Chapter 7 Government and fiscal policy 1 a Suppose that the economy expands strongly due to a building boom. Demonstrate on both a government spending/tax diagram and on a fiscal stance diagram what could be expected to happen to the budget balance. b Suppose the government is pursuing a contractionary fiscal policy. Show how an increase in the actual fiscal deficit might arise. 2 In regard to government expenditure, what do the following terms mean? a exhaustive expenditure? b transfer expenditure? c financial expenditure? 3 Suppose that the government spends $10,000m on operating expenses, sells assets worth $2000m and has current revenue equal to $11,000m. During the year the state builds a new motorway valued at $3000m and lends $500m to students. At the end of the year the balance sheet shows: student loans = $2500m other state assets less depreciation = $45,000m and public debt = $50,000m. Determine: a the operating balance b net worth c the amount that the state had to borrow this year d the change in assets, debt and net worth. 4 Explain the difference between the: a the structural surplus, b the operating surplus, and c the OBERAC 5 Suppose that the government projects an increasing structural surplus over the next five years. If no other sectors change what is the likely impact on the economy? 6 a In the 1990s, the government financed some of the budget deficit by selling assets. What were some of the problems associated with asset sales? b In the early 2000s, the government generated budget surpluses and used some of this to acquire assets. What possible problems might be associated with increasing state assets such as student loans, investment in the New Zealand Superannuation fund, the new Kiwibank, and the purchase of 80% of Air New Zealand’s shares? 7 Suppose the government has a large operating surplus. What are its options? What are the advantages and disadvantages of each of these and what factors should be taken into account in deciding what to do? Chapter 8 Tax and distribution 1 Examine Table 2 - the sources of tax revenue in New Zealand. a What proportion of taxes are direct as opposed to indirect? How large is GST in total taxes? b What determines whether overall taxes are progressive? c What does an average family get for the taxes it pays? d Do you agree with the view held by some that taxes are robbery? e What factors would change the tax paid for low-income families? f What information would you need to assess whether an overall tax/GDP ratio of approximately 31% was appropriate? 2 There is often a fine line between a tax and a user charge or levy. Read the Rural News extract and answer the following questions: a. What are the grounds for charging exporters and importors directly for this new cost? b. How would this new levy be included in the government’s accounts? c. Thinking about incidence, who would bear the final cost of this new charge? 3. What are the criteria for a good tax system? Discuss why trade-offs may be needed. What other objectives, besides raising revenue, might governments hope to achieve by imposing a tax? 4 The government is anxious to raise some more revenue and has some propositions, each of which is designed to give the same revenue. Using the criteria of a good tax system, examine the case for: reintroducing death duties increasing the rate of GST to, say, 15% taxing gambling and alcohol raising the first statutory income tax rate to, say, 21% increasing the tax rate on high incomes to, say, 45% including the imputed rent on owner-occupied land taxing farmers on the emissions of their cows and sheep that contribute to global warming including imputed rent from home production such as gardening and home maintenance. 4 Why is it more difficult to introduce a Social Responsibility Act than an Act designed to produce a given rate of inflation or a specific notion of fiscal responsibility? 5 Students are generally on low incomes. Why is the government less likely to redistribute income to students than to the unemployed, the elderly or the sick? Why does the government loan money to students for their studies, but the private sector in general does not? 6 a Illustrate the difference between the Social Left and the New Right in their attitudes to desirable equality and redistribution. b What are the differences in the way they each would pursue the aim of more equality? c What are the efficiency and equity issues for students today? Chapter 9 The labour market and unemployment 1 What is used as the official unemployment rate and how accurate do you think it is in measuring the extent of the problem of unemployment in the economy? Refer text page 271 The official unemployment rate is the number of unemployed workers who are available for work and who have either actively looked for work in the last four weeks or have a new job to start within four weeks as derived from the Household Labour Force Survey (HLFS). The official rate may not accurately reflect the true extent of unemployment in the labour market because any people may be underemployed and yet counted as employed in the statistics because they are working some hours a week. The HLFS joblessness measure may provide a more complete picture of how far community employment aspirations are not being met. Typically then the joblessness rate is hence substantially higher than the official unemployment rate. Refer text pages 271-274. 2 a Define frictional, structural, and cyclical unemployment. Refer text pages 283–284. frictional: A level of unemployment which corresponds to the normal degree of turnover in the labour market, those in between jobs, and which reflects the ongoing relocation of resources that would be expected in a healthy, dynamic economy. structural: Unemployment that occurs because job seekers and available jobs are mismatched. The mismatch may be due to inappropriate workers’ skills and/or geographical location. cyclical: Unemployment that occurs when the output of goods and services falls below the level where all resources including labour are being fully utilised, i.e. it includes those people out of work due to insufficient aggregate demand (demand deficient unemployment because Y<Yf) and/or SAS shifts left (supply-side unemployment). 2b What does ‘full employment’ mean? Refer text page 270 Full employment does not mean everyone who wants to work is employed. It is sometimes called potential GDP and occurs when the only unemployment is frictional and structural. This unemployment rate may be called the natural rate of unemployment. The full employment level of income or potential GDP can also be defined to be where unemployment equals job vacancies (see pages 285- 287). 3 What reasons did Keynesians advance to explain the observation that labour markets in modern economies do not appear to clear at anything like full employment equilibrium? 4 a Use AD/AS diagrams to show how cyclical unemployment can be explained by: i The theory of supply side unemployment. Refers to real wage unemployment caused by nominal wages rising faster than productivity increases. (SAS moves left due to higher costs of production.) ii The theory of demand-deficient unemployment. Demand-deficient unemployment caused by insufficient aggregate demand. (AD moves out only slowly, or AD shifts in.) 4 b What policy would each theory suggest for reducing this unemployment? Real wage unemployment (supply side): Solution, competition in the labour market. This should reduce wage levels, thereby reducing costs to business and see a shift out of the SAS to SAS1 (see previous diagram). Demand-deficient unemployment: Solution, expansionary monetary and/or fiscal policies or wait for the market. AD shifts out to AD1 (see previous diagram). 4 c What happens to real wages in each case? Both adjustments result in a reduction in real wages (see text pages 292-294). Supply-side: The movement (SAS – SAS’) reverses the original cause of this type of unemployment, and is achieved by a reduction in nominal wages, hence real wages must fall (from their initial level). Demand-deficient: The increase in AD causes the price level to rise, hence if nominal wages remain fixed, real wages must fall. 5 What makes up the ‘natural rate’ of unemployment? Can this ‘natural rate’ be changed, and if so how? The natural rate is made up of structural and frictional unemployment. Investment in education oriented towards producing a working population with the capability and attitude to adjust to economic changes should reduce the long-term structural component, while new education/training initiatives for long-term unemployed (micro policy) should alleviate current levels of structural unemployment. While faster job search facilities and job placement services (micro policy) should alleviate any excessive duration of frictional unemployment. 6 What would the following tell you about trends in unemployment? a The number of vacancies exceeds the number of unemployed. The economy is at greater than full employment. There may be some frictional unemployment and some structural unemployment, but demand/supply conditions in the economy are more than adequate to eliminate cyclical unemployment. b The number of vacancies and the number of unemployed fall by the same amount. Employment has increased by the number of vacancies filled (equal to the fall in the number unemployed). There has been a decline in frictional or structural unemployment. c The number of vacancies equals the number of unemployed. The economy is at full employment. All unemployment is either frictional or structural; none is cyclical. d The number of unemployed exceeds the number of vacancies. There is some cyclical unemployment due to demand/supply conditions. Show how you would depict each of these situations in an Unemployment- Vacancy (U-V) diagram. 7 Concern is often raised about disproportionate rates of unemployment in particular sectors of society such as Maori, Pacific Islanders, young persons, the unskilled, and the disabled. Should we be concerned about such matters and what if any macroeconomic policies might have a beneficial effect on particular sectors of society? Treat as an essay type question. Consider such things as government spending, education, taxation and economic growth. It is difficult for macro policies (in terms of aggregates) to be beneficial to particular groups. It is hence necessary to somehow target specific policies to the relevant group, e.g. transfer payments, taxes, education initiatives, business development programmes, training programmes, etc. Note: This is not a problem that is unique to New Zealand. In the USA, the disproportionate numbers of unemployed appear among Blacks, Hispanics and Native Americans. 8 Define unemployment hysteresis and suggest what may account for such a phenomenon. Hysteresis is a phenomenon whereby markets, which are disturbed from equilibrium, may not return to the initial equilibrium when the conditions, which bought about the initial disturbance, are reversed, because of the changes that occur during the movement away from the initial equilibrium. For example, people who become unemployed during a lengthy recession may not regain employment during the following economic expansion if their work skills have deteriorated in the meantime. Hysteresis is a possible explanation for the long- term persistence of mass unemployment. 9 Discuss arguments for and against the view that there is not a trade-off between unemployment and inflation even in the short-run. See text pages 297-306 The arguments for the trade-off are encapsulated in the Phillips curve, based on the observational study by A.W. Phillips. The implication of this relationship was taken to be that governments could manipulate monetary and fiscal policy to achieve whichever combination of unemployment and inflation on the Phillips curve they preferred. The relationship began to breakdown in the 1970s and 1980s leading to considerable modification of the trade-off incorporating research on the ‘natural rate of unemployment’ and ‘adaptive expectations’. Although this did add further dimensions to the model evidence in more recent decades does not support the hypothesis of a trade-off, which is further undermined by the behaviour of business cycles. What views of the trade-off are reflected in current policy approaches in New Zealand? See text pages 297-306. The 1990s saw greater emphasis on labour market flexibility, only limited active labour market policies, limited demand management policies, limited incomes policies, and possible supply-side effects through research and development (R&D) tax policies. In relation to the trade-off between inflation and unemployment this suggests that the costs in terms of higher inflation of pursuing lower unemployment through expansion of aggregate demand were seen as unacceptable, and/or a belief that the economy’s ‘self-correcting mechanism’ could be relied upon to keep unemployment at or close to its ‘natural rate’. 10 Explain what is meant by labour market flexibility and why it is considered important? Flexibility in the labour market is typically associated with greater labour mobility in the economy. Labour mobility is the ability of labour to move freely in response to market signals provided (chiefly) by wages. If there is a high degree of labour mobility in the economy adjustment may take place primarily though through movement of labour between the expanding and declining sectors without significant change in wages. Immobility may be geographical, structural or occupational. Mobility of labour can be enhanced by measures which encourage relocation of workers and retraining in skills needed in the expanding industries. Chapter 10 The balance of payments, the exchange rate, and the economy 1 How would each of the following be shown in the New Zealand balance of payments? a You spend the August vacation travelling in Australia. Invisible payment (import of services) – current account. b Your uncle in England sent you $500 as a present. Invisible receipt (transfer) – current account. c You bought a new German car. (Merchandise) imports – current account. d You bought shares in the Australian stock market. Capital payment – capital account. 2 Identify and discuss the economic arguments relevant to the question as to whether, and to what extent, New Zealand’s current account deficit should be a matter of concern to policymakers. What are the policy options available if a government decides that action must be taken to curb or reduce the current account deficit? What are the advantages and disadvantages of each option you have identified? Arguments for lack of concern A current account deficit can be viewed as a the result of a collective decision by the community to take advantage of the availability of overseas capital in order to enjoy access to a higher level of resources today, accepting that the need to service the resulting debt will involve a corresponding reduction in the level of resources available in the future – this may, however, be offset by the increased availability of resources resulting from the growth of the economy, allowing the debt to be serviced without any reduction in the standard of living. The current account deficit must be financed by a capital account inflow. The deficit is sustainable as long as foreigners are willing to provide this capital inflow. Under a floating exchange rate, if foreigners become less willing to provide the capital inflow, this will lead to a fall in the value of the New Zealand dollar, discouraging imports and encouraging exports, so that the current account balance improves to match the reduced inflow of capital. Thus the situation is likely to be self-correcting. The financing of continual large current account deficits is reflected in the growing accumulation of overseas debt. However, as long as this debt is being incurred by the private sector, it can be assumed that the costs and risks have been fully evaluated by both borrowers and lenders. The private sector is not likely to incur debt which cannot be serviced. Arguments for being concerned If the deficit is reflecting increased levels of consumption rather than investment, there may not be an increase in productive capacity sufficient to ensure that the resulting debt can be serviced without any reduction in the standard of living. The increased consumption may be enjoyed by today’s generation, but the costs in terms of reduced future consumption may be borne by future generations. At some point, foreigners are likely to become concerned about the sustainability of the deficit and the associated level of overseas debt. Experience shows that the adjustment to a reduction in capital inflows associated with a loss of foreign investor confidence in the economy may be far from smooth. The change in sentiment and corresponding change in capital inflows may be large and sudden, forcing in turn a large and painful adjustment on the domestic economy. Experience also shows that private borrowers and lenders are not always prudent in limiting the amount of debt which is incurred. This was clearly illustrated in the East Asian economic crisis of 1997–98. High levels of overseas debt may be sustainable today but they also increase the vulnerability of the economy to negative external shocks in the future. Ways of reducing the deficit Reduce imports by increasing tariffs. This can have an immediate apparent effect, but true effect may be much less as exports may be also adversely affected, offsetting the reduction in imports. Increasing tariffs involves giving up some of the gains for trade, increasing the level of inefficiency in the economy, and reducing the total potential output of the economy. It may also violate international trade agreements and provoke costly retaliation by trading partners. • Promote exports. Exports subsidies are prohibited by international trade agreements. Furthermore, they effectively involve a subsidy to overseas customers by domestic taxpayers, and experience in New Zealand and elsewhere has shown that they are readily open to abuse. Some encouragement to exports may be provided by trade promotion activities, export-related training programmes, investment in export-related infrastructure, etc. • Lower the exchange rate. Advantage is that this is an ‘across-the-board’ measure which does not discriminate for or against any particular sector, thus it does not encourage economic inefficiency. Disadvantage is that it creates increased inflationary pressures via higher import costs. Long-term impact on both growth and the current account deficit should be positive however. This is difficult to do as a conscious act of government policy in New Zealand where the exchange rate is freely floating and where monetary policy (which could affect the exchange rate via interest rate changes) has been entrusted to a politically independent Reserve Bank with the requirement that it pursue the single goal of maintaining price stability. This situation could be changed by changing the Policy Targets Agreement or the Reserve Bank Act, but this might undermine confidence in the economy both domestically and overseas. Meantime, recent experience has shown that falls in the exchange rate may have less serious consequences for inflation than was previously believed, thus the Reserve Bank could arguably take a more permissive approach to such exchange rate changes. Trigger a recession in the economy (e.g. slash government spending or increase taxes). This will reduce the demand for imports. This involves policy instruments fully under the government control but it may be a very costly approach and politically is likely to be highly unpopular. Increase national savings. This attacks a fundamental cause of the current account deficit, i.e. the nation’s propensity to spend more than it earns. It could be achieved by increasing public savings (i.e. increasing the government’s budget surplus or reducing its deficit). It is difficult to be sure that the increased public savings will not be offset by reduced private savings, however. Another danger is that it might have similar results to the previous suggestion. Could also be attacked by finding ways to encourage increased private savings (without any offsetting reduction in public saving), however it has been difficult to find any reliable way of doing this. In essence, there are no easy answers! 3 Suppose a government wishes to reduce the level of overseas claims on the economy. Suggestions are made that restrictions might be applied to foreign direct investment and other capital inflows in pursuit of this objective. How might these restrictions be applied in practice, and what are the arguments for and against using such restrictions for the purpose indicated? What alternative policies could you suggest? Discuss why your alternatives might or might not be a better approach to achieve the stated policy objective. Government could change the restrictions governing foreign direct investment, making investment approvals more difficult to obtain. By limiting the availability of new capital to the economy, economic development will be slowed. The stricter control will inevitably discriminate between different types of new investment, increasing the likelihood that capital will be allocated inefficiently. This may be at the cost of violating various international agreements. To restrict other types of capital flows, such as portfolio investment and international borrowings, the government could impose foreign exchange controls, making all foreign exchange transactions subject to approval and prohibiting some or all capital account transactions. Such controls are always costly and cumbersome to administer, and typically give rise to abuse, corruption and increased political lobbying, especially if some capital transactions are allowed while others are prohibited – this also inevitably leads to inefficient allocation of resources. Imposition of exchange controls is likely to lead to a loss of foreign confidence in the economy, and may violate some international agreements. Governments sometimes seek to deter unwanted capital inflows by imposing a special tax on short-term capital inflows. This can discourage capital from flowing in but cannot prevent it from flowing out once it is there. The purpose of these measures is usually to forestall unwanted exchange rate appreciation rather than limit the size of foreign claims on the economy. The more general argument against capital controls is that they are not an efficient way of attacking the fundamental cause of increasing overseas claims on the economy, which is overspending relative to overseas earnings at the national level (or put another way, inadequate domestic savings). This ‘overspending’ results in a current account deficit, which must be financed by capital inflows of some kind. In these circumstances, restricting capital flows while continuing to leave current account transactions unrestricted hardly seems logical. If current account transactions are uncontrolled while capital flows are restricted, there will be an imbalance in the foreign exchange market (supply of NZ$ will exceed demand for NZ$), leading to an exchange rate depreciation until current account transactions come into balance (or match the permitted rate of capital inflow). Thus the imposition of exchange controls will force an adjustment in the domestic economy, but it is a very inefficient way of doing so, and the adjustment is likely to be unnecessarily sharp and painful. In order to reduce the level of overseas claims on the economy, it is necessary to run a sustained surplus on the current account of the balance of payments (see pages 321–325). Ways of improving the current account balance are canvassed in the notes on Question 2 above. The preferred way of achieving this would be through an exchange rate adjustment (if this can be managed within the policy framework), or through measures designed to increase national savings. 4 Using first AD/AS, then the market for the NZ dollar, show the impact of a a favourable terms of trade shock arising from an increase in the world price for dairy products, and AD/AS – outward shift of the AD curve caused by rising exports, adjusted by some inward shift of AD curve (effect of exchange rate appreciation on net exports) and outward shift of SAS (effect of exchange rate appreciation on price of imported inputs). In terms of the market for NZ dollar – outward shift of D curve (increased export receipts), could be partially offset by outward shift of S curve (imports increase as domestic incomes increase). The net result is an exchange rate appreciation. b an unfavourable trade shock arising from a rise in world oil prices. AD/AS – inward shift of SAS curve caused by rising cost of imported inputs, reinforced by further inward shift as falling exchange rate further increases these costs. The AD curve movement results from net result of inward shift (higher payments for oil imports) and outward shift (impact of exchange rate depreciation on net exports). 5 Define the real exchange rate. Explain the effect of a depreciation in the $NZ (ceteris paribus) on the real exchange rate. The real exchange rate is the nominal exchange rate (the $NZ) corrected for differences in relative prices between New Zealand and its trading partners. Changes in the real exchange rate reflect changes in the nominal exchange rate adjusted for differences in inflation between New Zealand and its trading partners. A depreciation of the $NZ will cause the real exchange rate to fall (provided the depreciation is not negated by larger rise in relative inflation). a Explain how this change in the real exchange rate affects New Zealand’s international competitiveness. Demonstrate the effect on net exports using appropriate diagrams. A decrease in the real exchange rate means an increase in international competitiveness. New Zealand exports in foreign markets fall in price compared with their foreign competition, therefore the export function shifts up. Imports in the domestic market increase in price compared with their New Zealand competition, therefore the import function rotates downwards (see Fig. 15.18). b Using an AD/AS diagram, demonstrate the likely effect of a depreciation in the $NZ on the domestic economy. The fall in the exchange rate means that net exports rise, so the AD curve shifts out. The fall in the $NZ causes the price of imported materials to rise, so the SAS curve shifts in. P rises, Y rises. (A rise in Y is most likely, and appears to be the New Zealand experience. However, it is possible that the effect of a higher SAS curve could outweigh the effect of the higher AD and result in a fall in Y.) See Fig. 15.21. 6 What is the importance of international competitiveness to an economy like New Zealand? With whom is New Zealand competing? Is it simply a matter of price? In the short term, New Zealand exporters are competing to sell a relatively fixed range of products in international markets. The ability to sell these products (or the attractiveness of doing so) is affected by changes in the real exchange rate (international competitiveness). For example, if costs rise in New Zealand (i.e. international competitiveness declines), it will become more difficult and/or less attractive to sell in overseas markets. The exporters’ competitive position can be restored by a fall in the exchange rate which offsets the rising costs. In the longer term, New Zealand’s ability to derive maximum benefit from international trade depends on productivity growth, which is based on factors like the level and quality of investment, capacity for innovation, skills development, etc. These factors determine changes in New Zealand’s comparative advantage and the range of products which New Zealand can expect to successfully sell in world markets, where prices can be taken as essentially fixed. Countries with high productivity are generally able to export products which yield a higher return to their domestic producers and are associated with a higher standard of living. The ability to successfully export these products also depends on factors such as the efficiency of the economic infrastructure (related to level and quality of investment), attention to quality control (related to skills development). 7 Why might some of New Zealand’s export industries be slow to respond to the stimulus of an exchange rate depreciation or devaluation? 8 Assume a floating exchange rate regime and government implementing a contractionary monetary policy to restrain inflation. What are the likely effects on: a interest rates Ceteris paribus a contractionary monetary policy will shift MS inward and result in a rise in interest rates. b capital movements Rising New Zealand interest rates will increase any favourable interest rate differential, or reduce any unfavourable interest rate differential with overseas financial markets, resulting in an increased willingness by foreign investors to hold their funds in New Zealand dollars. This will cause an increase in the demand for NZ dollars (i.e. D$NZ shifts outwards) while New Zealand investors will be less inclined to invest their funds offshore, so that the supply curve for NZ dollars shifts inwards. c exchange rate The overall result will be a rise in the equilibrium value of the NZ dollar, i.e. an appreciation of the NZ dollar. d international competitiveness The rise in the nominal exchange rate acts to reduce international competitiveness. At the same time, there may be some offsetting effect as the tighter monetary policy leads to some reduction in inflation in New Zealand. The overall effect is likely to be a rise in the real exchange rate and a fall in international competitiveness. e current account balance An appreciation of the $NZ resulting in a rise in the real exchange rate will worsen the current account balance by discouraging exports and encouraging imports. f national income? See Fig. 15.22. National income will fall (unless the outward shift of theSAS curve is so great as to fully offset the inward shift of AD). 9. Would New Zealand benefit from adopting the Australian currency? Does your answer change depending on whether you are an importer or an exporter? 10 In late 2003, the $NZ dollar was rising strongly and there were calls for the government to ‘do something’. What is the impact of an appreciating exchange rate? What options are available to the government in the event that it decides to ‘do something’? Chapter 11 International Trade, growth and globalisation 1 a Use the production possibility frontier and terms of trade line to illustrate the ‘gains from trade’. b What would change in your illustration if the domestic economy were to experience a decline in its terms of trade? 2 a Suppose that a country produces lamb and oil at a point on the PPF where the opportunity cost of having another unit of lamb is the sacrifice of three units of oil. If the terms of trade are two units of oil for one unit of lamb , show on a diagram what the country should do. b Now explain what should happen if the terms of trade (international price of lamb in terms of oil) doubles. 3 What types of policies might be implemented to boost labour productivity? Why is productivity so important to the New Zealand economy? 4 Explain the difference between endogenous and exogenous growth models. 5 Which is more important to sustainable growth in New Zealand, capital or labour? 6 What are the typical objections to globalisation? Some reasons to fear globalisation Producers must adapt to more intense international competition and faster technological changes – some individuals and groups may be left behind. More economic power concentrated in the hands of multinational corporations – may be feared if their objectives and activities are regarded with suspicion. Excessive depletion of natural resources and increased environmental damage in the absence of effective environmental and resource management policies. Domination of media by alien (American?) culture and values; homogenisation of cultures and values? Governments less able to pursue independent economic and social policies (this fear may be exaggerated – see some of the comments in Box 2.7). Downward pressure on wages for unskilled work (evidence inconclusive – see Box 2.7). Some comments on opponents of globalisation and third-world workers There is a powerful coalition of interests in some developed countries, especially the United States, which seeks to restrict as far as possible the competition from developing countries. This competition is faced by their own industries employing largely unskilled labour (which can of course be hired at much lower cost in third-world countries). These objectives are sometimes pursued by seeking to require developing countries to apply developed country labour and environmental standards, in the knowledge that this will greatly reduce or even eliminate the ability of third-world producers to compete in developed country markets. If successfully applied, these policies would certainly place limitations on third-world countries’ ability to expand their economies, raise living standards, and provide job opportunities for their workers. Other strategies used to exclude third-world imports are quotas, safeguard actions and anti-dumping actions. Developed countries’ tariffs also tend to be higher (sometimes much higher) on products exported by third-world countries. There are also NGOs and other groups concerned for the welfare of third- world workers and communities, who believe that trade policy measures should be used to persuade or force third-world countries to improve working and environmental conditions. Some points to consider: Accepting that improvements in labour and environmental standards in third-world countries are desirable, what are the potential contributions of: – international environmental agreements and international labour standards agreed in the ILO? – sanctions or prohibitions imposed by developed countries? – higher incomes in developing countries (leading to demands from communities for higher standards and increased capacity of governments to supply them)? If developed countries ban or restrict imports from third-world countries of goods deemed to have been produced under unacceptable labour and environmental conditions, to what extent is this likely to: – cause third-world countries to change their production methods to meet the required standards? – force third-world producers to cut production and lay off workers (due to inability to be competitive if the higher standards are applied)? If workers in third-world export industries are laid off, what realistic alternative avenues are available to them to improve the living standards of themselves and their families? What is the impact on the economy and how will this affect the ability to achieve higher standards? Would third-world workers be better off if their governments adopted economic strategies based less on international trade and more on self- sufficiency? How do these issues relate to the analysis of the gains from trade and the theory of comparative advantage presented in Chapter 2? Who decides which standards are to be applied? Is it appropriate to require ‘first-world’ standards in ‘third-world’ countries? Chapter 12 Further thinking in macroeconomics: the IS/LM model and schools of economic thought 1 Use the concept of the 4 interacting macro markets to show what happens in each of the other three markets when there is a disturbance in a. The market for money because there is a tightening of monetary policy b. The goods market that comes from an increase in spending on retail goods c. The foreign exchange market that sees an increased demand for NZ dollar financial investments d. The labour market from an increased supply due to immigration 2 Use the IS/LM framework developed in this chapter to analyse the effect of loosening (expansionary) monetary policy in both the closed and open economy cases. Are there any differences in the outcome? 3 Explain what is meant by ‘perfect capital mobility’. Is this a reasonable assumption to make in the IS/LM open economy model? What would be the implications for the model if this assumption did not hold? 4 A country reduces its inflation rate from 18% to 3% over a five-year period. Unemployment rises from 4% to 7%, and the annual rate of growth increases from 2.5% to 3%. Can you conclude that the country is better off? 5 What are some of the costs of unemployment for people in the 2000s? 6 Is inflation currently a threat in New Zealand? If so, what kind of costs are feared? 7 In her book False Economy Anne Else writes: ‘Without families and communities, the economy means nothing. It has no life of its own. Its only purpose is to enable us to live, to care for one another and to raise our children to take our place. If we lose the power to do that, no matter how fast GDP rises or how much the budget surplus grows we will have no future worth working for.’ Distinguish between the objectives of government’s policy and the ultimate goals of economic policy and purpose of the economy.