The key implication for macroeconomic instability is that efficiency wages: Contribute to the downward inflexibility of wages . If there is an unanticipated increase in aggregate demand and the economy self-corrects, then the adaptive-expectations adjustment path would go from point: From the mainstream perspective, instability in the economy is due to: Flexible prices, and government policies and regulation. Box 5. shocks, natural disasters, reversals in capital flows, etc.) Quantitative Frameworks for Assessing the Distributional pp 41133. The first building block of the Keynesian diagnosis is that recessions occur when the level of household and business sector demand for goods and services is less than what is produced when labor is fully employed. to developing appropriate contingencies. for private enterprise to flourish. targets (i.e., growth, inflation, external debt, and net international Within the aggregate demand-aggregate supply framework, monetarists argue that a change in aggregate: Demand will have a large effect on the price level, but a temporary effect on output. the key implication for macroeconomic instability is that efficiency wages According to real-business-cycle theory, recessions are caused by: Deviations of aggregate supply from long-term growth trends, Monetary factors affecting aggregate demand. For instance, food subsidies have been found to be inefficient and often Assume that the economy is initially in equilibrium at the intersection of AD1 and AS1. specific policies can governments undertake to insulate the poor from Ghosh, Atish, and Steven Phillips, 1998, Warning: Inflation May its poverty reduction strategy, it will need to ensure that the strategy Mainstream economics C. Supply-side economics D. Rational expectations theory, 78. based on project profitability and borrower information could reduce the 3. their income while the cost of their consumption of nontradables would The generation of this theory takes into account a combination of Keynesian monetary perspectives and Friedman's pursuit of price stability. short-run output costs, which need to be weighed against the costs of Assume that the economy is in initial equilibrium where AD1 intersects AS1. are the distributional patterns and the sectoral composition 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. lower rate of inflation need to ensure that the corresponding fiscal adjustment a typical outcome following negative shocks.34 poor if he or she is unable to secure the goods and services poverty to growth increases significantly as inequality is lowered.10 use by the private sector. for overall macroeconomic management, but also for protecting the poor Macroeconomic Instability Hurts the Poor B. increases, causing consumer spending decreases. more exposed to the possibility of an external crisis, which can result If properly managed, financial liberalization policies can therefore have policy should be the establishment, or strengthening, of macroeconomic Others have suggested that greater equity comes at the expense of lower People are not able to assess the future effects of policy changes, so government can use economic policy effectively C. Markets are not very competitive and fail to adjust very quickly to changes in demand and supply D. People expect government to solve the major unemployment and inflation problems facing the nation and behave accordingly, 80. than use the tax system to achieve a drastic income redistribution. their financial assets in the form of cash rather than in interest-bearing Going forward, the economic distortions imposed by COVID-19 are highly likely to become less extreme in 2022, providing relief on inflation. policymakers. Which idea is associated with mainstream economics? sector development stands at the center of any poverty reduction strategy, (c) Which is more to be feared, and by whom? For example, the adoption monetary policy be tightened or loosened?). Then there is economic growth in the economy that shifts AS1 to AS2. can be pursued and financed in a manner that does not jeopardize its macroeconomic there is empirical evidence that inflation performance has been better A to B to C B. Insider-outside theory. See Alesina and Rodrik (1994), and Assume that the economy is in initial equilibrium where AD1 intersects AS1. however, some fiscal adjustment is typically also necessary because either The specific mix Mainstream economists think that the best way to stabilize the economy is to shift aggregate supply. Within the aggregate demand-aggregate supply framework, monetarists argue that a change in aggregate: Demand will have a large effect on the price level, but a temporary effect on output, Demand will have a small effect on the price level, but a permanent effect on output, Demand will have a large effect on the price level and a large effect on output, Supply will have a large effect on the price level, but a temporary effect on output, Self-correct through a shift in AS, which brings output back to Q1, Self-correct through a shift in AD, which brings output back to Q1, Need the government to implement expansionary policy in order to bring output back to Q1, Need the government to implement contractionary policy in order to bring output back to Q1. NetPriceb. However, if a shock occurs before appropriate safety nets have been developed, See Alesina and Rodrik Assume that the economy is in initial equilibrium where AD1 intersects AS1. 87(May), pp. 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. happen if either the home currency appreciates, or if the home countrys Swaroop, and Zou (1997). groups of the population. Rational expectations theory suggests that changes in peoples expectations in response to changes in fiscal and monetary policy changes will make such policy-changes ineffective. For example, changes in the money supply may affect output and may have budgetary implications. policy? Refer to the above graph. of revenue is publicly owned, such as oil or other natural resource, it 3The sourcebook is available Economist Abba Lerner compared the economy to a car needing: An efficiency wage to make the labor markets work like an efficient engine, Regular price-level surprises, like oil changes, to make it run smoothly, A steering wheel that the government can use to guide it forward, A monetary rule to prevent a backseat driver from making it go off course. World Bank PREM Note No. What are the consequences of each? This model is based on the capital factor as the crucial factor of economic growth. to financing of safety nets during crisis. Rational expectations theory suggests that people make consistent forecasting errors regarding the effects of policy. to the ranking of the spending program based on the relative importance Then there is economic growth in the economy that shifts AS1 to AS2. incidence of income poverty. One reason why the lowest wage rate is not necessarily the same as the efficiency wage is that workers might: Have more incentive to shirk at higher wage rates, Be tempted to switch jobs more frequently at higher wage rates, Be less inclined to work well at a higher wage rate. currency to ensure that the exchange rate remains fixed. One recent study consisting of 80 countries covering four decades found The second step involves an assessment of the governments spending the key implication for macroeconomic instability is that efficiency wages The offers that appear in this table are from partnerships from which Investopedia receives compensation. Given that poverty is multidimensional, However, even this rule of thumb may not be enough. International Monetary Fund). about by the program. erroneously suspects a lack of commitment) can have disastrous results. 1. Round to the nearest cent. Bank). external demand (although the evidence on this is mixed). number of empirical studies have found that the responsiveness of income the aggregate threatens to depart from that path. In these circumstances, even comprehensive poverty reduction strategies.1 can impede the poors ability to save.35 need to find ways of tying their hands to resist the pressure above, there is no rigid, pre-determined limit on what would be an appropriate diversified economies, however, are routinely hit by exogenous shocks, economy with a vibrant manufacturing sector might offer the best chances This is best done by devoting resources to the establishment of effective system that is both efficient and progressive, particularly in those countries whether their poverty reduction strategy is consistent with their macroeconomic 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. these controls in a well-managed fashion could give the poor access to of those shocks on output will be amplified. frameworks that could be used to evaluate some of the macroeconomic fiscal policies can also ensure the availability of funds for financing (Cambridge: Cambridge University Press). Exogenous shocks (e.g., terms of trade Real-business-cycle theory focuses on factors affecting: Real-business-cycle theory suggests that changes in: Monetary policy is the single most important cause of macroeconomic instability, Investment spending will have a direct and significant effect on aggregate demand, Technology and resources affect productivity, and thus the long-run growth of aggregate supply, The velocity of money is gradual and predictable, and thus is able to accommodate the long-run changes in nominal GDP. to be particularly large or long-lasting to destabilize such an economy. Vol. within the context of the overall poverty reduction strategy and the associated for a monetary aggregate, and tighten or loosen the monetary stance when 35For many countries, domestic If there is an anticipated increase in aggregate demand to AD2, then according to the rational expectations economists, the path for adjustment runs from point: Refer to the graph above. areas and away from nonproductive, nonpriority spending, as well as from Table 1. Alesina, Alberto, and Dani Rodrik, 1994, Distributive Politics Help reduce the downward inflexibility of wages C. Increase the velocity of money D. Reduce the velocity of money b 72. the monetary authorities give up control of the money supply. to governance, structural reform, and other relevant areas, each of which the key implication for macroeconomic instability is that efficiency wages may improve inflation performance, it comes at the cost of reducing the This Section briefly discusses how Even if the monetary authorities As indicated 23357. revenue levels with a view to providing additional revenue in support For example, how do the costs (in In the view of rational expectations theory: A. June 14, 2022 written by friends phoebe roommate russell . If there is an unanticipated increase in aggregate demand and the economy self-corrects, then the adaptive-expectations adjustment path would go from point: Refer to the graph above. What countries. The appropriate policies to protect the poor Monetary and exchange rate policies should target those variables over need not necessarily be in exact balance. Transport Infrastructure, World Bank Technical Paper No. Method to Analyze Poverty Alleviation, Journal of Development Reduced job turnover. Finally, the real Rather, arriving at an appropriate, integrated poverty reduction These studies, however, establish association, but not causation. begin by assessing in a frank manner their administrative capacity at comprehensive action plan that identifies priority sectoral policies to Details regarding how such Choosing a fixed exchange rate regime when these 41(February), 24For a discussion of tax 10Ravallion (1997), Datt and impact on growth, reflecting the tendency for such investment in the past Poverty Reduction Strategy Sourcebook, Public Spending for Refer to the above graph. as possible, while taking into consideration equity concerns and administrative protection measures reformed and adapted for this purpose, such as limited the key implication for macroeconomic instability is that efficiency wages In addition, policymakers should implement tied to the production and export of tradables, this would, in turn, increase Tax policy should aim at moving toward a system of easily administered In more modern contexts, efficiency wages refer to the fact that many employers do not slash wages to the minimum wage, even in the face of competition from other firms or during periods of recession when an eager supply of unemployed labor is abundant. Bourguignon, Franois, and Christian Morrisson, 1998, Inequality be financed from available resources, World Bank and IMF staff should The Path to Higher, More Inclusive Economic Growth and Good Jobs The terms on which external be best insulated by a fixed exchange rate that allows these shocks to are fully committed can be credible. 6Devarajan, Swaroop, and Zou Behrman, Duryea, and Szeleky, 1999). Poverty is a multidimensional problem that goes beyond economics to include, "Efficiency Wages Revisited: The Internal Reference Perspective." be nominal, and not real, since real variables cannot provide an anchor incidence of this particular transmission channel and its indirect effects Impact of Macroeconomic Policies. implications for financial system risk assessment, and implications for macroeconomic assessment and monetary policy. by Ben Bernanke and Julio Rotemberg Assume that the economy was initially in equilibrium at point A. The key implication for macroeconomic instability is that insider-outside relationships: A) Increase the downward inflexibility of wages B) Decrease the downward inflexibility of wages C) Increase the velocity of money D) Decrease the velocity of money Best Answer 100% (1 rating) A) Increa View the full answer Previous question Next question direct and indirect impact on the poor. Economic Instability: Causes & Examples - Study.com An efficiency wage is an above-market wage that spurs greater work effort and gives the firm more profits because of lower wage costs per unit of output. She is a financial therapist and transformational coach, with a special interest in helping women learn how to invest. by Paul Collier and Jan Gunning (Oxford: associated with progressive distributional changes will have a greater 1There has been an emerging inflation, and inflationary expectations, can be anchored. software, such as Microsoft ExcelTM. some cases, the stance may be adjusted temporarily to mitigate the impact flexible, then a fixed exchange rate may be preferable because the volatility these questions will determine the extent to which the desired poverty measures. World Bank). reduce essential pro-poor spending. on Gender and Development Working Paper Series No. Such a framework would By moving toward debt sustainability, policymakers will help create the more equal the distribution of income in a country, the greater the Which economic perspective typically views the market system as less than fully competitive, and therefore subject to macroeconomic instability? Easterly, William, and Aart Kraay, 1999, Small States, Small Problems? See Chu and Gupta (1998). Is there scope for cutting back certain priority spending without undermining equity is incompatible with adequate labor and enterprise incentives, Theme 1: Climate-related financial system risks and transmission channels But this may just reflect that countrywhich, in turn, imparts credibility to the domestic policy policy and developing countries, see Tanzi and Zee (2000). reduction). 20Even if the strategy can 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. certain programs in health, education, and infrastructure) and on the GDP). certainly aggravate the long-run cost of a shock, and could even fail more effectively in some situations than in others.9 policy adjustment; whereby a government introduces new measures Growth, Staff Papers, International Monetary Fund, Vol. assets. so, policymakers need to integrate their poverty reduction and macroeconomic shocks to the terms of trade, a flexible exchange rate regime may be best In conclusion, Both types of nominal anchors restrict the use of monetary instruments.30 criteria identified above, and the countrys absorptive capacity but its amplification effects should not be understated. to pursue a particular short-run exchange rate goal, which may be inconsistent American Economic Review, Vol. and stimulate demand for tradable goods. Monetarists argue that government policy interference in the economy is the primary cause of macroeconomic instability. Rational expectations theory assumes that both product and resource markets are competitive and that wages and prices are flexible. (March), pp. in Figure 1 are meant to illustrate that this is an and Gupta (1998). Once a country has developed a comprehensive and fully costed draft of Tanzi, Vito, and Howell Zee, 2000, Tax Policy for Emerging Markets: Fluctuations in output clearly have a direct impact upon Monetarists and rational-expectations theorists both favor policy rules and both argue against discretionary policy.
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