policies: Fiscal Policy and Monetary Policy 12/30/2024 2 The Influence of Monetary and Fiscal Policy on Aggregate Demand 12/30/2024 3 Keynesian Theory In 1936, Keynes attempted to explain short-run economic fluctuations in general and the Great Depression in particular. Keynes’s primary message was that recessions and depressions can occur because of inadequate aggregate demand for goods and services. “The long run is a misleading guide to current affairs. In the long run, we are all dead.” As the world’s economies suffered with high unemployment, Keynes Advocated policies to increase aggregate demand, including government spending on public works. 12/30/2024 4 Government Policies Fiscal policy refers to the government’s Monetary policy refers to the actions choices regarding the overall level of undertaken by a central bank or monetary government purchases and taxes. authority to manage a country's money supply, interest rates, and overall financial conditions to achieve specific economic objectives. These objectives typically include controlling inflation, stabilizing the currency, achieving full employment, and fostering economic growth. 12/30/2024 5 Expansionary and Contractionary Policy 12/30/2024 6 Changes in the Money Supply 12/30/2024 7 Extensive Use to Money Expansion 12/30/2024 8 How Fiscal Policy Influences Changes in Government Purchases and Changes in Taxes12 Aggregate Demand Macroeconomic Perspective: Keynes argued that the Great Depression was primarily caused by a collapse in aggregate demand rather than by issues of supply or productivity. Active Fiscal Policy: Keynes advocated for increased government intervention to stimulate demand. Infrastructure Investment: Keynes suggested that governments should invest in public works projects (such as roads, bridges, and schools) to create jobs and increase employment. Welfare Programs: Keynes believed that social safety nets, such as unemployment insurance and direct assistance to the poor, could help maintain consumer spending during economic downturns. 12/30/2024 9 State’s Budget statement 12/30/2024 10 Extensive fiscal policies Budget Deficits and National Debt: Large-scale fiscal policies can lead to substantial budget deficits if government spending exceeds revenue. Over time, persistent deficits contribute to an increasing national debt, which can create long-term economic challenges, including higher interest rates and reduced government flexibility. Inflationary Pressures: Extensive fiscal stimulus can lead to inflation, especially if the economy is already operating near full capacity. Increased government spending can drive up demand for goods and services, leading to higher prices, which can erode purchasing power and reduce consumer confidence. Crowding Out Effect: When the government borrows extensively to finance its spending, it can lead to higher interest rates. Higher interest rates can crowd out private investment, as businesses may find it more expensive to borrow. This can slow economic growth in the long run. 12/30/2024 11 Extensive fiscal policies Dependency on Government Support: Extensive fiscal policies, particularly those involving social welfare programs, can create dependency among individuals and businesses. This can disincentivize work and innovation, potentially leading to lower overall productivity and economic stagnation. Inefficiencies and Misallocation of Resources: Large government programs may be prone to inefficiencies and waste due to red tape and bureaucracy. Distortions: Extensive fiscal policies can distort economic behavior. For example, tax incentives can lead to unintended consequences where individuals or businesses alter their behavior to take advantage of tax breaks rather than making economically sound decisions. Shadow prices: a situation where market prices do not reflect real prices due to subsidy or price controls. 12/30/2024 12 Fiscal Policy vs Monetary Policy 12/30/2024 13 Productivity of Labor Productivity: the quantity of goods and services produced from each unit of labour input. Determinants of Productivity: Physical capital: the stock of equipment and structures that are used to produce goods and services. Human capital: the knowledge and skills that workers acquire through education, training, and experience. Natural resources: the inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposits. Natural resources take two forms: renewable and non- renewable. Technological Knowledge A fourth determinant of productivity is technological knowledge—the understanding of the best ways to produce goods and services. 12/30/2024 14  Economic Growth and Public Policy Public policy refers to the actions, decisions, and plans formulated and implemented by governments or public authorities to address specific societal issues, meet public needs, and achieve desired outcomes. It serves as a framework for guiding the behavior of individuals, organizations, and institutions within a society. 12/30/2024 15 Economic Growth and Public Policy Saving and Investment Because capital is a produced factor of production, a society can change the amount of capital it has. If today the economy produces a large quantity of new capital goods, then tomorrow it will have a larger stock of capital and be able to produce more goods and services. Thus, one way to raise future productivity is to invest more current resources in the production of capital. The growth that arises from capital accumulation is not a free lunch: It requires that society sacrifice consumption of goods and services in the present to enjoy higher consumption in the future. The traditional view of the production process is that capital is subject to diminishing returns: As the stock of capital rises, the extra output produced from an additional unit of capital falls. In other words, when workers already have a large quantity of capital to use in producing goods and services, giving them an additional unit of capital increases their productivity only slightly. 12/30/2024 16 Catch-up Effect 12/30/2024 17 Investment from Abroad Two Types of Foreign Investment: Foreign Direct Investment (FDI) refers to an investment made by a company or individual in one country into business interests located in another country. For example: Ford Motor Company might build a car factory in Mexico A foreign portfolio investment is an investment financed with foreign money but operated by domestic residents. An American might buy stock in a Mexican corporation, and the corporation can use the proceeds from the stock sale to build a new factory. Investment from abroad is one way for a country to grow. Even though some of the benefits from this investment flow back to the foreign owners, this investment does increase the economy’s stock of capital, leading to higher productivity and higher wages. Investment from abroad is one way for poor countries to learn the state-of-the-art technologies developed and used in richer countries. 12/30/2024 18 Education Education—investment in human capital—is at least as important as investment in physical capital for a country’s long-run economic success. Investment in human capital, like investment in physical capital, has an opportunity cost. Some economists have argued that human capital is particularly important for economic growth because human capital conveys positive externalities. An externality is the effect of one person’s actions on the well-being of a bystander. This argument would justify the large subsidies to human-capital investment that we observe in the form of public education. human capital does have positive externalities, then this brain drain makes those people left behind even poorer. 12/30/2024 19 Health and Nutrition The term human capital usually refers to education, but it can also be used to describe another type of investment in people: expenditures that lead to a healthier population. Healthier workers are more productive. The causal link between health and wealth runs in both directions. Today, malnutrition is rare in developed nations such as Great Britain and the United States. (Obesity is a more widespread problem. But for people in developing nations, poor health and inadequate nutrition remain obstacles to higher productivity and improved living standards. 12/30/2024 20 Property Rights and Political Stability Countries with questionable Protection of property rights There is little incentive to enforcement of property and promotion of political produce products if there is rights or an unstable political stability are two other no guarantee that they climate will also have important ways that cannot be taken. Contracts difficulty in attracting foreign policymakers can improve must also be enforced. (or even domestic) economic growth. investment. 12/30/2024 21 Free Trade Some of the world’s poorest countries have tried to achieve more rapid economic growth by pursuing inward-oriented policies. Domestic firms often advance the infant-industry argument, claiming they need protection from foreign competition to thrive and grow. This argument has at times led policymakers in less developed countries to impose tariffs and other trade restrictions. Most economists today believe that poor countries are better off pursuing outward-oriented policies that integrate these countries into the world economy. International trade in goods and services can improve the economic well-being of a country’s citizens. 12/30/2024 22 Research and The primary reason that living standards are higher today than they were a century ago is that technological Development knowledge has advanced. Knowledge is a public good: That is, once one person discovers an idea, the idea enters society’s pool of knowledge and other people can freely use it. Just as government has a role in providing a public good such as national defense, it also has a role in encouraging the research and development of new technologies. Government policy encourages research is through the patent system. 12/30/2024 23 Population Growth Economists and other social scientists have long debated how population affects a society. Stretching Natural Resources Thomas Robert Malthus concluded that “the power of population is infinitely greater than the power in the earth to produce subsistence for man.” Thomas Malthus argued that an ever-increasing population meant that the world was destined to live in poverty forever. The world population has increased about sixfold over the past two centuries, but living standards around the world are on average much higher. Where did Malthus go wrong? Diluting the Capital Stock when population growth is rapid, each worker is equipped with less capital. A smaller quantity of capital per worker leads to lower productivity and lower GDP per worker. Promoting Technological Progress. Some economists have suggested that world population growth has been an engine of technological progress and economic prosperity. 12/30/2024 24 Sustainability 12/30/2024 25 Thank you Readings: Ch 25 Production and Growth Ch 34 The Influence of Monetary and Fiscal Policy on Aggregate Demand 12/30/2024 26