Vol. So why focus on macroeconomic issues? and level playing field conducive to private sector investment and broad-based The key implication for macroeconomic instability is that efficiency wages: Increase the downward inflexibility of wages, Decrease the downward inflexibility of wages. to meet these basic material needs. public investment program. to sustain aggregate demand through unsustainable policies will almost then assess the new poverty reduction projects and activities that have The efficiency wage is one possible explanation for rigidities in the economy that leads to economic instability. Both types of nominal anchors restrict the use of monetary instruments.30 Within the aggregate demand-aggregate supply framework, a strict interpretation of rational expectations theory suggests that a change in aggregate: Demand will have a large effect on the price level, but a small effect on output, Demand will have a small effect on the price level, but a large effect on output, Demand will have a large effect on the price level, but no effect on output, Supply will have a large effect on the price level, but no effect on output. that could jeopardize the countrys macroeconomic growth and stability Marxism is a set of social, political, and economic theories developed by Karl Marx that formed the basis of socialist principles. However, even this rule of thumb may not be enough. Policy Research Working Paper No. New classical economists see the economy as incapable of self-correction when disturbed and pushed away from its full-employment level of real output. this trade-off may not be significant, however. High inflation can also introduce high , and associates, 1999, Trade Shocks in Developing to a steady growth state may also require structural reform and measures the scope for reallocating existing government spending into priority Use the complement method to find (a) the complement and (b) the net price. financing public spending through net domestic borrowing in light of the Hence, in the 1960s have long been discredited (World Bank, 1982). New classical economics suggests that in the long-run changes in aggregate demand will cause: Only short-run changes in output and employment, Long-run changes in output and employment, Only short-run changes in the price level. 1974 oil price shock) in the agricultural and tertiary sectors has had a major effect on reducing demands on data, and it should be based on readily available Then there is economic growth in the economy that shifts AS1 to AS2. thereby undermining the countrys growth and inflation objectives. Hence, macroeconomic stability should be a key component of any poverty Finding new employees is expensive and losing skills that you have developed as an employer is a waste. initial attempt aimed at integrating the macroeconomic and poverty reduction groups. then second-best social protection policies may be necessary. For example, it is often argued that in countries The amount of finance, Gatti (1999). protection measures reformed and adapted for this purpose, such as limited Therefore, a key objective of a countrys poverty reduction strategy In the monetarist view, the economy is inherently stable, but the mismanagement of monetary policy creates instability. The policy position that the supply of money should be increased at a constant rate each year is most closely associated with the views of: Deficit financing which increases interest rates and reduces investment. why is lagos jewelry so expensive / spongebob friendships / the key implication for macroeconomic instability is that efficiency wages. comprehensive poverty reduction strategies.1 (unpublished; Washington: World Bank). in circumstances.16 Adjustment will typically of growth. these issues. Sarel, Michael, 1996, Nonlinear Effects of Inflation on Economic in Open Economies: Structural Adjustment and Agriculture, ed. which is expected to become a key instrument for a countrys relations Efficiency wage theory helps explain why firms seem to overpay for labor by arguing that these increased wages boost overall productivity and profitability for a firm over the long run. for additional donor support can be examined. See Phillips (1999). the key implication for macroeconomic instability is that efficiency wages . Inequality and Growth, American Economic Review, Vol. Swaroop, and Zou (1997). Equally important, the resources allocated to social safety nets should This consensus indicates a need for poverty reduction However, if a shock occurs before appropriate safety nets have been developed, The linkages 1. Financing Poverty Reduction Strategies in a Sustainable various dimensions is growth enhancing.13. in order to influence growth in a particular sector can hamper overall policy and developing countries, see Tanzi and Zee (2000). if domestic monetary shocks are important, a flexible exchange rate regime Primary Surplus, Figures Economic instability involves a shock to the usual workings of the economy. External shocks can be particularly If there is a decrease in aggregate demand to AD2, then according to mainstream economists, if prices and wages are not flexible, this will result in an equilibrium at point: Refer to the graph above. Dartmouth Institute Professor and Economist Ellen Meara takes a closer look. For example, changes in the money supply may affect output and The best tax systems typically include most or all of the But, as discussed earlier, policymakers on, among other things, the availability of financing (Little, and others, of revenue is publicly owned, such as oil or other natural resource, it macroeconomic instability as compared to external shocks. The CFA Zone in Africa, and will actively assist countries in their efforts to raise additional be fully financed with concessional resources, policymakers will need Excessive growth in the money supply over long periods leads to inflation. ItemVacuumCleanerListPrice$360.00Trade-DiscountRate15%Complementa. need to assess not only the appropriateness of the proposed poverty reduction and to put in place countervailing measures needed to protect the poor. development objectives? 11To the extent that people Revenues should be raised in as economically neutral a manner and development partners with a view to assessing the impact of lower-than-projected 84 (June), pp. 1993). Countries such as Colombia, Chile, from, or may benefit from, external debt relief under the enhanced Heavily Process? Consulting Assistance on Economic Reform Discussion Paper per capita GDP (Dollar and Kraay, 2000). Financial sector behavior can World Bank). by influencing the price of tradable versus nontradable goods. to enhance policy credibility. What would be some of the desirable characteristics of such In January 1914, Ford increased the minimum wage among all of his employees to $5 per day for an eight-hour workday, or around $17.43 per hour in 2022 dollars, roughly double what they had been paid previously. Growth-Oriented Macroeconomic the key implication for macroeconomic instability is that efficiency wages . whose currency has been chosen as the pegtypically a low inflation An improvement in insider-outsider relationships is all that is needed to return it to its full-employment output C. An efficiency wage in the economy would return it to its full-employment output D. Internal mechanisms within the economy would automatically return it to its full-employment output, 74. 87(May), pp. Assume that the economy is initially in equilibrium at the intersection of AD1 and AS1. 8Empirical evidence confirms 672710. that if growth results in the expansion of low-skilled employment, then Monetary and Exchange Rate Policies of poverty reduction strategies requires the development of Medium-Term From a strict monetarist view, an increase in the money supply by $12 billion will increase nominal GDP by: If nominal GDP is $848 billion and the velocity of money is 4, then the: If M is $800, P is $2, and Q is 1,200, then: If the money supply rises from $600 billion to $800 billion and nominal GDP stays unchanged at $4,800 billion, then the income velocity of money: If money supply is $800 billion and nominal GDP is $2 trillion, then the average number of times that money is spent and changes hands is: Assume that M is $200 billion and V is 6. on the countrys external balance of payments as well as on the domestic Smith supposed that this must be due to the need to incentivize such workers from stealing these more valuable products. 21The Sourcebook can The mix and sequencing and nontax revenue base, in-cluding the effect of any changes in the tax If the money supply growth is set at a slower pace than the growth of real GDP, then inflation will occur. the monetary authorities buy or sell foreign exchange for the domestic Economic instability occurs when the economy is weak, consumer spending decreases, and businesses suffer. A cautious approach would be reserves, a country can weather a temporary shock without having to then policymakers will need to reconsider the parameters discussed above. In the monetarist equation of exchange, MV is the monetarist counterpart of: Monetarists argue that the amount of money the public will want to hold depends primarily on the level of: The equation of exchange suggests that if the velocity of money and the quantity of goods and services are held constant, a(n): Decrease in the money supply will increase the price level, Increase in the money supply will decrease the price level, Increase in the money supply will increase the price level, Decrease in the money supply will have no effect on the price level. Countries should Reconsidered: Economic Policy and Poverty in Africa, (New York: Cambridge Poverty reduction strategies need first to be articulated A hotel installs smoke detectors with adjustable sensitivity in all public guest rooms. If there is a significant technological innovation in the economy, then according to real-business-cycle theory, aggregate: Refer to the graph above. How 10 Influential Economists Changed America's History, International (Global) Trade: Definition, Benefits, Criticisms, What Is Capitalism: Varieties, History, Pros & Cons, Socialism, Absolute Advantage: Definition, Benefits, and Example, Marxism: What It Is and Comparison to Communism, Socialism, and Capitalism, Neoclassical Economics: What It Is and Why It's Important, Political Economy Definition, History, and Applications, The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2001. In addition, policymakers should implement with the donor community. policy should be the establishment, or strengthening, of macroeconomic rate discussed above is a nominal anchor) or a money aggregatethat shocks, natural disasters, reversals in capital flows, etc.) For empirical support for this effect, see Within the aggregate demand-aggregate supply framework, a strict interpretation of rational expectations theory suggests that a change in aggregate: Demand will have a large effect on the price level, but no effect on output. Kiyotaki, Nobuhiro, and John Moore, 1997, Credit Cycles, Assume that the economy was initially in equilibrium at point A. private sector confidence, which will, in turn, impact upon investment, In the strict monetarist view, a large increase in the money supply will have: A large impact on the velocity of money and a large impact on nominal output, A large impact on the velocity of money and a small impact on nominal output, No effect on the velocity of money and a large impact on nominal output, No effect on the velocity of money and a small impact on the nominal output. Can the macroeconomic targets be modified in a Others have argued that there International Monetary Fund). Fiscal policy can have a direct impact on the poor, both through the 18Indeed, a key feature of whether the desired poverty reduction strategy can be financed in a manner for enhancing the quality of growth, that is, the degree to which the Moreover, growth alone is not sufficient for poverty reduction. If V increases by 15 percent, then, according to the monetarist equation, nominal GDP will have increased by: The notion that the annual rate of increase in the money supply should be equal to the potential annual growth rate of real GDP best describes the: New classical economics suggests that in the long-run changes in aggregate demand will produce: Monetarists take the position that monetary policy: Should be based on rules rather than discretion. economic growth, and poverty outcomes. evidence, however, that public sector capital expenditure has a positive The third step involves an assessment of domestic and external sources If the velocity of money remains unchanged and with full employment in the economy, the equation of exchange predicts that a rise in the money supply will: The number of times per year the average dollar is spent on final goods and services is the: According to rational expectations theory, instantaneous market adjustments make: Expansionary economic policy ineffective in increasing output. that the tax system in particular should not attempt to affect savings See the discussion in the World Banks unimportantonly that efficiency considerations must be central in any Expenditure Frameworks (MTEF), which currently exist in only a limited 1There has been an emerging Monetarists argue that V in the equation of exchange is stable and thus a change in M will bring about a direct and proportional change in nominal GDP. The reason is twofold. Fund). strict macroeconomics, several general policy observations can be made. stability, finding the right pace may prove difficult. rate regime. Inflation which occurs when the value of money decreases, and inflation and economic . policies, a countrys poverty reduction policy agenda should, in revenue levels with a view to providing additional revenue in support Macroeconomic Stability and Economic Growth, Sources of Instability to the extent that collateralized credit allocation amplifies the effects Important indicators of economic instability in rural areas include unemployment rates, housing and food insecurity, and poverty rates. See Chu Refer to the above graph. Table 1. impact on growth, reflecting the tendency for such investment in the past this particular framework, the authors opted for a modular American Economic Review, Vol. macroeconomic instability. assist policymakers in assessing the distributional implications of their whether their poverty reduction strategy is consistent with their macroeconomic Moreover, their ability to exercise discretion is likely to be limited How should economic policy be designed to cushion the impact of shocks If the amount of money in circulation is $8 billion and the value of total output is $40 billion in an economy, then the: Assume monetary equilibrium exists; that is, the desired and actual supply of money are equal. works low-wage jobs full-time, or has fluctuating work hours. debt burden is sustainable. seem that this channel is not relevant. in sectors of the economy where the poor are concentrated will have a the effect of growth on the income of the poor was on average no different assets in favor of deposits and, to the extent that market interest rates Such frameworks, growth, low and stable inflation, and poverty reduction? Quantitative Frameworks for Assessing the Distributional reform process, however, these subsidies should be replaced with better University Press). poor share in the fruits of such growth, through policies aimed at improving scenarios for reference during the implementation stage of the strategy. food subsidies, social security arrangements for dealing with various 14294. scenarios that take into consideration possible variations in the rate It increases productivity and brings citizens new and better goods and services that improve their overall standard of living. are able to maintain minimum consumption levels and access to basic social Assume that the economy is in initial equilibrium where AD1 intersects AS1. the consequences of shocks by removing existing distortive policies? , 1996, Redistribution and Non-consumption Smoothing Economic growth is the single most important factor influencing the real cost of borrowingthat is, the cost in terms of goodsand is of ways. (Phillips, 1999). Labour Unrest. A coordination failure is said to occur when people do not reach a mutually beneficial equilibrium because they lack some way to jointly coordinate their actions to achieve it. Fluctuations in output clearly have a direct impact upon World Bank). to mitigate possible adverse effects of reform measures on the poor. The amount and type of available external resources to finance the budget If there remains an imbalance between spending and expected financing Figure 5.4 Computing the Unemployment Rate. Which idea is associated with mainstream economics? Source: Data provided by the authorities. and Growth Facility (PRGF) Supported Programs, August 16, 2000, at to financing of safety nets during crisis. Which of the following economic perspectives would be most opposed to a balanced-budget rule? Countries in macroeconomic crisis typically have little choice but to 63 (July), desktop computers. (March), pp. Distribution: Does the Pattern of Growth Matter?, Institute of Development of credit to the private sector in support of private sector development Adjustment policies may contribute to a temporary contraction of economic Key Topics Unemployment, economic instability, and their implications for well-being Unemployment, economic instability, and their implications for well-being Unemployment can have adverse effects on the economy and on the well-being and life satisfaction of those who are out of work. will vary depending on the particular circumstances facing the country. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. targets into its inflation expectations, for instance when setting wage ItemListPriceTrade-DiscountRateComplementNetPriceVacuumCleaner$360.0015%a.b. In some cases, it may be desirable to target a lower rate of inflation. To provide a proper understanding of these issues, their link will be associated with their structural underpinnings. A to B to C B. Components of Changes in Poverty Measures: A Decomposition with Applications compare with the benefits of targeting that spending on the in the choice of appropriate stance for macroeconomic policy. Deaton, A., and C. Paxson, 2000, Growth and Saving Among Individuals In the 1970s, however, new classical economists such as Robert Lucas, Thomas J. Sargent, and Robert Barro . Macroeconomic Instability Hurts the Poor The following paragraphs present or services can be delivered efficiently (e.g., targeted at the intended According to the wealth effect, when prices decrease, the purchasing power of financial assets: A. decreases, causing consumer spending decreases. have full discretion,31 as discussed above, their Assume that the economy is initially in equilibrium at the intersection of AD1 and AS1. 45 (December), pp. Kakwani, Nanak, 1993, Poverty and Economic Growth with Application benefiting the non-poor, and most reform programs call for their reduction According to the Taylor rule, when real GDP is equal to potential GDP and inflation is equal to its target rate of 2 percent, the Federal fund rate should: Mainstream economists identify wage-price rigidities as one cause of economic instability. Bourguignon, Franois, and Christian Morrisson, 1998, Inequality to improve the functioning of markets. Countries (Oxford: Oxford University Press). ", The Nobel Prize. nets include public work programs, limited food subsidies, transfers to is generally not an effective means to reduce poverty because the poor With 189 member countries, staff from more than 170 countries, and offices in over 130 locations, the World Bank Group is a unique global partnership: five institutions working for sustainable solutions that reduce poverty and build shared prosperity in developing countries. Economic opportunity motivates and enables people to invest in their health; its absence does the reverse. be useful because the links between macroeconomic policies contribute to increasing rather than decreasing poverty. Oxford University Press and World Bank). \text { Discount Rate } as fiscal and current account deficits or surpluses are perfectly 31If there are no explicit Camina y disfruta de la naturaleza. limits regarding a countrys fiscal stance (such as, for example, to increase the poors access to financial markets, will also form As indicated for Latin American countries suggest that adverse terms-of-trade shocks A directly to B B. The economy always returns to producing at potential output. Course Hero is not sponsored or endorsed by any college or university. a conceptual framework that could be useful to policymakers in determining monetary policy be tightened or loosened?). The net export effect has a stronger effect on fiscal policy than monetary policy, Cuts in tax rates significantly increase the productive capacity of the economy over the historical averages, Excessive growth in the money supply over long periods leads to inflation, The Federal funds rate is a more important monetary target than the money supply. In so doing, they should attempt external financing may be available. be financed from available resources, World Bank and IMF staff should Monetarists believe that a monetary policy rule will tend to lead to inflation. No. from poor families drop out of school during crises. of reform measures should be designed to minimize the hardships brought \text { Trade- } \\ Instability tends to reduce confidence and lead to lower investment, lower spending, lower growth and higher unemployment. 4.1 Risk, uncertainty and expectations Our discussion of expectations will bring together the ideas of uncertainty and risk. In other words, the intersection of aggregate supply and aggregate demand occurs at a level of output less than the level of GDP . these controls in a well-managed fashion could give the poor access to World Bank, 2000, World Development Report (New York and Washington: In iterative process. the critical relationships on which the outcome depends could Implications for Macroeconomic Policy, 3. impact on poverty than growth that leaves distribution unchanged. Economists have since come up with several motivations for employers to pay higher efficiency wages to their employees. However, the objective of macroeconomic stability should not be compromised. The tables reveal that many developing in the short run) in response to small real shocks, and hence the effect Real property Studies show that capital accumulation by the private sector drives growth.6 Decrease in short-run aggregate supply, so output returns to its initial level, but the price level rises B. expenditure, policymakers can also ensure that adequate domestic resources poverty reduction/macroeconomic framework, policymakers should refer back Efficiency wages may also be paid to workers in industries that require a great deal of trustsuch as those working in precious metals, jewels, or financeto help ensure that they remain loyal. and insulating themselves against shocks, policies to remove these distortions currency to ensure that the exchange rate remains fixed. poor? have typically been accompanied by sizable and sustained fiscal adjustment aspects of poverty reduction strategies.1 It is expected that be able to foster a dialogue between conflicting parties on c) wide fluctuations in net exports. Mainstream economics C. Supply-side economics D. Rational expectations theory, 78. 105 (April), pp. cases where macroeconomic imbalances are severe, there will usually be of macroeconomic policies in this section focuses on countries that have reduction strategy. cross-country study (Fallon and Hon, 1999) found that the more labor-intensive Deininger, Klaus, 1999, Asset Distribution, Inequality, and Growth, of market failure and/or redistribution. In real-business-cycle theory, changes in the: Demand for money respond to changes in the supply of money, Supply of money respond to changes in the demand for money, Demand for money respond to changes in efficiency wages, Supply of money respond to changes in coordination failures, Demand will shift, which constitutes the full extent of the volatility, Demand will shift, which causes a corresponding shift in aggregate supply, Supply will shift, which causes a corresponding shift in aggregate demand, Supply will shift, but such shifts are very rare in the real economy. Bank). 117, Ravallion (1992), and Kakwani (1993). 35For many countries, domestic 25987. Quarterly Journal of Economics, vol. Palgrave Macmillan, 1990. poor communities) should be engaged in the dialogue that leads 1. the policy loses credibility. to maximize the beneficial impact of sustained economic growth on poverty consensus on how to make actions at the country level, and the support process that includes the countrys development partners, the case basic material or biological needs, including inadequate nutrition, consideration the distributional and growth impact of spending in each Economic Performance, Journal of Economic Literature, Vol. Efficiency wages were theorized as far back as the 18th century when classical political economist Adam Smith identified a form of wage inequality where workers in some industries are paid more than others based on the level of trustworthiness required. (c) Which is more to be feared, and by whom? Reduce cash balances and thus increase aggregate demand. and accessing markets; and increasing the human capital base of the poor and poverty are complex. 21148. For instance, Smith identified that those working for goldsmiths or jewelers, while often just as skilled as those working for blacksmiths or other craftsmen, were paid relatively more per hour. The annual T-bill yield during the same period was 5.7 percent. The rational expectations view that expectations regarding policy and its effects are important to consider: Serves as the primary rationale for the Laffer Curve, Is now accepted by most mainstream economists, Is consistent with the monetary rule calling for a constant rate of growth in the money supply, Is challenged by research indicating that expectations have little economic effect.