Typically, during economic recessions, governments introduce various expansionary measures to stimulate the economy. Primarily, these measures purpose to increase economic activity in the aggregate economy and enhance total demand. Often, the government utilizes expansionary fiscal and monetary policies (Amadeo, 2016). Essentially, expansionary fiscal policy pertains to the attempts made to enhance demand by reducing taxes or increasing government spending. In turn, this may result in higher economic growth. In the same way, an expansionary monetary policy aims at increasing aggregate demand and economic growth through reduced interest rate levels or increased money supply. Normally, the resultant increase in aggregate demand and economic growth may bring about inflationary effects in the economy. Therefore, to correct this, the government must implement complementary aggregate supply measures.
It is worth noting that expansionary fiscal and monetary policies may give rise to inflation within the economy. For instance, when the expansionary monetary policy is implemented, the money supply is increased (Amadeo, 2016). Consequently, households have a lot of money to spend on buying goods and services. Besides, expansionary monetary policy often makes spending more attractive than saving. Hence, the overall demand increases. Notably, as the total demand increases over and above the aggregate supply, inflation may arise in the economy (Amadeo, 2016). Particularly, this is because the surplus demand creates an upward pressure on the price of services and goods in the economy. Eventually, this creates inflation in the economy. Inflation has adverse effects on the general economy
A Graphical Illustration of the Effects of Expansionary Fiscal and MonetaryPolicy
Source: (Amadeo, 2016).
It is imperative for one to note that a highly prevalent and long-lasting period of inflation may have an adverse effect on the economy. For this reason, the government may employ various supply side and demand side policies to reduce its impact.
Primarily, supply side policies refer to the attempts by a nation’s government to increase the level of productivity within the economy. Often, these policies aim at improving the marginal productivity of firms in order to improve the overall supply of goods and services in the economy.
Increase Production. Firstly, the government may try to shift the country’s aggregate supply to meet the new aggregate demand. This way, the increase in total supply will counter the growing demand, thereby keeping the prices of services and goods at their original equilibrium price (“Controlling Inflation,” 2010). Predominantly, the government may increase the total supply by offering production incentives to firms within the economy. By doing so, the overall level of production in the economy for services and products will increase, thereby meeting the overall demand. This way, inflation will be eliminated (“Controlling Inflation,” 2010). In addition to this, the country’s GDP will grow significantly, thus enhancing economic growth.
Source: (Amadeo, 2016).
Reduce Unnecessary Expenditure. Alongside enhancing the level of production in the economy, the government may reduce unnecessary public expenditure on non-development activities (Amadeo, 2016). Mainly, this will minimise the competition for funds. Normally, lenders prefer to lend to the government instead of private companies due to low risks associated with government borrowing. Therefore, private firms will be able to access funds and expand their operations if governments borrowed fewer funds. Consequently, an increase in funds will enhance their productivity (“Controlling Inflation,” 2010). Eventually, the supply of goods and services in the economy will rise, thereby meeting the new aggregate demand. Overall, inflation levels will be kept in check.
Price Control. The government may introduce a price control system to control inflation directly. Primarily, price control pertains to fixing an upper limit for prices of certain products within the country. Mainly, this is done to stabilize the prices of basic services and goods in a nation (Gyan, 2016). Thus, the government may fix a maximum price law that should be maintained in the country, and law punishes anyone that charges higher prices. Typically, many sellers will abide by this law to avoid unnecessary litigations. Thus, by doing so, the government can reduce the incidence of price increases in the economy. Eventually, the level of inflation in the economy will be eliminated or kept at significantly low rates.
Demand side policies refer to those policies that are implemented by the government in an attempt to influence the level of aggregate demand in the economy. Thus, in addition to monetary and fiscal policies, the government may use strategies such as rationing of goods and wage ceilings to influence the level of demand in the country. Predominantly, these methods will substantially reduce the level of aggregate demand and thereby reduce pressure on prices. Eventually, this would control the level of inflation in the economy.
Rationing of Goods. The government may also institute rationing of various commodities to reduce inflation. Characteristically, rationing aims at distributing consumption of scarce products to make them available to a large number of consumers. Primarily, it is applied to necessaries such as sugar, oil, kerosene. Mainly, this aims at stabilizing prices of basic goods and ensures distributive justice (Amadeo, 2016). Consequently, its successful implementation will significantly reduce inflation levels in the economy.
Rational Wage Policy. Notably, inflation periods are often characterized by a wage-price spiral. For this reason, the government may try to maintain a reasonable wage and income policy. Mainly, this may be done through freezing salaries, bonuses, dividends, profits, and incomes. By reducing the average income and wage level in the economy, consumers will have limited resources to purchase commodities. Subsequently, this will reduce the aggregate demand. Ultimately, this will exert a downward pressure on prices within the country. In the end, the price level will be low, thereby controlling inflation in the country.
It is imperative to note that the formulation and enactment of monetary and fiscal policy are characterized by the existence of time lags. Notably, these policy lags arise when a significant amount of time is taken between the recognition of the problem to the actualization of the desired impacts of the policy (Pettinger, 2012). Predominantly, fiscal and monetary policies are designed to influence the level of aggregate demand and enhance economic growth in the country. Although this is the aim, it takes a substantial amount of time before the fiscal and monetary policy authority recognizes the need to instigate these policies (Pettinger, 2012). Even after their implementation, the results may take a while to be achieved. Notably, the duration of these time lags may differ between monetary and fiscal policies.
Basically, a recognition lag refers to the duration between the occurrence of an actual economic shock and the time the market reacts to them. Often, before a policy action is undertaken, the government or the responsible authority must identify that the problem exists. Unfortunately, it takes time before relevant economic data can be collected and analyzed to realize that a problem exists (Pettinger, 2012). For instance, data on unemployment, business cycle contractions require time before they are collected and analyzed. Hence, this may delay the recognition of an economic problem. Notably, the recognition lag between the two policies is relatively the same.
A decision lag occurs due to the fact that policy decisions take time. Typically, government decisions are not instantaneous and must undergo a series of bureaucracies before they are made. During this period, alternatives are considered, and consequences are analyzed before a final verdict is made concerning a policy (Thoma, n.d.). Thus, the process of selecting a policy and evaluating its prospects take time. Typically, the decision lag for monetary policy is often short. Essentially, monetary policy assessments and resolutions are conducted by the county’s monetary authority and Open Market Committee. In contrast, the lag for fiscal decisions is characteristically long (Thoma, n.d.). Predominantly, one can attribute this to the fact that they are made by a nation’s congress before it is presented to the president for signing. Thus, this often takes a lot of time.
Essentially, this refers to the period it takes for the relevant strategy authority to take the steps needed to activate and implement a chosen policy. After a particular policy has been selected, the necessary measures must be undertaken to implement the plan. Notably, an implementation may take a while. Imperatively, the implementation lag for monetary policy is often short. More specifically, once the policy decision has been made, its implementation begins instantly, usually by the end of the same day. Predominantly, this is because the policy works through financial markets which function swiftly. On the other hand, the implementation lag for fiscal policy is often long. Any changes in tax rates and government spending must undergo sophisticated bureaucracies before they can be implemented. Normally, such bureaucracies are lengthy, and hence prolong the implementation period.
Notably, this is an outside lag. It refers to the time it takes for any particular policy change implemented to affect households and firms in the economy. Any variations in the government spending, taxation, interest rates and money supply must operate through the economy first and generate changes in income and production (Karmakar, n.d.). Afterward, this may induce changes in consumption, which further influences the level of output and revenue. Normally, a series of such changes must occur before the actual impact of a policy is felt in the economy. For this reason, an impact lag may take between one and two years. However, by nature, impact lags are shorter in monetary policies than in fiscal policies.
Primarily, macroeconomic policies are implemented to achieve price stability in the economy and full employment. However, according to the Phillips (1958), both objectives cannot be achieved at the same time. Instead, only one objective can be achieved at a particular point in time (Pettinger, 2013). Predominantly, this is because the model postulates that there is a tradeoff between unemployment and inflation in the short term (Phellan, 2012). The rationale behind this model is founded on the idea that as the unemployment rate drops; workers are empowered to seek for higher wages and salaries. Higher wages for workers translate to greater costs for firms. Thus, firms transfer the high wage costs to consumers. In turn, this results in higher prices for goods and services in the economy, creating a buildup of inflationary pressures in the economy (Phillips, 1958). Hence, when the level of unemployment is low, inflation levels are expected to be relatively high.
Essentially, the Phillips curve depicts the relationship between unemployment and inflation within the economy. By and large, the curve suggests that variations in the unemployment rate have a predictable effect on the level of inflation (Fisher, 1973). Thus, over the short term period, the government may employ inflationary policies to enhance the level of employment in the economy. However, this tradeoff is only seen in the short run. Over the long term, inflationary strategies may not have an effect on the country’s level of unemployment (Akerlof et al., 2000). Graphically, the long term Phillips curve is represented by a perpendicular line (Hoover, n.d.). In reality, this tradeoff was experienced in the US between 1979 and 1983. During this period, inflation fell from 15 percent to 2.5 percent. In effect, the level of unemployment in the country rose from 5 percent to approximately 11 percent (Pettinger, 2013). For this reason, it is imperative to note that there is a significant correlation between unemployment and inflation
Source: (Khan, n.d.).
Over the past few years, the South African economy has been experiencing various macroeconomic challenges. Mainly, the economy has deteriorated significantly, thus dragging down the country’s GDP growth and revenue projections (SARB, 2017). In addition, the nation’s currency has been weakening against the dollar (National Treasury 2017). For this reason, the government proposed various policies to stimulate the economy, and enhance economic growth and stability. More precisely, the government set forth a set of fiscal policy adjustments in the country. In November last year, the nation’s Monetary Policy Committee (MPC) set the repurchase rate at a constant rate of 7 percent (National Treasury 2017). Previously, the committee had changed this rate twice to control inflation in the country.
Consequently, this action enhanced positive development trends in the country. In addition, the South African rand appreciated against the dollar thereby improving the country’s trade balance. Unfortunately, the CPI inflation rose by about 0.3 percent (Trading Economics, 2017). Notably, the terms of business in the private sector increased significantly. The consistent repurchase rate increased investors’ confidence in the country, thereby increasing their investments in the company (“Global Rates,” 2017). In turn, an increase in investments brought about significant improvements regarding productivity and efficiency. Indeed, the policy has worked in the best interest of the company as well as the economy as a whole.
Conclusion:
For a long time, the South African economy was experiencing high economic growth and stability. However, in the recent past, the economy has been experiencing challenges pertaining to unemployment, price instability and stagnant economic growth ( Plessis et al., 2017). In order to reduce these macroeconomic challenges, the government has implemented various expansionary monetary and fiscal policies to stimulate aggregate demand. However, it is imperative to note that the implementation of expansionary aggregate demand policies may result in inflationary pressures. Thus, to control this, it may implement various aggregate supply measures. It may also carefully influence the level of inflation and unemployment rate to achieve the most favorable level of inflation. Mainly, this can be obtained by determining the optimal tradeoff between the two variables as suggested by the Phillips curve. In addition to this, the government must take into consideration the fact that implementation of macroeconomic policies may be delayed due to time lags in the process of implementation. Regardless, the application of macroeconomic policies is crucial in the economy as it influences the aggregate economy.
References:
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