Assess macroeconomic policies which might be used to respond to rising
commodity prices during a period of slow economic growth [30]
Macroeconomic policies are policies set by both government and central bank to control
a countrys growth (aggregate demand) and inflation. This is done using the two types
of macroeconomic policy fiscal policy and monetary policy. Fiscal policy is the control
of aggregate demand through manipulation of government spending and taxation.
Monetary policy is the control of the supply of money through using interest rates and
quantitative easing.
The first policy that the central bank could pursue would be the raising of interest rates.
This would enable a stream of hot money to enter the country, because short term
investors would see the prospect of a higher return on their investment in the UK. As a
result, a higher demand for the GBP would boost the exchange rate of the pound (as
shown in the diagram) from P to P1. This increased strength in the pound would mean
that any imported goods would be much cheaper, because consumers in the UK would
be able to buy much more of a commodity for every pound. This would therefore drive
down the price of rising commodity prices. Good.
However, this solution does not address the problem of slow economic growth. In
raising the interest rates, consumers in the UK also face increased cost of borrowing,
which subsequently means that less people will borrow, sparking a drop in consumption
(a component of AD) and then there will be a decrease in aggregate demand from AD
to AD1. This is a contractionary policy to reduce aggregate demand. A drop in
aggregate demand would mean a drop in output, which is not advisable in a time of
slow economic growth, where AD needs to be stimulated not hindered. Good point, but
make sure you relate it to the question otherwise it might be considered irrelevant. Ie A
rise in commodity prices may cause a fall in economic growth. So although the rise in
interest rates tackles the cost push inflation, it fails to address the faltering growth.
An increase in the commodity prices can be as a result of two things; demand pull or
cost push. If the rise in commodity prices was cost push, then the government could
implement some supply side policies to counteract the contraction in aggregate supply.
An example of one of these policies would be to implement compulsory education up
until the age of 18. This would mean that a greater proportion of the work force was
better educated and this would therefore boost productivity and counteract the
reduction in AS (as shown in the diagram) In theory maybe, but really?? Are you really
going to tackle rising oil prices by making it compulsory to stay in school till youre 18??
That, Jamie, would be a spin nightmare.
However, what this policy doesnt deal with is stimulating economic growth. This is
because supply side policies only focus on the expansion of the capacity of the
economy, and in most cases do not stimulate aggregate demand. Furthermore,
education policies are very long run, and can be changed by different governments that
come into power, which means that they take a very long time to come into effect.
Commodity prices on the otherhand, are constantly rising, which means that the
actions taken by the government could be too little too late by the time they are
implemented.
But if there is more government spending around this legislation, such as the
construction of new schools and sixth form colleges for students to continue to the age
of 18, then this will not only stimulate AS but also AD, and this will fulfil the criteria of
responding to a rise in commodity prices, and also stimulating economic growth.
Another problem with rising commodity prices is the rise in inequality due to the
proportion of income spent by the poor on commodity goods. The government could
combat this by introducing a higher tax on the wealthy, and lowing taxes on the poor.
This would mean that the poor have a larger amount of income, which means they
spend proportionally less on commodities such as food, gas and electricity.
However, the Laffer diagram shows that there is an optimum level at which to tax
the wealthy. Point A shows where the most optimum point is. If the tax is raised from T
to T1, you can see that the government revenue shrinks from P to P1. This fall in the
amount of tax revenue could have serious consequences for the budget, particularly as
we are still heavily in a deficit.
Finally, and most importantly, I think that government investment into researching
areas such as fracking and locating valuable resources within the UK would be a clever
fiscal policy to pursue. Investment into these areas will increase AD (because
government spending is a component of AD) but it could also increase AD. This is
because with increased resources, we are more likely to be able to export any excess to
international markets. This will raise the amount of exports which in turn will raise AD.
Good.
Overall, I think that the most important macroeconomic policy would have to come
from the government in the form of fiscal policy, alongside legislation to back up any
supply side policies that are also implemented alongside the fiscal policies. But why???
No marks if not justified.
Better. Still room for improvement. You need to really think about your answers. Ie how
can I match the theory I know to the problem at hand?
24/30
