Macroeconomic Policies in Advanced Economies — Negative Interest Rates, Minimum Wage, Government Spending and Automatic Stabilisers
Answers
(a)(i) Nominal growth and nominal GDP, 2014–2016 [2] — describe
The nominal rate of growth fell (from 4.4% to 2.7%), but nominal GDP rose over 2014–2016 — growth remained positive throughout, so the level continued to increase, only at a slowing pace.
(a)(ii) Real GDP growth in 2018 [1] — calculate
Real growth ≈ nominal growth − inflation = 5.2% − 2.4% = 2.8%.
(b)(i) Negative interest rates and the circular flow [4] — explain
A negative interest rate affects two key sectors of the circular flow of income: households and firms. For households, the purchasing power of savings erodes over time, lowering the opportunity cost of current consumption; households consume more, so consumption flowing to firms (their revenue) rises. For firms, cheaper finance raises willingness to take on risk — investing in R&D and equipment — so investment, an injection, rises and flows into the firms sector. Both raise spending in the circular flow.
(b)(ii) What reduces its effectiveness [2] — explain
A negative income effect (Extract 6): conservative households, seeing their savings eroded, may save more to restore their target future consumption, rather than spend. If negative rates are expected to persist, consumption may stay low now and in future, offsetting the intended boost.
(c) Rising minimum wage and unemployment [3] — explain
A minimum wage is a price floor set above the equilibrium wage in the labour market. At that wage, the quantity of labour supplied exceeds the quantity demanded — a surplus of labour, i.e. real-wage unemployment. Raising the minimum wage further widens the gap between quantity supplied and quantity demanded, increasing the surplus and worsening unemployment.
(d) Does increased government spending affect AD differently in the US and South Korea? [8] — discuss
An increase in government expenditure (G) raises aggregate demand, and via the multiplier the eventual rise in AD exceeds the initial injection. The size of the multiplier differs between the two economies. From Table 2, South Korea is far more open (imports 37% of GDP vs 15% for the US), so its marginal propensity to import — a leakage — is larger, giving it a smaller multiplier; the US, with a large domestic consumption share (69%) and smaller import leakage, has a larger multiplier. So a given rise in G raises AD by more in the US than in South Korea.
A counter-consideration is the constraint on the initial injection. From Table 3, US public debt is 105% of GDP versus South Korea’s 40%. Heavy US borrowing to fund higher G risks crowding out: rising interest rates deter private C and I, partly offsetting the rise in AD — a larger risk for the US. South Korea, with fiscal space, can sustain the stimulus more readily.
Judgement. The net effect depends on which force dominates: the US enjoys the larger multiplier but faces greater crowding-out risk and debt constraint; South Korea has a smaller multiplier but more fiscal room. The most important consideration is the size of the spending relative to each government’s fiscal capacity and the state of private confidence — so increased G is likely to raise AD more reliably in South Korea despite its smaller multiplier, while in the US the multiplier advantage is tempered by crowding out.
(e) Automatic stabilisers versus discretionary fiscal policy in recession [10] — discuss
Automatic stabilisers — progressive taxes and unemployment benefits — act counter-cyclically without deliberate action: in a recession, falling incomes cut tax payments and raise benefit payments, automatically supporting aggregate demand and cushioning the downturn.
Case for automatic stabilisers. Their key virtue is timing. A typical advanced-economy recession lasts about a year, but discretionary fiscal policy “takes months just to be enacted” (Extract 8) and is delayed further where there is no political consensus on what to spend on (the US, Germany). Automatic stabilisers act immediately and require no decision; Europe’s higher social insurance and taxation make its stabilisers correspondingly stronger and its counter-cyclical effect more powerful.
Case for discretionary fiscal policy. Discretionary policy — deliberate changes in G and taxes — can be targeted at high-return education and infrastructure projects that raise both AD now and productive capacity later (potential growth), which automatic stabilisers cannot do. In small economies with broad social consensus (Denmark), it can also be implemented quickly. Automatic stabilisers, moreover, carry negative incentive effects — the higher taxes and benefits that power them can blunt work and investment incentives.
Judgement. Desirability depends on the nature of the economy and the recession. For a short, typical recession where speed is paramount, automatic stabilisers are more desirable — they act without the implementation lag that cripples discretionary policy, especially in politically divided economies. But for a deep or prolonged recession, or where an economy has a backlog of high-return projects, discretionary fiscal policy is the better complement because it can raise long-run capacity. The strongest position is that the two are complements rather than substitutes: automatic stabilisers provide the immediate cushion, while well-chosen discretionary spending addresses the deeper, structural recovery — with the optimal mix set by the country’s fiscal space, political consensus and the depth of the downturn.