Lecture 7

Government Macroeconomic Policy

What is macroeconomics?
• Macroeconomics
analyzes all aggregate
indicators and the
microeconomic factors
that influence the
economy. Government
and corporations use
macroeconomic models
to help in formulating
of economic policies
and strategies.
Main aims of Government Economic
Policy
• Stable prices (low inflation)
• Steady and sustained economic growth
• Low unemployment or full employment
• A balanced balance of payments
• Equitable distribution of income
Policy Instrument for macroeconomics
• Monetary policy- interest rate and money supply
• Fiscal Policy-government expenditure and taxation
• Supply-side policy- increase production, direct impact to aggregate
supply
 NATIONAL ECONOMIC GOALS
Policy Targets Policy Policy Goals
Instruments

• Money supply • Monetary • Stable prices

• Aggregate Policy • High
demand • Fiscal Policy employment
• Exchange rate • Supply side • Sustained
• Real GDP Policy growth
growth • Exchange • Rising living
• Budget deficit control standard
• Reduction in
poverty
• Higher
productivity
Focus of macroeconomic policy:
• Inflation rate
• Because maintaining a stable economic environment is crucial for markets to
operate effectively.
• Control the inflation rate +- 2% and focus on monetary policy.
• Unemployment
• Utilization of resource (labours). High unemployment = inefficiency.
• Economic growth
• Based on GDP
Monetary system
• Set of mechanisms by which a government provides money (cash) in a
country's economy. It usually consists of a mint, central bank, and
commercial banks.
Function of money
• Medium of exchange.
• Money's most important function is as a medium of exchange to facilitate
transactions.
• Without money, all transactions would have to be conducted by barter, which
involves direct exchange of one good or service for another.
• The difficulty with a barter system is that in order to obtain a particular good
or service from a supplier, one has to possess a good or service of equal value,
which the supplier also desires.
• Money effectively eliminates the double coincidence of wants problem by
serving as a medium of exchange that is accepted in all transactions, by all
parties, regardless of whether they desire each others' goods and services.
Function of money
• Store of value.
• In order to be a medium of exchange, money must hold its value over time; that is, it
must be a store of value.
• If money could not be stored for some period of time and still remain valuable in
exchange, it would not solve the double coincidence of wants problem and therefore
would not be adopted as a medium of exchange.
• As a store of value, money is not unique; many other stores of value exist, such as
land, works of art, and even baseball cards and stamps.
• Money may not even be the best store of value because it depreciates with inflation.
• However, money is more liquid than most other stores of value because as a medium
of exchange, it is readily accepted everywhere. Furthermore, money is an easily
transported store of value that is available in a number of convenient denominations.
Function of money
• Unit of account.
• Money also functions as a unit of account, providing a common
measure of the value of goods and services being exchanged.
Knowing the value or price of a good, in terms of money, enables both
the supplier and the purchaser of the good to make decisions about
how much of the good to supply and how much of the good to
purchase.
 Types of Money
• Depend on the degree of liquidity
• M1, M2 and M3
M1 – narrow money
Types of Money
Highly liquid, direct and
immediately spendable
M2 – current money
• Currency + checkable
bank deposits
• Currency – includes notes
and coins in circulations
(cash in hands)
• Checkable deposits –
current account balance in
commercial banks
M2 – current money M3 – broad money
M1 + near money. Near money
M2 (M1 + near monies)
Longer term time deposits
includes short-term deposits in
banks (short notice account) it
serve store of value.
• M1 (currency + checkable
deposits)
• Short term time deposits
(saving and fixed deposits)
in commercial banks
• Negotiable certificate of
deposits (overdraft)
• Repurchase agreement
• Foreign currency deposits
• Bank Negara certificates
other deposits
The Central Bank & Money Supply
• What are the roles of C.B?
• Responsible for monetary policy
• Regulating financial markets
• Issuing currency
• Monitoring the operations of banks- ensuring
performance
• Setting statutory reserve requirement (SRR) for
merchant banks
• Holding reserves
• Serving as banker to government
• Financial advisor to government
• Controlling money supply
• Control inflation
Why Central Bank need to control money
supply?
• Amount of money can affect :-
• Inflation
• unemployment
• economic growth
• Interest rates
• Exchange rates
• Balance of payments
• Too much money = inflationary, too little money = restrict trades and development
• Too much money with least production can create inflation - producer unable to
cater/serve the rapid increment of demands.
• CB play an important role to control the amount of money supplied.