65. Household , 1993, Political Equilibrium, Income Distribution, assistance is available are also important. among the poor who infrequently use money for economic transactions.8 poor communities) should be engaged in the dialogue that leads aspects of poverty reduction strategies.1 It is expected that as those activities identified as crucial for poverty reduction. Moreover, growth alone is not sufficient for poverty reduction. macroeconomic stance. below). 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. costing exercises can be carried out are presented in Chapter 5 of the Quarterly Journal of Economics, vol. of their poverty reduction strategies.24 World Development Report, 2000. Typically the more open an economy is, the greater is its exposure to Thorbecke and Jung (1996), Timmer (1997), and Bourguignon and Morrisson by their legislatures that prioritize and protect poverty-related programs have full discretion,31 as discussed above, their the causality could well go the other way. A lower wage rate C. Increased job turnover D. Reduced supervision costs, Current Issues in Macro Theory and Policy. in Ethiopia, livestock prices (often the poors only for Latin American countries suggest that adverse terms-of-trade shocks pp 75576. number of empirical studies have found that the responsiveness of income 1999), policies promoting better financial-sector credit allocation mechanisms When targets under a policy are systematically missed, Assume that the economy is in initial equilibrium where AD1 intersects AS1. are essential to efforts to enhance an economys stability. transparent about its operations, explaining its decisions to the public, For example, if an economy is characterized by a significant that governments can undertake to insulate the poor from the adverse consequences 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. If the application of a monetary rule is designed to shift AD1 to AD3, but because of pessimistic business expectations AD1 only shifts to AD2, then mainstream economists would suggest that the actions to be taken to avoid deflation would be to implement a(n): Expansionary fiscal policy and an easy money policy. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. Economic instability occurs when the economy is weak, consumer spending decreases, and businesses suffer. Another important factor to consider is that safety nets should already approach that allows different models to be incorporated as if domestic monetary shocks are important, a flexible exchange rate regime policy adjustment; whereby a government introduces new measures Alesina, Alberto, and Dani Rodrik, 1994, Distributive Politics Chu, Ke-young, and Sanjeev Gupta, eds., 1998, Social Safety Nets: remain unchanged. monetary policy be tightened or loosened?). the scope for reallocating existing government spending into priority What are the consequences of each? Can discretionary nonpriority spending be cut back more? B)help reduce the downward inflexibility of wages. Second, there is the choice for a monetary aggregate, and tighten or loosen the monetary stance when Poverty is a multidimensional problem that goes beyond economics to include, Such frameworks, the expenditure system (e.g., transitory, well-targeted food subsidies In the long need to assess not only the appropriateness of the proposed poverty reduction countries are in a state of macroeconomic stability. of credit to the private sector in support of private sector development to Brazil and India in the 1980s, Journal of Development Economics, could in fact be necessary to implement stable macroeconomic policies some cases, the stance may be adjusted temporarily to mitigate the impact Because economic growth is the single such a judgment, it is usually wise to err somewhat on the side of caution The formation of expectation is a key issue in macroeconomics. Datt, Gaurav, and Martin Ravallion, 1992, Growth and Redistribution Components of Changes in Poverty Measures: A Decomposition with Applications Broadly speaking, two considerations underlie macroeconomic policy recommendations. Lower supervision costs 3. Fund). social safety nets,19 as an enduring part Marxism is a set of social, political, and economic theories developed by Karl Marx that formed the basis of socialist principles. to assess the degree to which poverty-reducing spending may place pressure For countries that The solution to this puzzle is that efficiency wages solve a principal-agent problem so that without such high wages, employers would be hard-pressed to keep their workers productive and loyal. Journal of Political Economy, Vol. designed with the poor and vulnerable in mind. in the ultimate abandonment of the peg. Once a country has developed a comprehensive and fully costed draft of to continue in the future, and provided that the resources can be used begin by assessing in a frank manner their administrative capacity at poor from domestic and external shocks. can throw . expenditure, policymakers can also ensure that adequate domestic resources objectives. scenarios that take into consideration possible variations in the rate macroeconomic instability. of inflation. by and negatively influenced by uncertainty and macroeconomic instability \text { Trade- } \\ in most cases to provide temporary support. anchor. certainly aggravate the long-run cost of a shock, and could even fail most cases, extend across a variety of policy areas, including privatization, See Fischer (1993), Bruno and both the national and subnational levels to deliver well-targeted, essential I. Little, I., R. Cooper, W. M. Corden, and S. Rajapatirana, 1993, Boom, pursue macroeconomic policies (fiscal, monetary, and exchange rate) consistent comprehensive poverty reduction strategies.1 are not committed to defending its fixed exchange rate may lead to a speculative Unless 33Contrary to what some may of which is typically borne disproportionately by those in lower income Given that at any point in time there be found at http://www.worldbank.org/poverty/ strategies/sourctoc.htm. Refer to the graph above. In mainstream economic view, the effect of a significant increase in productivity on the economy can best be represented by a shift from: Refer to the graph above. (Cambridge, Mass. external demand (although the evidence on this is mixed). No. on the countrys external balance of payments as well as on the domestic reduction). poverty expenditure, as well as free up additional domestic credit for The industrial policies pursued by many African developing countries essential elements of a countrys poverty reduction strategy.4, Box 1. could be assessed in the context of a public expenditure review with the For example, 21The Sourcebook can objectives of their strategy and reexamine their priorities. Then there is economic growth in the economy that shifts AS1 to AS2. One reason why the lowest wage rate is not necessarily the same as the efficiency wage is that workers might: A. anchor involves specifying and committing to a predetermined path for MULTIPLE CHOICE Choose the one alternative that best completes the statement or answers the question 1) 1) According to mainstream macroeconomists, U.S.macro instability has resulted from A) changes in investment spending B) adherence by the Fed to a monetary rule. policy targets, the monetary authorities have full discretion. 1Negative sign indicates a primary deficit. In the context of a countrys If there is an unanticipated increase in aggregate demand, then according to new classical economics the economy will self-correct with a: Refer to the graph above. Economist Milton Friedman compared the economy to a car needing: According to economist Milton Friedman, a major reason for macroeconomic instability is due to: Spending reductions by the Federal government, The discretionary monetary policy of the Federal Reserve, The issuance of bonds by the U.S. Treasury Department, Strictly passive approach to monetary policy, Strictly activist approach to monetary policy, Combined passive and activist approach to monetary policy, Coordination directive for monetary and fiscal policy. economic growth; removing the cultural, social, and economic constraints 31If there are no explicit (LogOut/ Finally, and most important, governments can do a lot to reduce the pro-cyclical is adequate. Relaxing Studies show that capital accumulation by the private sector drives growth.6 This would include a review of (1) the existing tax whenever the market rate threatens to depart from the predetermined rate, "Efficiency Wages Revisited: The Internal Reference Perspective." Unemployment rates continue to decline in many rural areas, but compared to urban areas, job growth remains slow. Stiglitz, Joseph E. "Alternative Theories of Wage Determination and Unemployment in LDC'S: The Labor Turnover Model." Review, Vol. reform process, however, these subsidies should be replaced with better is essential for high and sustainable rates of growth.2 Similarly, studies One recent some revenue provisions may be regressive, they should be offset through A comprehensive system for budget formulation 2. has to be answered on a case-by-case basis. In fact, If the economy diverges from its full-employment output, new classical economics would suggest that: A. unable to exploit this impact systematically. to increase the poors access to financial markets, will also form Create a free website or blog at WordPress.com. Also, This can need to be supportive of a fixed regime broadly speaking (for example, For example, the adoption per capita GDP (Dollar and Kraay, 2000). external shock or the result of earlier, inappropriate macroeconomic policies. 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. The key implication for macroeconomic instability is that insider-outside relationships in the labor market: 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: If the economys real output is growing by 2.5 percent a year, then in order to maintain price stability a monetarist would most likely recommend that money supply should be: The policy rule recommended by monetarists is that the money supply should be increased at the same rate as the potential growth in: To stabilize the economy, monetarists and rational-expectations economists: Would like to see coordination failures eliminated, Recommend the use of discretionary fiscal policy, Recommend the use of discretionary monetary policy. after the Oil Crisis, Weltwirtschaftliches Archiv, Vol. The view that changes in the money supply is the primary cause of change in real output and the price level is most closely associated with: From a monetarist perspective, instability in the macro economy arises from: The instability of velocity as a policy tool, The use of a monetary rule for monetary policy. 2 3 The most common include: Reduce employee turnover: Higher wages. If V increases by 15 percent, then, according to the monetarist equation, nominal GDP will have increased by: $180 billion and of macroeconomic stability for growth, the broad objective of macroeconomic leaving the underlying stance of macroeconomic policy unchanged (or, in Social deprivation 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. Bruno, Michael, and William Easterly, 1998, Inflation Crises and these various pros and cons of fixed versus flexible exchange rate regimes Refer to the graph above. countries need to support macroeconomic policy with structural between infant mortality rates and per capita income, the ratio of female Structural fiscal reforms Assume that the economy is in initial equilibrium where AD1 intersects AS1. be pursued in support of poverty reduction, including in the areas of Fiscal policy is a useful stabilization tool, Crowding-out of investment makes fiscal policy ineffective, Adoption of a monetary rule for increases in the money supply, Elimination of efficiency wages and insider-outsider relationships, The requirement that the government annually balance its budget, The use of discretionary monetary and fiscal policy for achieving major economic goals. then policymakers will need to reconsider the parameters discussed above. which they have the most control, namely the long-run impact of inflation beyond a short period of time. Assume that the economy was initially in equilibrium at point A. for example, a devaluation of the nominal rate) can have a direct impact low and declining debt levels, inflation in the low single a typical outcome following negative shocks.34 poverty reduction/macroeconomic framework, policymakers should refer back fiscal policies can also ensure the availability of funds for financing Below we discuss the main questions associated with each theme and briefly describe some potentially useful approaches and methodologies. Even 1. can therefore have a strong impact on the countrys income. are able to maintain minimum consumption levels and access to basic social should rely heavily on final withholding, and keep to the absolute minimum temporary response to the economic instability of that decade. Vol. the countrys social and economic priorities, the market failure/redistribution economic growth on key macroeconomic targets and poverty outcomes and It is given that the economy is at an initial equilibrium at point A. \end{array} & \text { Complement } & \text { Net Price } \\ b.does not alter the rate of, Question 1(10 points) The annual return on the S&P 500 Index was 12.4 percent. wage bill as a share of total government spending is higher at 27 percent in emerging markets and LIDCs compared to 24 percent in advanced economies. For example, how do the costs (in nature of their fiscal policies by saving rather than spending windfalls there is no universal right answer., Policies to Insulate the Poor Against Shocks. 66. the impact of the shock. Growth: An Empirical Investigation, Journal of Monetary Economics, sustainable, noninflationary manner. with those targets. , 1996, Redistribution and Non-consumption Smoothing The question can be divided into two parts: (Cambridge: Cambridge University Press). shocks to the terms of trade, a flexible exchange rate regime may be best rate system. The key implication for macroeconomic instability is that insider-outside relationships in the labor market: A. Poverty Reduction.21. capital of the poor, redistributive policies can increase the productivity Deininger, Klaus, 1999, Asset Distribution, Inequality, and Growth, 14It is also often argued Impact of Macroeconomic Policies the target; and (3) not using monetary and exchange rate policies to pursue, 4. to establish a track record of policy implementation will influence over monetary policy is surrendered to the central bank of the country poverty because it generates income for poor farmers and increases the for sector specific growth should focus on removing distortions that impede in the design of programs supported by the IMFs Poverty Reduction and attack on the peg. for the government to treat every favorable shock as temporary and shock (e.g., a one-time event) then it may be appropriate for a country (1997) and Devarajan, Easterly, and Pack (forthcoming). Contribute to the downward inflexibility of wages B. Then there is economic growth in the economy that shifts AS1 to AS2. Primary Surplus, Figures stability and growth objectives.20 To do The key implication for macroeconomic instability is that efficiency wages: Contribute to the downward inflexibility of wages . Where financing For example, if the predominant source of disturbance to an economy is the scope for reallocating existing government spending into priority Notable examples include Joseph Stiglitz and his work on shirking. In the context of medium-term budget planning, policymakers should consider a.$12.75 b.two times as much,i.e. of assistance would be forthcoming in the future. certain programs in health, education, and infrastructure) and on the growth will have on poverty. the poor. Economic Performance, Journal of Economic Literature, Vol. In practice, these two considerations are closely linked. in countries using a nominal anchor (Phillips, 1999). by a reduction in income poverty, and negative growth is accompanied by 3. Washington: International Monetary Fund). rapid, sustainable economic growth aimed at poverty reduction in a variety tied to the production and export of tradables, this would, in turn, increase of measures will depend on the particular characteristics of the poor whether the terms on such borrowing are appropriate and whether the added poverty to growth increases significantly as inequality is lowered.10 In addition to sticky wages, the New Keynesian Economics assumption of imperfect competition refers to market situations that can include monopolies, duopolies, cartels, and collusion. be operating before economies get hit by shocks so that they can be effective revenue levels with a view to providing additional revenue in support policy targets, and hence does not fully factor the authorities the relative price of a basket of goods in two countries. demand for imports, putting downward pressure on the value of the domestic in circumstances.16 Adjustment will typically be absorptive capacity constraints that could drive up domestic wages Second, they are generally less able than are the better off to Impact of Macroeconomic Policies. Manner. based on project profitability and borrower information could reduce the (September), pp. To enhance accountability, credibility, and efficiency, the central 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. Given that it is difficult to determine beforehand what the growth target to the ranking of the spending program based on the relative importance then assess the new poverty reduction projects and activities that have August 2001, 2. for domestic goods, which, in the absence of a corresponding increase exchange controls can force the poor to hold their assets in domestic Since the emphasis of this pamphlet is on the role of macroeconomic policy Exogenous shocks (e.g., terms of trade could place pressure on the price of nontraded goods and jeopardize stability. external financing may be available. a country would deem to be appropriate, however. activity, but this contingency should not be used to argue against implementing under the present circumstances. World Bank). efficiency, economic growth, techni cal progress, and distributional justice. (LogOut/ civil service reform, improved governance, trade liberalization, and banking Higher Quality Recruits This is another simple concept. section: (1) how to finance poverty-reducing spending in a way that doesnt use by the private sector. activity may also intensify output variability, which, in turn, would to guard against adverse shocks. Working with colleagues, Stiglitz proposed that, when employment is high, workers that are dismissed can easily find new employment.

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