GOVERNMENT MACRO
INTERVENTION
Broad topic objectives:
To explain
The aims of macro policy
Fiscal, monetary & supply side
policies.
Effectiveness of macro policies
Aims of macroeconomic policy
• 1. Sustainable economic growth
• 2. Low & stable price inflation
• 3. Equilibrium or stable BOP
position
• 4.Full employment/low
unemployment .
• 5.Minimal exchange rate
fluctuations
• 6. sustainable economic
development
• Macro econ goals of govts. video.
Types of macro econ policy:.
There are 3 policies used to achieve
macro econ objectives;
Fiscal policy
Monetary policy
Supply side policy
Give mind map from page 118:
• 1.FISCAL POLICY (FP):
• It’s a dd side policy that uses
taxation & government spending
to manage AD so as to attain
macro econ aims.
Tools of
fiscal policy
Taxation
Government
spending
Types of fiscal policy:
• 1. Expansionary FP
• AKA reflationary FP.
• Designed to raise AD thru cutting
tax rates & raising Government
spending on investment projects.
• Aim: expand the economy so as to
create more jobs and income.
2. Contractionary FP
• AKA deflationary FP
• Designed to lower AD thru raising
tax rates & cutting Government
spending on investment projects.
• Aim: solve inflation by reducing
disposable income.
Top tip
• A deliberate change in taxation(T)
& government spending(G) to
affect the AD is called
Discretionary FP.
• Forms of G & T that change
without deliberate govt action are
called automatic stabilizers.
Examples of automatic
stabiliers
• During a recession, govt spending
on unemployment benefits
increases automatically due to
rises in unemployment.
• During a boom, higher incomes
drags people in to higher tax
brackets.
Diagram : page 115
Observations
• Y is the initial equilibrium which is
below full employment.
• As GDP rises Taxes increases and
govt spending falls automatically.
• The Budget
• It’s a government annual fiscal
plan outlining the govt revenue
and spending sources.
Types of budgets 
• 1. Balanced budget:
• Occurs when tax revenues = govt
expenditures.
• 2. Surplus budget:
• Occurs when tax revenues > govt
expenditures
• 3. Deficit budget:
• Occurs when govt expenditures >
tax revenues
Top tip
• Copy the cyclical & structural
budget deficits from page 116.
• 2. MONETARY POLICY(MP):
• It’s dd side policy thru’ the
central bank/Fed to alter AD so
as to regulate the macro
economy.
Tools of
monetary
policy
Interest rates
Money supply
Exchange
rates
Types of monetary policy(MP)
• 1. Expansionary MP
• AKA reflationary MP:
• Occurs to raise money supply &
AD thru a cut in interest rates,
increases in money ss and
reduction in exchange rates
2. Contractionary MP
• AKA deflationary MP.
• Occurs to lower money supply &
AD thru an increase in interest
rates, reduction in money ss and
rises in exchange rates
3. Supply side policy
• Designed to increase the LRAS
or the economies productive
capacity thru the product &
factor markets.
• Draw the diagram:
Tools of MP
• 1. Deregulation.
• These are policies that encourage
competition in the economy.
• They reduce barriers to entry in
various markets
• This enables business growth while
increasing investor confidence
• E.g. Liberalisation of power
generation & supply in Kenya
2. Tax & welfare benefits reductions
• This causes pple to have high
disposable incomes by increasing
incentive to work.
• They also reduce the firms prodn
costs leading to prodn of high
output
• Lower benefits reduces the return
of not working hence more
incentive to work.
3. Education & training
• This makes workers more skilled,
flexible, mobile and more
productive.
• It can be continuous staff devpt
thru on or off the job training
• 4 Trade union reform
• These are labour associations that
represent workers before
employers
• Reform means making them
comply with labour laws.
• It increases worker motivation due
to proper representation leading
to higher productivity.
• 5. Privatization
• This involves converting state
enterprises in to private sector
businesses.
• It helps to improve efficiency &
productivity.
• 6. Subsidies:
• These are govt financial grants to
help firms.
• This is to increase productive
efficiency and capacity.
Tasks
• Self assessment task page 118.
• Policies to correct BOP
disequilibrium:
• They are of 2 types
1. Expenditure switching policies
2. Expenditure dampening policies
1.Expenditure switching
policies
• Policies used to encourage the
purchase of local products and less
of imports.
• Both locals and foreigners are
encouraged to buy local goods &
services.
• They help reduce the amount of
spending on imports and to
redirect/switch the spending on
local goods and services.
• Their impact is a fall on import
expenditure and a rise on export
earnings.
• They are the trade barriers or
methods of trade protection
described in topic 4.
• List them down here…..
• 1. Tariffs
• 2.
• 3.
• 4.
2. Expenditure dampening
policies
• They help to reduce the amount of
spending in the country
• Their effect on the economy is 2 fold:
i. Few products will be imported
ii. Dampening of the domestic market
demand .
They include;
1. Deflationary fiscal policy
2. Deflationary monetary policy
Effectiveness of policy
framework to solve a
current account deficit
• 1. Effectiveness of fiscal policy:
• Current account deficit occurs
when imports > exports.
• Deflationary FP may help to
reduce import demand.
• It involves raising taxes on all
economic agents.
• High taxes reduce disposable
incomes and possibly import dd.
• However, high taxes may cause
disincentive to work,
unemployment, slow econ growth
& low AS.
• Imports may not reduce as much
if PED for imports is inelastic.
• FP should be used in conjunction
with expenditure switching policies
e.g. tariffs * quotas though they
may provoke retaliation.
• 2. Effectiveness of monetary
policy;
• MP can be used to reduce growth
of money ss to correct a current
account deficit
• High interest rates may reduce
incomes and imports dd.
• However, they may cause capital
inflows and a rise in the floating
exchange rates making imports
cheaper.
• Changing interest rates is not
automatic & may take like 18
months to effect them
• Again, high rates will harm
borrowers & benefit
savers/investors.
• It may reduce investments, raise
unemployment and cause a slow
down in econ growth.
• Devaluation of exchange rates will
make exports cheaper & imports
• Expensive thereby reducing import
dd.
• However, effectiveness depends of
PED of X & M as implied by the
Marshal Lerner condition & |J
curve effect.
• Like fiscal policy, MP wont be
effective on its own.
3. Effectiveness of
supply side policy
• Deregulation & privatization may
increase competitiveness of
domestic markets.
• This leads to low prices and high
quality products that may
encouraging expenditure switching.
• However, privatized firms may
become inefficient if they turn out
to be monopolies. They may also lay
off staff so to maximize profits.
• Deregulation & trade union
reform may increase inefficiencies
especially where market failure
exists.
• Education & training of labour
force improves productivity &
may attract more FDI’s.
• However, benefits of education &
training are only feasible in the LR
and may constitute a huge
opportunity cost.
• Subsidizing local firms may also
raise output and possibly check on
import dd.
• However, subsidies are costly to
the taxpayers.
• They may have high opportunity
costs, provoke retaliation &
subsidized firms may not pass
entire benefits to consumers.
Polices to correct
inflation & deflation
• Policies to correct demand pull
inflation:
• Deflationary FP & MP policies are
used.
• This deals with raising tax rates &
cutting govt spending hence
cutting back on AD & spending.
• The Fed/central bank may also
raise interest rates hence raising
the cost of borrowing.
• Large scale purchases e.g.
mortgages will be reduced.
• High rates also cause more savings
hence reducing present
consumption
• Again high rates may attract hot
money investments which may
raise the exchange rates.
• High exchange rates makes
imports more expensive.
• Supply side policies are also used
to check on dd pull inflation.
Task:
• Make short notes on the
effectiveness of policies to correct
demand pull inflation. Page123-4
• Policies to reduce cost push
inflation:
• Cost push inflation occurs from
the supply side due to high costs of
production.
• Supply side policies are used e.g.
training of labor force to increase
productivity & to reduce labor
costs.
• Lower corporate taxes may
encourage firms to buy more
efficient capital equipment.
• Subsidizing firms with high
production costs may help firms to
lower prodn costs & prices.
• Evaluation of supply side policies:
• Training workers may raise their
productivity but make them more
expensive to hire.
• Low corporation taxes may not
lead to more investments if firms
are pessimistic about the future.
• Lastly subsidies may raise AD but
firms may not use them efficiently
to raise output.
Policies to correct deflation
• Deflation is the fall in the rate of
inflation.
• Reflationary FP & MP are used
e.g. cutting tax, interest rates &
increases in MS.
• However, rise in govt spending
may be better since it will
stimulate AD causes more
spending.
• Again, if interest rates are already
low, cutting them again would not
help much.
• Lastly even though CBK raise
money supply, banks may not lend
more if borrowers aren’t credit
worthy.
The end
Prep – page 126
Revision summary and questionspage 127
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