Grade 11 Economics Exam
June 2015
MEMO
Name: _______________________
Set: _____
1.1.1
A
B
C
D
1.1.2
A
B
C
D
1.1.3
A
B
C
D
1.1.4
A
B
C
D
1.1.5
A
B
C
D
1.1.6
A
B
C
D
1.1.7
A
B
C
D
1.1.8
A
B
C
D
1.2.1
H
1.2.2
G
1.2.3
A
1.2.4
B
1.2.5
D
1.2.6
F
1.2.7
C
1.3.1
TRUE
FALSE
1.3.2
TRUE
FALSE
1.3.3
TRUE
FALSE
1.3.4
TRUE
FALSE
1.3.5
TRUE
FALSE
1.3.6
TRUE
FALSE
1.3.7
TRUE
FALSE
Teacher: _____
Grade 11 Economics June 2015
QUESTION 2: MEASURING THE PERFORMANCE OF THE ECONOMY
2.1
List TWO Macroeconomic goals of government
1.
2.
3.
4.
5.
(2 x 2 = 4)
economic growth
full employment
price stability
balance of payments stability (or external stability)
equitable distribution of income
2.2.1 Which two industries shrunk in the 1st quarter of 2015?
(2)
1. agriculture
2. manufacturing
2.2.2 Why do you think the primary sector was the best performing sector in the 1st quarter
of 2015?
(4)
Weak rand – made exports cheap
Strong growth in rest of world – demand for raw materials increased
Any well-argued answer
2.2.3 Comment on South Africa’s quarter-on quarter growth for the last four years.
(4)
Low and fluctuating
Seasonal/follows a relatively consistent pattern
2.3.1 Define “Gini Co-efficient”.
(2)
The Gini coefficient is a measure of inequality of a distribution. It is defined as
a ratio with values between 0 and 1 – 0 being perfect equality.
2.3.2 Which country has the most uneven distribution of income before government
involvement?
(2)
Poland
2.3.3 Which country’s distribution of income improves the most as a result of government
involvement?
(2)
Poland
2.3.4 Explain how governments use “taxes and transfers” to improve income inequality.
(4)
Progressive taxes
Welfare payments and grants
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Grade 11 Economics June 2015
2.4
Explain how the Balance on the Current Account is calculated.
(8)
Merchandise exports: includes the trade in all physical goods, which consist of raw materials as well as
intermediate and final goods. All exports of capital goods also fall into this category.
Net gold exports: shown separately due to the traditional role of gold as a form of international currency
and South Africa’s role as major gold producer.
Service receipts: includes the transportation of goods and passengers between countries, travel,
construction services, financial and insurance services, various business, professional and technical
services, as well as personal, cultural and recreational services and government services.
Income receipts: refer to income earned by South African residents in the rest of the world. There are two
categories of income flow: compensation of employees and investment income.
Merchandise imports, payments for services and income payments: calculated on the same basis as
merchandise exports, service receipts and income receipts respectively. The main difference, of course,
is that the income or expenditure flows are in the opposite direction, that is, from South African residents
to the rest of the world.
Current transfers: money, goods or services are transferred without receiving anything tangible in return
(ie without any quid pro quo). Examples include gifts, personal, immigrant and other remittances and charitable
donations.
Balance on current account: the net total of all the various items in the current account.
2.5
Discuss how the Consumer Price Index is constructed in South Africa.
(8)
The consumer price index (CPI): index of the prices of a representative “basket” of consumer goods
and services.
The CPI thus represents the cost of the “shopping basket” of goods and services of a typical or average
South African household. In constructing the CPI, Stats SA…
 Assigns a weight to each good or service to indicate its relative importance in the basket
 Decides on a base year for calculating the CPI
 Collects prices each month to calculate the value of the CPI for that month
To select the goods and services to be included in the basket and to determine their relative weights, Stats
SA conducts a comprehensive, in-depth survey of household income and expenditure in South Africa. The
weight allocated to each good or service is based on the relative importance of the item in the average
consumer’s budget or “shopping basket”. This requires a lot of time and effort and is therefore done only
every five years or so.
Currently, the South African CPI was based on a household income and expenditure survey conducted in
2005/2006. The total CPI basket consists of more than 400 different consumer goods and services. These
goods and services are classified into more than 40 groups and sub-groups for which separate indices are
constructed. In addition, different CPIs are published each month for, inter alia, five expenditure groups, for
pensioners, for the nine provinces and for 42 urban areas in South Africa. An average of around 100 000
prices are collected every month by Stats SA.
/40/
Please turn over the page
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Grade 11 Economics June 2015
QUESTION 3: MONETARY SECTOR
3.1
List TWO characteristics of a good form of money.
1.
2.
3.
4.
5.
(2 x 2 = 4)
Uniformity
Durability
Divisibility
Portability
etc
3.2.1 Define “M1”.
(2)
M1 includes all notes and coins as well as all demand deposits of domestic
private sector
3.2.2 Which function of money becomes more important in the progression from M1 to M3?
(2)
Store of value
3.2.3 Calculate the growth in M1 from 2010 to 2014
(2)
(1 242 750-862 876)/862 876 x100 = 44%
3.2.4 What explains this growth?
(4)
Banks create money by making loans – because the public accept deposits as
money. Banks can therefore create their own assets.
etc
3.3.1 Keynes identified two motives for holding money. What are they?
(2)
Transactionary
Speculative
3.3.2 What is the determinant for each of those motives?
(2)
Income
Interest rates (respectively)
3.3.3 Explain the relationship between the interest rate and the quantity of money
demanded. In your answer, mention should be made of the role of bond prices. (6)
Individuals have the choice of either holding money (which earns no interest)
or bonds (which do) – therefore the opportunity cost of holding money is the
interest that could have been earned by holding bonds. Consequently, the
higher the interest rate, the higher the cost of holding money and therefore
people will demand less money for speculative purposes than when the interest
rate is low.
Therefore, there is a negative or inverse relationship between the quantity of
money demanded for speculative purposes and the interest rate.
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Grade 11 Economics June 2015
According to Keynes, the speculative demand for money stems from
uncertainty about the direction of changes in interest rates. If people feel the
present level of interest rates is lower than it should be, they expect interest
rates to rise in the near future. If interest rates do rise, as expected, it means
that the price of bonds will fall. Anybody holding on to bonds under these
circumstances may suffer a potential capital loss because of the decline in
bond prices. When people expect interest rates to rise, there will be a demand
for money balances.
By holding money one can avoid the expected loss associated with holding
bonds. Moreover, one will then be in a position to purchase bonds more
cheaply, once their prices have fallen.
3.4.
Identify and briefly explain TWO functions of the SARB.
(2 x 4 = 8)
Formulation and implementation of monetary policy
The SARB is responsible for formulating and implementing monetary policy. The way in
which the Bank’s other functions are fulfilled is determined mainly by the goals of monetary
policy at that juncture. The Bank’s accommodation policy (also referred to as the Bank’s
refinancing system or more commonly the repo rate tender system) is the main instrument
through which monetary policy is conducted in South Africa. Through its refinancing system
the Bank meets the daily liquidity needs of private banks. In order to ensure that the
refinancing system’s influence on interest rates in general remains effective, the Bank has
to compel the banks to borrow a substantial amount (the liquidity requirement) from the
SARB. Other instruments like open market transactions
are used to drain excess liquidity from the money market in order to ensure a liquidity
shortage at all times.
Service to the government
The services provided by the SARB to the central government are threefold:
 Banker and advisor. Until the early 1990s the Bank handled all financial receipts and
payments of the central government. Nowadays the government also has accounts
(called tax and loan accounts) with private banks. Nevertheless, the Reserve Bank is still
the main banker for the government. It grants credit, deals with the weekly issues of
Treasury bills on behalf of the Treasury, advises the government with regard to monetary
and financial matters and is responsible for the administration of all exchange control
regulations.
 Custodian of gold and foreign exchange reserves. With the exception of necessary
balances held by banks and the Treasury, the Reserve Bank keeps all the country’s gold
and foreign exchange reserves. Gold coins and gold bullion are added to the reserves
at a market-related price. The level of South Africa’s gold and other foreign reserves is
one of the main barometers of the state of the economy and of prospects for future
economic growth. In this regard the Bank is also responsible for the formulation of
exchange rate policy.
 Administration of exchange control. The Reserve Bank is responsible for exchange
control in South Africa. Exchange control restricts the movement of foreign exchange in
order to protect an economy from disruptive fluctuations in capital movements and other
international economic shocks. Exchange control in South Africa was introduced for the
first time in 1939 and has never been totally abolished since then.
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Grade 11 Economics June 2015
Provision of economic and statistical services
The Bank collects, processes, interprets and publishes economic statistics and other
information. The data these publications contain are a major source of information for
policymakers, analysts and researchers.
Maintaining financial stability
The SARB presently regards financial stability (particularly price stability) as its most
important objective. In pursuit of this objective the Bank plays a pivotal role in the following
areas:
• Bank supervision. The Reserve Bank is responsible for bank regulation and supervision
in South Africa. The purpose is to achieve a sound, efficient banking system in the
interest of depositors of banks and the economy as a whole. This function is performed
by issuing banking licenses to banking institutions and monitoring their activities.
• The National Payment System. The Bank is responsible for overseeing the safety and
soundness of the National Payment System (NPS). The main aim is to reduce interbank
settlement risk with the objective of reducing the potential of a systemic risk crisis
emanating from settlement default by one or more of the settlement banks.
• Banker to other banks. The Bank acts as custodian of the minimum cash reserves that
banks are legally required to hold or prefer to hold voluntarily with the Bank. By exerting
control over the level and composition of these reserves the Reserve Bank can, to a
certain extent, affect the quantity of money. The reserves are also used to clear the
banks’ mutual claims and obligations to one another. In this way the Reserve Bank acts
as a clearing bank. Obviously the success of clearing bank activities is very closely
related to the smooth operation of the National Payment System mentioned above. In
terms of its “lender-of-last-resort” activities the Bank may in certain circumstances
provide liquidity to banks experiencing liquidity problems. The way in which the Reserve
Bank accommodates (or finances) the banking sector is known as the refinancing
system, which has already been referred to.
• Banknotes and coins. The Reserve Bank has the sole right to make, issue and destroy
banknotes and coins. The SA Mint Company, a subsidiary of the Bank, mints all coins
on behalf of the Bank while the SA Bank Note Company, another subsidiary of the Bank,
prints all banknotes on behalf of the Bank. In its issues of notes and coins the Bank is
largely guided by the public’s cash requirements. The cash comes into general
circulation through the purchase of assets (usually financial assets) by the Bank. Note
again that the coins and banknotes become money only once they come into circulation
outside the banking sector.
3.5
Briefly explain accommodation policy and open market policy.
(2 x 4 = 8)
ACCOMMODATION POLICY
A crucial element of the classical cash reserve system is the fact that banks are obliged to
hold 2,5 per cent of their total liabilities to the public in the form of cash reserves with the
Reserve Bank. When a bank experiences a shortage of cash reserves, it can either change
other financial assets into cash or borrow funds on the interbank market to eliminate the
shortage. Normally one would expect banks that are in need of funds to make use of the
overnight interbank market where they borrow from other banks that have excess funds at
their disposal. These funds are obtained at the interbank overnight rate. However, if all
banks have the same liquidity problems, the Reserve Bank, as bankers’ bank, acts as
lender of last resort and the banks can then obtain funds by means of the repo system.
Through the repurchase tender system (repo system), which was introduced in March
1998 liquidity is provided to the banks by means of repurchase agreements (repos) between
the Reserve Bank and its banking clients. Banks apply for refinancing by tendering for
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Grade 11 Economics June 2015
central bank funds at weekly auctions of repos with seven-day maturities. Eligible underlying
assets for these repos are restricted to government bonds, Treasury bills, Land Bank bills
and Reserve Bank debentures of all maturities. The fixed rate determined by the Bank
represents the interest rate that banks have to pay for their required reserves.
The accommodation policy of the Reserve Bank thus mainly comprises changes in the repo
rate and other conditions on which cash is made available to banks. It is therefore an
instrument by which the SARB can regulate the quantity of money through variations in the
cost of credit. Changes in the repo rate lead to adjustments in the interest rates at which
credit is made available by the banks to their clients. The cost of credit in the economy is
therefore directly linked to the repo rate. Other interest rates (eg deposit rates and mortgage
rates) also tend to move in sympathy with the repo rate.
OPEN-MARKET POLICY
Open-market transactions as an instrument of monetary policy consist of the sale or
purchase of domestic financial assets (mainly Treasury bills and government bonds) by the
central bank in order to exert a specific influence on interest rates and the quantity of money,
via its influence on the cash reserves of the banks. As mentioned earlier, the repo system
(or accommodation policy) will be effective only if the banks are “forced” to approach the
central bank for funds, that is, if they experience a liquidity shortage. The central bank uses
open-market transactions to ensure such persistent shortages of liquidity, also called the
money market shortage.
If it wishes to create or enlarge the banks’ liquidity shortage, the central bank sells
government bonds or other securities to the banks, thereby reducing their cash reserves
(directly or indirectly). In this way the banks are compelled to make use of the central bank’s
financing facilities through repurchase agreements, thereby rendering the central bank’s
accommodation policy more effective.
When the central bank wishes to stimulate the creation of bank deposits it can also use open
market operations to ease liquidity conditions and lower interest rates. In such a case (which
is sometimes called quantitative easing) the central bank will buy government bonds and
other securities. In order to persuade institutions to sell the securities, the central bank will
offer higher prices to induce the bondholders to part with their bonds. Bond prices will
therefore tend to rise and, given the inverse relationship between bond prices and the yield
(interest rates) that can be earned on them, interest rates will tend to drop.
/40/
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Grade 11 Economics June 2015
QUESTION 4: MACROECONOMIC THEORY AND INFLATION
4.1
List TWO negative consequences of inflation.
(2 x 2 = 4)
1. distribution effects
2. economic effects
3. social and political effects
4.2.1 What is the “repo rate”?
(2)
Rate of interest charged by SARB to commercial banks for loans
4.2.2 Identify the percentages “A” and “B” in the third paragraph of the text.
(2)
A: 3
B: 6
4.2.3 Explain why “higher oil prices and a weak rand” contribute to a “deteriorating inflation
outlook”.
(4)
Transport costs are heavily weighted in CPI – higher oil costs coupled with
weak rand will substantially effect transport costs and therefore all of the CPI
4.2.3 What do you expect to happen with regard to interest rates in South Africa in the near
future?
(2)
Increase
4.3.1 Give ONE example of a potential supply-shock in an economy.
(2)
Drought, oil price increase, strikes etc
4.3.2 Explain the shape of the AS curve illustrated above.
(4)
At low levels of output economy has excess capacity – can increase output
without price increases.
At high levels of output, capacity is strained and any increase in output would
result in significant price increases
4.3.3 Assuming the economy is operating at Y1, what will occur if the government
implemented an expansionary fiscal policy?
(4)
AD increases, price and output increases.
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Grade 11 Economics June 2015
4.4
Identify and explain TWO reasons why the Aggregate Demand curve slopes
downward
(2 x 4 = 8)
The three main reasons for the downward slope of the AD curve are…
a) The wealth effect (also called the real balance effect)
When prices fall, the money in consumers’ pockets may be used to purchase more
goods and services than before, that is, the real value of their money holdings
increases. By the same token, the real value of all other nominal assets also
increases. The real wealth of households thus increases.
The fact that they become wealthier encourages households to spend more, with the
result that consumption spending (C) and thus aggregate spending increase.
b) The interest rate effect
When the price level falls, less money is demanded and this may lead to a decline in
interest rates, which will stimulate investment spending (I). The result is an increase
in the quantity of goods and services demanded and thus aggregate spending
increase.
c) The international trade effect
 If a fall in the price level results in a decline in interest rates, the latter may
result in an increased outflow of capital in pursuit of higher interest rates
overseas and/or a decline in capital inflows, because domestic interest rates
are less attractive than before.
 This would result in a greater demand for foreign currency and a lower demand
for the rand, which will give rise to a depreciation of the rand against the major
currencies.
 The weaker rand, in turn, will tend to boost exports (X) and dampen imports
(Z), resulting in an increase in the quantity of domestic goods and services
demanded.
 The change in the prices of domestic goods relative to the prices of foreign
goods will reinforce this effect.
4.5.
Discuss how Monetarists use the Quantity Theory of Money to explain inflation.
This is based on the “Equation of Exchange” identified by Irving Fisher:
An identity:
where:
MV = PQ
M = quantity of money
V = velocity of circulation
P = average (general) price level
Q = physical quantity of goods and services produced (GDP).
The velocity of circulation (V) is an indication of the number of times the average rand
changes hands in the form of cash or demand deposits.
Monetarists convert the equation of exchange into a theory (The Quantity Theory of Money)
by making certain assumptions:


V is stable (see above)
M is determined by the monetary authorities and is not affected by P or Q.
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Grade 11 Economics June 2015

MV = PQ

Direction of causality
If M changes, PQ has to change by the same proportion or percentage e.g.:
If V = 4 and M increases from R 200 to R 300 (a 50% increase), PQ must increase
from R 800 to R 1200 (a 50% increase).
Thus the Monetarists believe that changes in M affect output PQ (Y) DIRECTLY.
Symbolically:
M  Y
Monetarists believe that changes in M will impact on P only (and not Q) in the long run since
Q is determined by the quality and quantity of the factors of production.  M will have
inflationary effects only in the long run. In the short run however, M may impact on both P
and Q.
(8)
/40/
Total Section B: /80/
Please turn over the page
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Grade 11 Economics June 2015
SECTION C: ESSAY
5.
The first and arguably most important macroeconomic objective is economic growth.
Discuss the three methods of measuring output in an economy.
(26)
Gross Domestic Product (GDP) measures the final value of output of goods and services produced within
the domestic boundaries of South Africa over a given time period. An important point is that our GDP includes
the output of foreign owned businesses that are located in South Africa following foreign direct investment in
the SA economy. The output of motor vehicles produced at the giant Mercedes car plant in East London for
example, contributes to the South African GDP.
There are three ways of calculating GDP - all of which should sum to the same amount since the following
identity must hold true:
National Output = National Expenditure (Aggregate Demand) = National Income
Firstly we consider total spending on goods and services produced within the economy:
(i)
The Expenditure Method of calculating GDP (aggregate demand)
This is the sum of spending on SA produced goods and services measured at current market prices. The full
equation for GDP using this approach is GDP = C + I + G + (X - Z) where:
C:
I:
G:
X:
Z:
Household spending
Capital Investment spending
Government spending
Exports of Goods and Services
Imports of Goods and Services
(ii)
The Income Method of calculating GDP (the Sum of Factor Incomes)
Here GDP is the sum of the incomes earned through the production of goods and services. The main factor
incomes are as follows:
Income from people employment and in self-employment
+ Profits of private sector companies
+ Rent income from land
= Gross Domestic product (by factor income)
It is important to recognise that only those incomes that are actually generated through the production of
output of goods and services are included in the calculation of GDP by the income approach.
We exclude from the accounts the following items:


(iii)
Transfer payments e.g. the state pension paid to retired people; income support paid to families on
low incomes; the Unemployed Insurance Fund given to the unemployed and other forms of welfare
assistance including child benefits and housing benefits.
Private transfers of money from one individual to another.
Output Method of calculating GDP – using the concept of value added
This measure of GDP adds together the value of output produced by each of the productive sectors in the
economy using the concept of value added.
Value added is the increase in the value of a product at each successive stage of the production process. We
use this approach to avoid the problems of double-counting the value of intermediate inputs.
GDP includes only the final goods and services produced in a country (final goods and services are consumed
by households – they are not processed further and then sold). Intermediate goods and services are used in
the production process and are sold again.
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Grade 11 Economics June 2015
Gross Domestic Product
Production Approach
Gross Domestic Product
Income Approach
Gross Domestic Product
Expenditure Approach
Primary sector
Agriculture, forestry and fishing
Mining and quarrying
Secondary sector
+ Manufacturing
Electricity, gas and water
Construction
Tertiary sector
Wholesale and retail trade,
+ catering and accommodation
Transport, storage and
communication
Financial intermediation
insurance, real estate and
business services
Community, social and personal
services
Central government services
Compensation to employees
C Consumption expenditure by
households
+
G Expenditure by government
+
I Gross fixed capital formation and
changes in inventories
(Gross fixed formation capital
- Changes in inventories)
+
Residual item (errors
&omissions)
= Gross domestic expenditure
(GDE)
X Exports of goods and non-factor
services
Z Imports of goods and non-factor
services
Net operating surplus
+
Consumption of fixed capital
+ (provision for depreciation)
= Gross value added at factor
cost
=
+
=
+ Taxes on production
- Subsidies on production
Gross value added at basic
= Gross value added at basic
prices
prices
+ Taxes on products
Taxes on products
- Subsidies on products
Subsidies on products
Gross domestic product (GDP)
Gross domestic product (GDP)
at market prices
at market prices
+ Primary income from the rest of
the world
the world
- Primary income to the rest of the - Primary income to the rest of the
world
world
= Gross national product (GNP) = Gross national product (GNP)
at market prices
at market prices
- Consumption of fixed capital
- Consumption of fixed capital
+ Primary income from the rest of
= Net national product (NNP) at
market prices
= Net national product (NNP) at
market prices
+
=
-
Expenditure on gross
domestic product (GDP) at
market prices
Primary income from the rest of
the world
Primary income to the rest of the
world
Gross national product (GNP)
at market prices
Consumption of fixed capital
= Net national product (NNP) at
market prices
Explain the importance of having tools available to measure the performance of an
economy.
(10)
Economic indicators measure macro-economic variables that directly or indirectly enable economists to judge
whether economic performance has improved or deteriorated. Tracking these indicators is especially valuable
to policy makers, both in terms of assessing whether to intervene and whether the intervention has worked or
not.
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Grade 11 Economics June 2015
6.
One of the basic difficulties associated with attempts to stabilise the economy using
monetary and/or fiscal policy is the existence of lags.
Describe the various lags associated with monetary and fiscal policy.
(26)
Monetary and fiscal policy lags
Whenever monetary and fiscal policy measures are considered, certain practical problems have to be taken
into account. One of the basic difficulties associated with attempts to stabilise the economy by using monetary
and/or fiscal policy is the existence of delays or lags. Four types of lag may be distinguished: the recognition
lag, the decision lag, the implementation lag and the impact lag.
The recognition lag
This is the lag between changes in economic activity and the recognition or realisation that the changes have
occurred. Economic data do not become available immediately – it takes time, for example, to compile the
national accounts. Even the consumer price index takes some time to compile. It thus takes time for
policymakers to establish or confirm that the economy has moved into a recession or a boom. The recognition
lag is the same for monetary and fiscal policy.
The decision lag
Once it has been established what is happening, the authorities have to decide how to react. In the case of
fiscal policy this means that ministers and officials from different departments, and eventually the Cabinet,
have to meet to discuss matters and to consider various policy options. This also takes time. In fact, the most
important fiscal policy measures are announced only once a year, in the budget speech of the Minister of
Finance (usually in February). With monetary policy the lag is generally much shorter. At the time of writing,
the MPC of the SARB was meeting six times a year to consider possible changes in the repo rate. However,
nothing prevents the Governor of the SARB from convening a meeting of the MPC at any time, and decisions
can be taken within a day or two.
The implementation lag
Once the decisions have been taken, it takes time to implement them. In the case of fiscal policy, government
spending and taxes cannot be changed overnight. Plans have to be drawn up and parliamentary approval
usually has to be obtained before the plan can be put into action. Certain changes can only be implemented
via the budget and may therefore have to wait up to a year before they can be applied. Income tax rates, for
example, are adjusted annually only. In contrast, the implementation lag associated with monetary policy is
very short. In fact, when a change in the repo rate is announced, it comes into effect immediately. Thus, as in
the case of the decision lag, the implementation lag is much shorter for monetary policy than for fiscal policy.
Impact lag
When the policy measures are introduced, a further period elapses before they actually affect economic
behaviour. In the case of fiscal policy, an increase in taxes, for example, will not have its full impact on the
economy immediately. The same applies in the case of a change in government spending, although you will
recall that government spending has a more direct impact on spending, production and income than taxes,
which have an indirect impact (eg via disposable income and consumption). The impact lag is often referred
to as the outside lag, to distinguish it from the first three types of lag, which together constitute the inside lag
(ie the delay from the time a need for action arises until the appropriate policies are implemented). In the case
of monetary policy the impact lag is very long. Most economists estimate that it takes between 12 and 18
months (and even up to 24 months) for a change in the repo rate to have its full impact on prices, production,
income and employment. It is generally accepted that the impact lag is significantly longer for monetary policy
than for fiscal policy.
The different lags are summarised in table
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Grade 11 Economics June 2015
Explain why the timing of policy decisions and actions is so important.
(10)
It should be clear, therefore, that the formulation and implementation of economic policy is no easy task. In
fact, by the time the policy measures become effective, circumstances may have changed to such an extent
that the measures may even have perverse effects. For example, by the time an expansionary policy comes
into effect, the prevailing conditions may call for a contractionary policy.
Timing is thus of the utmost importance. If the authorities’ timing is wrong, monetary and fiscal policy may
prove to have a destabilising, instead of a stabilising, effect on the economy. The practical difficulties we
have referred to have led certain economists to recommend that the government should not attempt to
achieve too much through monetary and fiscal policy. Their recommendation, therefore, is that monetary and
fiscal policy should be as neutral as possible. As far as fiscal policy is concerned, they tend to call for
balanced budgets. A balanced budget refers to a situation in which all government spending is financed by
taxes, that is, where the budget deficit is zero. With regard to monetary policy, some economists call for
stable interest rates, while others call on the monetary authorities to try to achieve low and stable rates of
growth in the money stock.
Total Section C: /40/
TOTAL: /150/
END OF PAPER
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