Unit 2

Macroeconomic performance and policy

1. Economic growth
Economic growth has two meanings. They are;

• Actual Growth

• Potential Growth
Actual growth

Increase in the real GDP of a country over a period of time is the actual growth. This is the growth which ca
n be measured by using the concept called GDP.

Actual growth can be calculated as follow

Real GDP

2009 $1400M

2010 $1500M

Potential growth

Increase in the potential output level or expansion of the productive capacity is the potential growth.

Actual growth can be shown by shifting the Aggregate demand curve to the right and potential growth can
be shown by shifting the long run aggregate supply to right.

Difference between nominal GDP and real GDP

The value of the GDP under the current market prices is the nominal GDP. (Inflationary effects are include
d)

If the nominal figures are used to calculate the economic growth, people will be misled. The value of the G
DP at constant prices is the real GDP.

It means the GDP value without Inflationary effects is the real GDP. This should be used to calculate the ec
onomic growth.

GDP AT MARKET PRICE AND BASIC PRICE

NET NATIONAL INCOME AT MARKET PRICe

TRANDFER PAYMENTS

Even the economic growth is shown as 20% under nominal figures economic growth becomes 0% under re
al GDP figures.

Per capita GDP (Per capita income)

This means the income per head.

GNP (Gross National Production) and GDP (Gross Domestic Production)

Value of the total value added produced by firms in a country during a period of one year is GDP

It can also indicate as the value of final goods produced in a country during a period of one year.

IF the value of all the goods and services produced in a country during a period of one year is taken for GD
P, double counting errors or multiple counting errors will occur.
Therefore value added method is normally used

The value of the output produced by one country's owned factors of production during a period of one yea
r is called GNP.

Wherever the output is produced by using the one country's owned resources, they will be taken for GNP.

GDP and GNP are national income measures.

Business cycle or economic cycle

This is the phenomenon which shows how the real GDP of a country moves around its underlining trend.

The trend rate represents the potential growth rate. when the actual growth rate is below the potential gr
owth it's the negative output gap. Another way of defining the negative output gap will be that actual outp
ut level is less than the potential output level.

In this case unemployment will rise while deflation takes place. (Average price level falling)

When the actual growth rate is greater than the potential growth rate, it's the positive output gap. In this c
ase, inflation of the country increases.

Limitations of using GDP to compare living standards between countries and overtime

Material wellbeing of people or the quality of the life spent by people is the living standard. When the GDP
is used to measure the living standards, there are more drawbacks of it.

1. Income inequalities of the countries are not shown by GDP figures.(By GDP per capita)
Even the per capita incom of a country increases; it doesn't mean that everyone receives a high income, b
ecause inequalities are not shown by GDP concept called per capita income.

2. Changes in population are not shown by GDP figures.

The idea given by GDP figures about the living standards will not be clear since the population Changes are
not shown between countries.

3. GDP will be a narrow concept to measure living standards.

GDP concept will indicate only the increase of the income level of people. It will not be enough to measure
the living standards because qualitative aspects such as education, health, facilities, access to pure drinking
water and new technology and leisure time spend by people should also be taken to measure the living sta
ndard.

4. Living standards of the less developed countries will be underestimated when GDP figures of such
countries are converted in to US $ for the international comparison of living standard.

This problem occurs since the currency of LDCs is really lower compared to US dollars.

Living standards is 17 times greater in USA than SL

However, this underestimation of the living standards of LDC can be reduced when purchasing power parit
y exchange rate is used without using nominal exchange rate.

The exchange rate which is calculated by considering the purchasing power of a country's currency is the p
urchasing power parity exchange rate.

The gap of living standard of USA and SL is shown to be low now it is only six times.

Inflation
Price stability or controling inflation is also an important macroeconomic objective such as the economic gr
owth.

Inflation, Deflation, Disinflation

Persistent rise in the general price level is called the inflation.

Fall in the average price level over a period of time is called deflation.

Fall in the inflation rate in the country over period of time is called disinflation.

Price stability is one macroeconomic objective. This does not mean that average price level of the country s
hould continuously fall.

This implies a situation where inflation rate is controlled.

There's an inflation target in the UK, which is 2% measured by CPI, this should be achived by the monetary
policy committee of bank of England.

The permitted range of increase of average price level set by the monetary policy committee and measure
d by using CPI.

The process of calculating CPI (Consumer Price Index)

Consumer Price index is used at present in UK to measure the inflation of the country. This index is also use
d in many other European countries.

This is calculated as follows;

A basket of goods and services of 650 items should be selected and family expenditure survey should be do
ne by interviewing 7000 households .it should be done to identify expenditure patterns. Price level changes
are identified from randomly selected shops throughout country and finally by giving weighted values to e
ach items of the basket of good s and services. Data is compiled to an index number considering 1996 as th
e base year. Base year value is always 100.

Causes of inflations

Three reasons affect to inflation

1. Demand pull inflation

This means rising AD leads to inflation

Increase in AD caused by increase in consumption level, investment, government spending and net exp
orts will lead to demand pull inflation.

AD=C+I+G+NX

2. Cost push inflation

Increasing cost faced by firms in economy will create cost push inflation.

Following reasons will affect this;

Increase in the wage cost of firms, rise in oil prices, rise in price of raw materials, depreciating of the ex
change rate, rising indirect taxes.
3. Money supply inflation
This means the inflation caused by increase in the money stock of the economy when new money is pri
nted and more loans are issued, this inflation will take place.

Effects of inflation

1. The purchasing power of disposable income will fall with inflation, so the living standard of people will
fall.

2. The international competitiveness of the country will fall with inflation, because exports will be
expensive, therefore exports revenue to the country will fall at the same time imports will appear
cheaper in the domestic market affecting to worsen the current balance of the balance of payments.

3. Investment level in the economy will fall, since their decision making will be distorted as the price
signals will not be effective with the inflation. Furthermore investors make decisions by considering
money based information. As the money value fall with inflation it will be difficult for investors to make
accurate decisions. the confidence with them regarding the economy will fall reducing the investment
level.

4. Income distribution of the country will be uneven with the inflation because some parties such as
savers, fixed income earners may suffer with the inflation while variable income earners will be
benefitted with inflation as they can increase their incomes with inflation.
Employment and unemployment
Reducing the unemployment is also a macroeconomic objective.

Measures of unemployment

ILO unemployment measure

ILO Unemployment Measure

ILO-International labor organization

Proportion of the workforce those who are willing to work, able to work and waiting for jobs but haven't g
ot a chance yet to work are considered to be unemployed people under ILO definition.

They should be out of work in last four weeks and ready to work in next two weeks.

Age group is from 16 to 65

The interviews, surveys by phone calls are normally used to identify unemployed people; this is the intern
ationally recognized measure.

Causes of unemployment
 1. Mismatch of skills.(occupation immobility)
2. Geographical immobility
3. Lower demand(Demand deficiency)
4. Higher wage rates caused by minimum wages or trade union activities
Effects of unemployment

1. resources of the economy will be wasted

2. poverty will increase
3. Government budget deficit will increase(Government finance will be weaker)
Government spending will rise since welfare payments such as JSA have to be increased and tax revenue f
alls if the direct and indirect tax revenues fall.

4. Crimes in the society will increase, family breakups may occur(social effects)
Underemployment

The situation where people are employed but in occupations which do not deserve to their qualifications
and skills

Significance of migration for employment and unemployment

Net migration = Immigration-emigration

When net migration becomes positive it will lead to increase both employment and unemployment levels.

When Highly Skilled immigrants are available in a country employment level will increase since they may h
ave definite jobs

Positive net migration in the country will help to increase the labor supply in the country and wage rate wi
ll fall in the economy.

The way of rising unemployment with positive migrations;

1. All the immigrants will not be highly skilled therefore when unskilled immigrants try to be
employed they may not be able to find jobs easily, so unemployment rate will rise.

2. When immigrants are ready to be employed for low wages, local citizens of the country may lose
their jobs raising unemployment.

Stability of the current account of the BOP

Balance of payment

The record which shows all transactions done by a country with the rest of the world over a pdriod of time
is called the balance of payments.

There are two main account of this;

1. Current accounts and capital and financial account

Stability of the current account of the BOP
Stability of the current A/C of the BOP is an important thing for a country so it is identified as a macroecon
omic objective

Current A/C of the BOP

The addition of the balance of trade in goods and services, the balance of investment income flows and bal
ance of the current transfers is the current account balance of the BOP.

Balance of trade in goods and services

The difference between visible and invisible exports and imports.

Deficit and surplus of the current account of the BOP

The balance of the trade of goods and services plus the balance of the investment income flows and the ba
lance of the current transfers is the balance of the current ac of the BOP. When the balance of the current
a/c is positive it is the surplus of the current a/c of the BOP.

When the balance of the current a/c is negative it's the deficit of the current a/c of the BOP.

The four elements of the current a/c are;

1. trading goods
2. trading services
3. investment income
 4. transfers
When there is a deficit of the current a/c of the BOP for a long time period, it is identified as a BOP proble
m. It will lead to run down the domestic assets while external debts of the country increase. The value of th
e local currency will also depreciate significantly due to the deficit of the current a/c of the BOP, so measur
es should be taken by the government to avoid long term deficit of the current a/c of the BOP.

The circular flow of income

The model which shows the flows of goods and services between households and firms and their correspo
nding payments in money terms is the circular flow of income.

Injections and withdrawals

Injections are the inflows to the circular flow of income. These will lead to create expansionary effects. The
se injections are investments, government spending and exports (I, G, X)

Withdrawals are leakages or outflows from the circular flow of income. These will lead to create contractio
nary effects in the economy. These withdrawals are saving, tax and imports. (S, T, M)

Income and wealth

Income is a flow of money which is received from different ways such as rent, wages, interest, profit, self e
mployment income ETC…

Wealth is a stock of assets which have a money value. Wealth can also be indicated as the accumulation of
past incomes. There is a positive relationship between income and wealth.

Aggregated Demand

Total demand in the country is identified as aggregate demand. It contains four components. They are;

1. Consumption (C)
2. Investment (I)
3. Government Expenditure (G)
4. Net Exports (NX)
Shape of the Aggregated Demand Curve
AD curve slopes downwards from left to right.

There will be a movement along the AD curve when the aggregate supply curve shifts to right or left sides a
nd there will be a movement of the AD when the components of aggregate demand change. (C, I G, NX)

Consumption

This is the largest component of AD. The expenditure made by households for consumption purpose is iden
tified under consumption.

About 65% in UK’s AD is contributed by consumption.

Factors influencing the the consumption in an economy

1. Disposable income
2. Interest rates
3. Consumer confidence
4. Social safety nets (welfare benefits given by the government)
5. Availability of credit
6. Wealth effect

1. YD = Y – (income tax +national insurance contribution)

2. Higher the interest rate lower the consumption
Lower the interest rate higher the consumption
6. Wealth effect

Change in AD due to the changes in assets prices is the wealth effect.

When the assets owned by households (Shares, gold, houses, land) increase they will tend to spend more for consum
ption as they feel that they are richer, so consumption will increase and AD will rise and wise versa.

Marginal propensity to consume and marginal propensity to save

Additional consumption made from the additional income or the extra consumption which is made when the income
level increases by $1 or E1 is called MPC.
Additional saving made from additional income is MPS or this is the extra saving made when the income level increas
es by $1 or E1

MPC and MPS value will also be in between zeros and one and addition of these will be equal to one in a simple econ
omy

There is an inverse relationship between consumption and savings.

As the consumption rises savings will fall and wise versa.

Investment

The increase in the capital stock of the country is called investment. This can also be indicated as producing or purch
asing of capital goods.

Factors influencing on investment

1. Interest rates – interest rates is identified as the cost of investment. Higher the interest rate lowers
investment. Lower the interest rate higher investment.

2. Confidence levels of investors – higher the confidence when there is an economic boom, lower the
confidence when there is an economic recession.

3. Rate of economic growth

4. Tax on company profit
5. Availability of credit
Government policy to promote investment
Tax relief
Subsidies
Reduction on the rate of corporate tax

Government expenditure

Factors influencing government expenditure

1. Fiscal policy used by the government – When the fiscal policy is implemented through large budget
deficit,government expenditure will rise and when the fiscal policy is implemented through a budget surplus
or by reducing the deficit,spending will fall.

2. Economic cycle - When the economy is in a boom, government spending will fall, when the economy is in a
recession government spending will rise.

3. Correction of market failure

4. Political priorities
Net Exports
The increase of net exports will lead to increase AD demand and wise versa. Exports means the demand for local goo
ds and services from foreigners and imports mean the demand for foreign goods and services from locals.

The impact in the net trade balance of cchanges in

The real income

The exchange rate

The state of the global economy

The degree of protectionism

Non price factors

Marginal propensity to imports

Additional imports made from additional income or the extra imports made when the income levels rises by $1 or E1

Aggregate Supply

Total supply in the economy is called aggregate supply. AS curve is upward sloping.

There will be movement along the AS curve when there is a shift in the AD curve and there will be a shift of the AS cu
rve due to the factors such as changing the stock of resources in the economy, changing in productivity, changing cos
t faced by firms etc…

It is considered that AS curve in a short run will be upwards sloping so AS curve will be relatively price elastic in the sh
ort run because an economy will not be able to achieve the potential output level in the short run.

But when the long run is achived AS curve is becoming inelastic and it becomes vertical in the long run because poten
tial output in the economy will be achieved in the long run so the economy will not be able to produce beyond that o
utput level even if the price level is rising
Short run and long run AS curves

Following factors will affect to shift the SRAS curve to the left or right;

1. Changing the cost of raw materials and energy

2. Exchange rates – When the value of the country’s currency depreciates, imported raw material and oil will be
expensive affecting to shift the short run AS curve to the left

3. Tax rates (Indirect taxes) – Higher the indirect taxes – SRAS curve will shift to the left
Factors affecting to shift LRAS curve

LRAS curve shows the potential output level of the economy so LRAS curve shift to the right indicating that the poten
tial output level in the country is rising.

This situation is similar as shifting the PPC to the right.

Following factors will affect the LRAS to the left/right

1. Technological advances
2. Changes of the productivity of economy
3. Education, skill changes
4. Changes in regulations
5. Changes in direct taxes
6. Demographic changes and migration – For instance increase in more women in the labor force and having
positive net migration will lead to increase the potential output level in the country, so LRAS curve will shift to
right

7. Competition policy of the government – If the competition is promoted in the economy productivity will rise
affecting to increase LRAS.
Equilibrium level of real output

Equilibrium level of real output is achieved when the economy is operating where AD = AS. At this equilibrium level, f
ollowing conditions are satisfied.

Causes of changing the equilibrium real output

As a result of shift in the AD or AS curve, the equilibrium real output in the economy will change. This will be sometim
es affected by changing of both curves at the same time. It cannot be guaranteed that the equilibrium output level b
e at the full employment level in the economy it may settle even below that as shown in the following diagram.

The Multiplier

Multiplier is the ratio which shows the relationship between equilibrium level of national income and the autonomou
s variables of the AD

This indicates that the changes of variables such as investments, government spending, exports, autonomous consu
mption will lead to a more than proportionate change in AD, then the equilibrium national income will change by sev
eral times like the change in the autonomous variable of AD

Example: - If it is assumed that government spending increases by $500 million and MPC is 0.75 then the multiplier ef
fects will take place as follows in the economy

There will be positive or negative multiplier effects according to the changes of the variable of AD. Until there are mu
ltiplier effects, AD curve will Shift to left or right.
There will be multiplier effects until the additional income fully leaks away from the system. Having multiplier effects
in the economy will not be suitable to the economy, when the economy is closer to the full employment (In this case
rising AD will lead to create higher inflationary effects while there will not be a significant increase in the real output
level.

Economic growth
Causes of growth

1. Causes of actual growth

Increase in the real GDP in the economy over a period of time is the actual growth. This will be caused by increase in
consumption, investment, government expenditure and net exports.

2. Causes of potential growth

Increase in the potential output level or expansion of the productive capacity of the economy. This will be caused by
increase in investment, innovations, growth in size of labor force, increase in the competition of the economy. All th
ese factors will affect to the shift the LRAS curve to the right, so potential growth will be achieved in long run

Constrains on growth

1. Less avaiailability and the quality of factors of production

2. Inadequacy of capital markets. E.g. underdeveloped share markets
3. Instability of the government (political issues)
4. Inadequate infrastructure (No sufficient electricity, Airports)
5. Absence of property right
6. Inappropriate regulations
Benefits of growth

There will be benefits of economic growth to various parties such as for citizens, firms and the government.
To citizens

Increase in the standard of living with the increase in employment level, because higher income generated from bein
g employed will make it possible for people to access to good education, healthcare facilities while the leisure time o
f people will also increase since higher income can be earned by working less no of hours than earlier.

To Firms

Increase in profits, this will occur since the revenue of firms increases as the spending of people increases with the hi
gher income followed by economic growth

To Government

Increase in tax revenue, both direct and indirect tax revenues will increase.

Cost of growth

1. Environmental damages will increase

2. Balance of payment problems will take place since current A/C of the BOP leads to a deficit with raising
import level

3. Income inequalities in the country will increase

4. Higher inflationary pressure will be created
Output Gap
The difference between actual growth rate and long term trends in growth is the output gap. This is also indicated as
the difference between actual output level and the potential output level. When the actual growth rate is greater th
an the long term trend in growth, it’s the positive output gap or when the actual output level is greater than the pot
ential output level.

The possible effects in this case will be inflationary effects in the economy. When the actual growth rate is less than t
he long term trend in growth, it’s the negative output gap. Unemployment is the possible result in this case. This can
also be indicated as a situation where actual output level is less than the potential output level.

Economic recession

When the real GDP of the country falls for two or more consecutive quarters, it’s the economic recession. It means h
aving a negative economic growth for more than two consecutive quarters.

Characteristics of recession

1. Rising level of unemployment

2. Having a deflation in the economy
3. Bankruptcies of business
4. Falling investor confidence
5. Raising government expenditure and creating a higher budget deficit. fall in tax revenue will also affect to
increase the budget deficit
Macroeconomic objectives
There are goals which are expected to be achieved by all governments in the world.

They are such as; Increase in economic growth

Control inflation
Reducing unemployment
Stabilise current account of BOP
Protecting the environment
Redistribution of income (Reducing income inequalities)

Conflicts between objectives

It is difficult to achieve all macroeconomic objectives at once by the government because achieving one objective ma
y conflict with another objective. It means there are conflicts between objectives.

They are as follows;

1. Inflation and unemployment

When measures are taken to reduce inflation, unemployment will increase and taking measures to reduce unemploy
ment will lead to higher inflation. This conflict is explained by bill Phillips using the Phillips curve. (Short run Phillips c
urve)

Bill Phillips has noticed a relationship between money wages and unemployment. Higher money wages implies that t
here’s a higher demand for workers in the labor market so unemployment will lower since more workers are deman
ded by firms. Higher money wages may have to be passed on consumers in the form of higher prices and the inflatio
n takes place so this link between money wages and unemployment rapidly generalize into a link between unemploy
ment and inflation.

However there are some situations where unemployment and inflation both are high. This situation is called Stagflati
on. This kind of a situation may take place when the government spends more for less productive projects such as all
ocating more money for winning elections.

2. Economic growth and environmental protection

When there is a higher economic growth environmental damage will occur in different ways. For instance; the car o
wnership will increase and no of air travel will also be high with the rising of income of people with economic growt
h.

Therefore CO2 emission will be higher contributing to a higher environmental damage so environment protection tar
get cannot be achieved and taking more measures to protect the environment may lead to limit the economic growt
h.
However economic growth may not lead to higher environment damage if sustainable growth is highly considered by
the government. It means promoting economic growth under the minimum damage to environment. Recycling of n
on renewable resources, promoting eco friendly tourism and considering the depletion rate of non renewable resour
ces will be measures taken for sustainable growth.

3. Inflation and current A/C of BOP

When the interest rate is increased to reduce the inflation that measures will affect to worsen the current A/C balan
ce of BOP, because when the interest rate is high, exchange rate will appreciate which will lead to make exports dear
er and imports cheaper. Therefore current A/C balance of BOP will worsen.

Macroeconomic policy instruments

Demand side policies

These are the policies which are manipulated to change AD in the economy for achieving macroeconomic objectives
E.g. Fiscal policy and monetary policy

The policy which is manipulated by changing taxations and government spending and burrowing (gov) to achieve eco
nomic activities is the fiscal policy. The policy which is manipulated by changing interest rate and money supply to inf
luence the economic activities is the monetary policy.

Reflationary and deflationary policies. (expansionary/contractionary)

Reflationary policies are those policies which are used to stimulate demand in the economy E.g. Expansionary fiscal p
olicy and loose monetary policy

Deflationary policies are those policies which are used to reduce the demand in the economy E.g. Contractionary fis
cal policy and tight monetary policy

Monetary policy instruments

These are the instruments or tools which are used to manipulate the monetary policy

1. Interest rates
 2. Asset purchases to increase money supply (quantitative easing) when the central bank of the country want to
increase the money supply in the economy (Stock of money circulating in the economy) Central bank will
purchase the treasury bills and treasury bonds (Government financial certificates) from commercial banks.
Then the commercial bank’s cash reserves increases and the ability of lending will increase. so asset purchase
is a monetary policy instruments used to increase money supply.

3. Reserve ratio is a legal requirement for all commercial banks to deposit a proportion the total deposits of
commercial banks in the central bank.
Central bank of the country can change this reserve ratio. If it wants to reduce inflation, then reserve ratio will increa
se then commercial banks will have to deposit a higher proportion in the central bank and abilities of giving loans will
fall so money supply in the country will fall and the inflation will fall.

Transmission mechanism of the monetary policy

The channel through which interest rate changes feed through to the economy is the transmission mechanism of mo
netary policy. An interest offered by the central bank to the commercial bank deposits maintained at central bank. T
his interest rate is called official rate or bank rate.

Change in the official rate will affect the economy to control inflation as follows;

Interest rate changes affect to the economy through this transmission mechanism. It takes a period of 18 to 24 mon
ths for interest ratechanges to influence the economy.

Fiscal policy instruments

These are the instruments or tools which are used to manipulate the fiscal policy. They are such as E.g. government s
pending and taxation

Using diagrams to show the effects of demand side policies

1. Increase in economic growth and reducing unemployment. AD will have to be increased to achieve these
 2. Reduce inflation, stabilize current A/C to BOP

Supply side policies

These are the policies which are manipulated to increase the potential output level or expand the productive capacit
y of the economy.

These policies are two types;

1. Free market measures

2. Interventionist measures

1. Free market measures

Under these measures government intervention is going to be reduced to the operation of the markets.

1. Deregulation of product and labour markets.

2. Privatization
3. Reduction in taxation
4. Completion policy
5. Benefit reformes.
Privatization will lead to increase the competition in the market so economic efficiency will increase and potential ou
tput level will increase. When direct taxes are reduced incentive to work and invest will increase due to lower tax bu
rden therefore potential output level will rise

Competition policy will be effective to prevent monopolies and to promote competition in the markets so eventually
potential output level will rise. When unemployment benefits and such welfare payments are reduced, more people
will tend to supply labor affecting to increase potential output level in the country

2. Interventionist measures
These are the supply side measures which takes place with government intervention
 1. Subsidies to education, training and investment
2. Infrastructure investment
3. Finance for business startups
4. Regional policies
Strengths and weaknesses of demand and supply side policies

Fiscal policy

This policy will be effective to achieve macroeconomic objectives in a short period because demand side policies will
be effective within a short period and this policy will also have supply side effects in the long run.

For instance if government expenditure is increased on education and training, demand in the country will be stimul
ated in the short run and the potential output level will be increased in the long run since a productive work force wil
l be created by education and training.

However fiscal policy may lead to create more problems to the economy because government will use the fiscal polic
y to win election by increasing the government spending especially. Therefore budget deficit will increase significantl
y.

Higher government expenditure levels which are allocated by governments ineffectively will lead to create higher infl
ationary effects in the economy. As well as government debt will rise with the accumulation of past borrowings of th
e government therefore future generation will also suffer.

The crowding out effect will also take place when there is a budget deficit. The government will try to finance the bu
dget deficit from bank loans, therefore funds available for private sector investments will fall and upward pressure o
n the interest rate will also be created due to the higher demand for loans so the private sector investors will discour
age to invest.

This process is called crowding out of private sector activities by the public sector. The effect is also identified as a co
nflict between fiscal policy and monetary policy. Having a higher budget deficit will also make the fiscal policy indisci
pline. Ability of reducing the national debts in the future will also be difficult when there is a continuous higher budg
et deficit.

Monetary policy

Advantages

1. Inflation in the economy can be controlled

In the UK monetary policy is implemented with the aim of controlling the inflation
 2. This policy has effects on both AD and AS so can have short term and long term effects
3. The implications of changes in the interest rates are clear to understand
Disadvantages

1. It can take up to two years for effects of interest rate changes to fully affect the economy of a country
2. The policy will also not be effective if there are significant external shocks to the economy E.g. rise in oil price
3. Just because the central bank changes the base rate, it does not mean that interest rates changes for
everyone in the economy because banking system may not follow the interest rate change rapidly.

4. We can’t calculate the exact effect of rising interest rate. data is incomplete and uncertain
Supply side

These policies will be affective to achieve economic growth without having inflationary effects in the economy howe
ver there are many drawbacks

There is an opportunity cost of spending on education and training. Government might not be in a best position to d
etermine which skill s will be needed in the future

Labor market flexibilities are not necessarily desirable for the point of view of workers because it makes it easier to l
ose jobs and increases competition for jobs which can cause insecurity and reduce worker motivation and labor prod
uctivity

Reducing access to unemployment benefits may encourage people into work but this might involve sacrificing the sa
fety net upon which many rely. It means welfare of society will fall.

All supply side policies will be effective only in the long run

Expected targets will not be achieved within a short period of time

Supply side measures will also lead to conflict with the fiscal policy and lead to a higher budget deficit and then lead
to make the fiscal policy indiscipline