Synthesis for Macroeconomics › 2014 › 08 › ...Synthesis for Macroeconomics Summary of Aggregate Demand and Aggregate Supply Relevance of Fiscal and Monetary Policy Fernando “Nandy”

Synthesis for Macroeconomics

Summary of Aggregate Demand and Aggregate Supply

Relevance of Fiscal and Monetary Policy Fernando “Nandy” T. Aldaba, Ph.D

Senior Executives Class Batc 3 Sinagtala APPLIED PUBLIC SECTOR ECONOMICS (APSE) MODULE

September 17-19, 2014

Aggregate demand (AD) is the total demand for final goods and services in the economy at a given time and price level

Aggregate supply (AS) is the total supply of goods and services that firms in a national economy plan on selling during a specific time period

Aggregate Demand and Supply

development academy of the philippines

AD = C + I + G + (X-M)

Aggregate Demand Policies

Aggregate demand policies aim to increase or decrease spending on its key components; major policies include fiscal and monetary policies.

Where

C = Consumption Expenditures

I = Investment Expenditures

G = Government Expenditures

(X-M) = Exports – Imports


AS = a * f (K, L, N)

Aggregate Supply Policies

Aggregate supply policies aim to increase productivity and efficiency of the economy; examples include education and training policies, infrastructure policies, R&D policies, etc.

Where

a = Technology

K = Physical Capital

L = Labor

N = Natural Resources


The macroeconomy or aggregate economy will be at that level where aggregate demand meets aggregate supply.

The typical measure is what we call the Gross Domestic Product found in the National Income Accounts of the Government.

The National Statistical and Coordination Board (NSCB) releases GDP figures every quarter .

GDP is computed from its expenditure components or from the value of production of key economic sectors.

The Macroeconomy


The Macroeconomy in Graph

AS curve is upward sloping in the short run and vertical in the long run.


GDP by Industrial Origin 3Q 2011

Source: NSCB

INDUSTRY/INDUSTRY GROUP Q3 2010 Q3 2011 Growth %

Agriculture, Hunting, Forestry and Fishing 149,181 151,822 1.8

Industry Sector 447,055 446,304 -0.2

Service Sector 783,995 825,626 5.3

GROSS DOMESTIC PRODUCT 1,380,231 1,423,752 3.2


GDP growth 1970-2013

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Philippines Real GDP Growth, Percent

Death of Aquino and Political Crisis

Balance of Payments Crisis

Asian Financial Crisis

Global Financial Crisis

Boom and bust cycles of the economy – recessions and depressions.

Crisis brought about by domestic and/or international factors.

Price volatilities due to internal and external factors.

Government uses tools to stabilize the economy – fiscal and monetary policies.

These could be expansionary or contractionary policies.

Macroeconomic Instabilities


Influence the level of economic activity though manipulation of government income and expenditure.

Influence Aggregate Demand (AD) –

a. Tax regime influences consumption (C) and investment (I)

b. Government Spending (G)

Also used to influence non-economic objectives and provide framework for supply side policy e.g. education and health, poverty reduction, welfare reform, investment, regional policies, promotion of enterprise, etc.

Fiscal Policies


Multiplier Effect: increase in government spending generates increase in GDP greater than the

initial amount spent

•Crowding Out Effect: a phenomenon occurring when government spending causes interest rates to rise,

thereby reducing investments i.e. increase in government spending crowds out investment spending

Two “Effects” of Fiscal Policy on AD


Most economists believe the short-run effects of fiscal policy mainly work through aggregate demand.

A cut in the tax rate gives workers incentive to work more, so it might increase the quantity of goods & services supplied.

Government spending on infrastructure like roads may increase business productivity, which increases the quantity of goods & services supplied

“Supply side economic policies – Reaganomics”

Fiscal Policy & Aggregate Supply


Taxation can be used for equity goals e.g. Luxury taxes, progressive income taxes.

Government spending can be used for poorer sectors of society e.g. Poverty programs.

Fiscal Policy and Equity


The process by which the monetary authority (BSP) of a country controls the supply of money supply, often targeting a rate of interest or inflation for the purpose of promoting economic growth and stability

Basically, the decrease or increase of money supply will affect the interest rate which in turn will affect the aggregate demand

Monetary Policy

MS is usually determined by the central bank (BSP) through various tools of monetary policy

1. increasing or decreasing policy interest rate

2. buying or selling government securities

3. increasing or decreasing reserve requirement

The Money Market & Interest Rate

The Interest Rate r is determined by the intersection of money demand (MD) and money supply (MS).


Using Policy to Stabilize the Economy

Economic stabilization has been a goal of Philippine government as enshrined in the constitution.

Economists debate how active a role the government should take to stabilize the economy


The Case for Active Stabilization Policy

John Maynard Keynes:

“Animal spirits” cause waves of pessimism and optimism among

households and firms, leading to shifts in aggregate demand and fluctuations in output and

employment.



Also, other factors cause fluctuations, e.g.,

booms and recessions abroad

stock market booms and crashes

political instabilities here and abroad

Real estate bubbles

If policymakers do nothing, these fluctuations are destabilizing to businesses, workers, consumers.



When GDP falls below its potential, use expansionary monetary or fiscal policy to prevent or reduce a recession.

When GDP rises above its potential (“overheating”), use contractionary policy to prevent or reduce an inflationary boom.

Proponents of active stabilization policy believe the government should use policy to reduce these fluctuations:


The Case Against Active Stabilization Policy

Monetary policy affects economy with a long lag:

Firms decide investment plans in advance, so I takes time to respond to changes in r.

Many economists believe it takes at least 6

months for monetary policy to affect output

and employment.



Fiscal policy also works with a long lag: Changes in G and T require Acts of

Congress.

The legislative process i.e. passing a law can take months or years


Taxes also affect the economy in the following ways:

A tax on a good reduces the market

quantity of that good.

A tax causes a deadweight loss (a loss in

consumer and producer welfare) development academy of the philippines


Due to these long lags, critics of active policy argue that such policies may destabilize the economy rather than help it:

By the time the policies affect aggregate demand, the economy„s condition may have changed.

These critics contend that policymakers should focus on long-run goals like economic growth and low inflation.


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Synthesis for Macroeconomics › 2014 › 08 › ...Synthesis for Macroeconomics Summary of Aggregate Demand and Aggregate Supply Relevance of Fiscal and Monetary Policy Fernando “Nandy”