Mr

Benjamin Thong | Macroeconomic Policies BOP

Contractionary Fiscal policy
To achieve Healthy Balance of Payment and to improve BOP by reducing deficit


Government can introduce Demand Management Policy such as Contractionary Fiscal policy.
Government can decrease the Government expenditure (G) on final goods and service such
as education and healthcare which directly decrease Aggregate demand.

Government can increase direct Taxes such as Personal Income Tax and Corporate Tax which
decrease Disposable Income and Post-Tax Profit.
Households becomes less willing and able to consume and Firms become less willing and able
to invest, causing Consumption (C) & Investment (I) to decrease.

When G, C & I decrease, Aggregate Demand will decrease as AD=C+I+G+(X-M)
When Aggregate Demand decrease, AD curve will shift left, causing an unplanned surplus of
inventories at the original general price level. The unplanned surplus will lead to a downward
pressure on general price level as firms clear their stock, as general price level decreases, real
national output will decrease. As real output decreases, firms may demand and employ lesser
factors of productions such as labour.

Therefore, Contractionary Fiscal policy will lead to a recession as Real National Income will
decrease via the multiplier effect, General Price Level will decrease and Unemployment Rate
MAY increase, especially Cyclical unemployment.

Contractionary fiscal policy is that it may lead to improving of Balance of Payment as decrease
in real national income and employment will decrease the demand for imports, and
decreasing GPL will decrease the demand for imports and increase exports, all causing the
improvement of Balance of trade and balance of payment.

The strength of fiscal policy is that it may have the shortest time lag as Government
expenditure is a component of AD.
Another strength of fiscal policy is that it may improve budget deficit or improve government
debt as there is a decrease government spending combined with increase in tax revenue
collected.
Another strength of fiscal policy is that it will lead to lower of general price level, reducing the
inflationary pressure.

Limitation of Contractionary fiscal policy is that it may lead conflict of macroeconomic aims
or economic growth and low unemployment, it may lead worsening of standard of living of
the population.

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Mr Benjamin Thong | Macroeconomic Policies BOP

Contractionary Monetary policy
To achieve Healthy Balance of Payment and to improve BOP by reducing deficit


Government can introduce Demand Management Policy such as Contractionary Monetary
policy through the Central Bank.

The Central Bank can decrease the Money Supply within the Economy through Open Market
Operations of selling Treasury Bills and Bonds, decrease Bank's Reserve Ratio. When Money
Supply decreases, Interest rate increases as banks has less money to be loaned out.

Central Bank can increase the domestic Interest Rate directly.
Increase in Interest Rate means that the Cost of Borrowing and Reward to Savings has
increased. Households becomes less willing and able to consume & Firms become less willing
and able to invest, causing Consumption (C) & Investment (I) to decrease.



When C & I decrease, Aggregate Demand will decrease as AD=C+I+G+(X-M)
When Aggregate Demand decrease, AD curve will shift left, causing an unplanned surplus of
inventories at the original general price level. The unplanned surplus will lead to a downward
pressure on general price level as firms clear their stock, as general price level decreases, real
national output will decrease. As real output decreases, firms may demand and employ lesser
factors of productions such as labour.

Therefore, Contractionary Monetary policy will lead to a recession as Real National Income
will decrease via the multiplier effect, General Price Level will decrease and Unemployment
Rate MAY increase, especially Cyclical unemployment.

Contractionary Monetary policy is that it may lead to improving of Balance of Payment as
decrease in real national income and employment will decrease the demand for imports, and
decreasing GPL will decrease the demand for imports and increase exports, all causing the
improvement of Balance of trade and balance of payment.

The strength of Monetary policy is that it it will lead to lower of general price level, reducing
the inflationary pressure.
Another strength of Monetary policy is that the financial market will decide how much AD will
change.
Another strength of contractionary Monetary policy is real national income will increase more
than proportionate to the initial increase in AD due to the multiplier.

Another limitation of contractionary Monetary policy is that it may not lead to desired
decrease in AD.
Limitation of contractionary Monetary policy is that it may lead conflict of macroeconomic
aims or economic growth and low unemployment, it may lead worsening of standard of living
of the population.

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Mr Benjamin Thong | Macroeconomic Policies BOP

Depreciation of Exchange Rate

To achieve Healthy Balance of Payment and to improve BOP by reducing deficit


Central Bank can depreciate the country's Exchange Rate in the foreign exchange FOREX
market by buying Foreign currencies using Domestic currency. When a currency depreciated,
it means that the same amount of that currency can only buy lesser amount of another
currency, or more of that currency is required to buy the same amount of another currency.
The same idea applies to Goods and Services in terms of imports and exports.

Export becomes relatively cheaper for the foreign countries, Export volume increases.
Import becomes relatively more expensive than domestic goods and services, Import volume
decrease. Assuming Marshall-Lerner Condition (PEDX+M >1) holds, Net Exports (X-M) will
increase. As balance of payment and net exports and BOT improve, Current Account improve,
Therefore, BOP improved.

The strength of Depreciation of Exchange Rate is that when (X-M) increase, Aggregate
Demand will increase as AD=C+I+G+(X-M), resulting in Actual Growth as Real National Income
will increase via the multiplier effect, and Unemployment Rate MAY decrease, especially
Cyclical unemployment.

The strength of Depreciation of Exchange Rate is that it does not contribute to budget deficit
as it does not require government spending or reduction in tax revenue collected.

The limitation of Depreciation of Exchange Rate is that it Marshall Lerner condition might not
hold.
Another limitation of Depreciation of Exchange Rate is that it may lead to imported inflation
and imported factors of production will be more expensive and SRAS will decrease.
Another limitation of Depreciation of Exchange Rate is that it will lead to inflation.

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Mr Benjamin Thong | Macroeconomic Policies BOP

Supply Management Policy


To achieve Healthy Balance of Payment and to improve BOP by reducing deficit


Market Oriented Policies aim at encouraging market forces to work freely as it is believed that
market forces always result in efficient allocation of resources.
Interventionist Policies aims at counteract the deficiencies of the market by government
intervening in the market directly.


Improve Quality and Quantity of Factors of productions.

Resulting in the increase in the Productive Capacity of the economy, increasing the full
employment output and LRAS, LRAS curve shift right. As the Productive Capacity of the
economy increased, the economy has achieved Potential Growth.

Increase in LRAS will cause an unplanned surplus of inventories at the original general price
level. The unplanned surplus will lead to a downward pressure on general price level as firms
clear their stock, as general price level decreases, real national income will increase as
household increase consumption. As real output increases, firms may demand and employ
more factors of productions such as labour.

Therefore, Supply Management Policy will lead to Potential and Actual Growth, reduction in
General Price Level and Unemployment Rate MAY decrease.

Supply Management Policy may lead to improving of Balance of Payment decreasing GPL will
decrease the demand for imports and increase exports, all causing the improvement of
Balance of trade and balance of payment.

The strength of Supply Management Policy is that it does not lead to conflicts between
different macroeconomic goals.
Another strength of Supply Management Policy is that it can lead to sustainable economic
growth as the economy achieve potential growth.

The limitation of Supply Management Policy is that it may have the long time lag as increasing
quality and quantity of factor of productions and improving technology might take time.
Another limitation of Supply Management Policy is that it does not confirm lead to an increase
in aggregate supply.

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