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MACRO POLICY IN THE WORLD WITH PERFECT CAPITAL MOBILITY

Macro Policy in the world Perfect Capital Mobility

To try to avoid major economic shocks, such as The Great Depression, governments make adjustments through policy changes they hope will stabilize the economy. Governments believe the success of these adjustments is necessary to maintain stability and continue growth. This economic management is achieved through two types of governmental strategies: -Monetary policy -Fiscal Policy

Macro Policy

Monetary policy

Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in order to avoid the resulting distortions and deterioration of asset values.

Fiscal Policy

fiscal policy is the use of government revenue collection (taxation) and expenditure (spending) to influence the economy. The two main instruments of fiscal policy are government taxation and changes in the level and composition of taxation and government spending can affect the following variables in the economy. Aggregate demand and the level of economic activity. The distribution of income. The pattern of resource allocation within the government sector and relative to the private sector.

Stances of fiscal policy The three main stances of fiscal policy are: Neutral fiscal policy is usually undertaken when an economy is in equilibrium. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity. Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually undertaken during recessions. Contractionary fiscal policy occurs when government spending is lower than tax revenue, and is usually undertaken to pay down

Perfect Capital Mobility


Eg: For better understanding, the following things to be known: Define hot money Determine what causes capital flow Understand what is the balance of payment and why it moves towards being equal to zero Assess effectiveness of monetary and fiscal policies in economies with flexible/fixed exchange rate policies with perfect capital mobility

Hot money is a term that is most commonly used in financial markets to refer to the flow of funds (or capital) from one country to another in order to earn a short-term profit on interest rate differences and/or anticipated exchange rate shifts. These speculative capital flows are called "hot money" because they can move very quickly in and out of markets, potentially leading to market instability. Capital flow : the movement of investment capital from one country to another for bigger returns The variable factors are : 1) Interest Rate (major focus) 2) Exchange rate

Balance of Payment = Current A/c + Capital A/c Current A/c = (Exports Imports ) Capital A/c = Money that flows in and out of the country BOP = 0 .?? For Perfect Capital Mobility Eg: Imports (-5bn) Burrows (+5bn) ( high interest rates, selling their bonds) Initially : Capital A/c use to be 0 coz of no capital mobility Today : Capital inflows & outflows do exists

Macro Policy

Fiscal

Monetary

Fixed Exchange Rate (Contacrtionary)

Flexible Exchange Rate (Expansionary)

Fixed Exchange Rate (Expansionary)

Flexible Exchange Rate (Contacrtionary)