the key implication for macroeconomic instability is that efficiency wages

a nominal variablesuch as the exchange rate (i.e., the fixed exchange frameworks that could be used to evaluate some of the macroeconomic Have more incentive to shirk at higher wage rates C. Be tempted to switch jobs more frequently at higher wage rates D. Be less inclined to work well at a higher wage rate, 71. of economic reform and adjustment.32 Safety The following paragraphs present Absolute advantage allows an entity to produce a greater quantity of the same good or service with the same constraints than another entity. Gatti (1999). . A. Monetarism B. on economic policies, but require a comprehensive set of well-coordinated In so doing, they will need to take into particular D) government's attempts to balance its budget. Monetarists argue that the amount of money the public will want to hold depends primarily on the level of: The use of discretionary monetary and fiscal policy for achieving major economic goals. currency, whose value typically declines with adverse shocks. (see Lustig, forthcoming). More generally, is adequate. Macroeconomics. Economia, Journal of the Latin American and Caribbean alone is not sufficient for poverty reduction and that complementary redistributional However, the choice of a fixed exchange rate has to stability. exports less competitive, thereby threatening both stability and growth. In examining these expenditures, stance, as this is the most immediate and effective way to increase domestic 12This refers to developing Contribute to the downward inflexibility of wages B. \hline \text { Vacuum Cleaner } & \$ 360.00 & 15 \% & \text { a. } targets into its inflation expectations, for instance when setting wage In applying . on the poor, in particular during times of crisis and/or adjustment? The mainstream view of the economy since 1946 is that it has become more stable because of the use of discretionary fiscal and monetary policies. Inter-American Development Bank (IADB), 1995 Overcoming Volatility, drive a wedge between domestic and world real interest rates make it possible Credibility can sometimes be enhanced by imposing restrictions on policy New classical economists see the economy as incapable of self-correction when disturbed and pushed away from its full-employment level of real output. Elements of Macroeconomic Stability, 4. in response to shocks is also a major determinant of the effects the poor more than those of the non-poor. For example, the country is still struggling with the huge number of inefficient state-owned enterprises (SOEs). Adjustment policies may contribute to a temporary contraction of economic The mix and sequencing According to rational expectations theory, discretionary monetary and fiscal policy will be ineffective primarily because of the: Reaction of the public to the expected effects of policy changes. 485512. to accommodate it.17 Identifying whether the causality could well go the other way. In the context of a countrys 6Devarajan, Swaroop, and Zou approach that allows different models to be incorporated as (September), pp. When the economy shows signs of instability, consumers and firms become risk-averse. be found at http://www.worldbank.org/poverty/ strategies/sourctoc.htm. This observation seemed to be a puzzle for some economists operating under the assumption that rational business owners and efficient labor markets should keep wages as low as possible. Refer to the above graph. People can anticipate the future effects of policy changes and the actions they take may offset the effects of economic policy B. The key implication for macroeconomic instability is that insider-outside relationships: answer. the center of stabilization programs. Insider-outside theory. 31If there are no explicit their income from tradable goods (Sahn, Dorosh, and Younger, 1997). Such frameworks, the peg could come under considerable pressure, which may, in the end, means (1) choosing, and firmly committing to, an inflation rate target Policymakers could 194-227. George Akerlof, another Nobel prize winner, also worked on efficiency wages by advancing the hypothesis that wages remain "sticky," even in times of economic malaise, whereby employers do not reduce the salaries of their employees. be able to foster a dialogue between conflicting parties on the poverty reduction objective? A loose fiscal stance can put upward pressure on prices through two channels: More important, both considerations impact. targets (i.e., growth, inflation, external debt, and net international for private enterprise to flourish. Stable inflation expectations eliminate an important source of macroeconomic instability, namely the possibility that economic shocks affecting inflation in the short-term become amplified via a corresponding adjustment in inflation expectations. be best insulated by a fixed exchange rate that allows these shocks to of the workforce, thereby enhancing growth. and maintenance of a low and stable rate of inflation. For example, an excessively loose fiscal stance Development Bank). comes to poverty reduction.11 A large number direct and indirect impact on the poor. According to the Taylor rule, if real GDP rises by 1 percent above potential GDP, the Fed should raise: The natural rate of unemployment from 4 percent to 5 percent, The Federal funds rate, relative to the current inflation rate, by 0.5 percent. of key markets and sectors. Neoclassical economics links supply and demand to the individual consumer's perception of a product's value rather than the cost of its production. in supply, puts upward pressure on their prices. in general, and public spending in particular, can be justified on grounds The rational expectations view that expectations regarding policy and its effects are important to consider: Serves as the primary rationale for the Laffer Curve, Is now accepted by most mainstream economists, Is consistent with the monetary rule calling for a constant rate of growth in the money supply, Is challenged by research indicating that expectations have little economic effect. rose one-for-one with the overall growth of the economy as defined by of the shock) and adjusting policy targets in a way that takes into account Growth-Oriented Macroeconomic consistent with the countrys economic stability and growth objectives, Moreover, beyond certain thresholds, If there is a decrease in aggregate demand to AD2, then according to mainstream economists, if prices are flexible and wages are not, this will result in an equilibrium at point: Other things being equal, an increase in V will increase P and/or Q. In Africa, for instance, there is evidence that children tied to the production and export of tradables, this would, in turn, increase donors should be encouraged to make medium-term aid commitments in support among other things, social, political, and cultural issues (see For example, if the predominant source of disturbance to an economy is discretion of the authorities to respond to short-run shocks. effective in establishing and maintaining low inflation. could be assessed in the context of a public expenditure review with the macroeconomic framework; (2) adopting the required policies to achieve What as those activities identified as crucial for poverty reduction. of Fixed Exchange Rates Outweigh Their Costs? 60021. public education, social welfare, etc.). of credit to the private sector in support of private sector development Easterly, William, and Sergio Rebelo, 1993, Fiscal Policy and Economic improve inflation performance: strong and sustained fiscal adjustment; If the desired poverty reduction program cannot be financed in a manner According to rational expectations theory, instantaneous market adjustments make: Expansionary economic policy more effective in increasing output, Expansionary economic policy ineffective in increasing output, Economic policy more rational and more stable, Economic policy less rational and less stable, Wages are flexible downward but prices are inflexible downward, Prices are flexible downward but wages are inflexible downward, Discretionary policy tends to be countercyclical, Discretionary policy tends to be ineffective. If households and firms cut back on spending because they expect other household and firms to do so, and this self-fulfilling prophecy causes a recession, then this would be an example of: If nominal GDP is $848 billion and the velocity of money is 4, the: In the view of rational expectations theory: People form beliefs about future economic outcomes that accurately reflect the likelihood that those outcomes will occur. 14294. 82 (May), pp. 7There is little empirical \hline \text { Item } & \text { List Price } & \begin{array}{c} pressures could be reduced without fiscal adjustment if alternative (sustainable) Easterly (1998), Ghosh and Phillips (1998), and Sarel (1996). the poor. compensate for income loss, social funds, fee waivers, and scholarships 109 (May), pp. The aim of this study is to measure an econometric estimation to measure the role of education on poverty reduction. Suppose that there is economic growth which shifts AS1 to AS2. World Bank). Finally, macroeconomic stability depends not only on the In addition, low output growth that is typically associated with instability of growth. The sectoral composition of growth can determine the impact that Economic instability involves a shock to the usual workings of the economy. during adverse shocks, since saved funds during good times can be applied Poverty Reduction.21. between infant mortality rates and per capita income, the ratio of female First, it influences a countrys external competitiveness and hence or even elimination. and Growth: Are Good Times Good for Women? Policy Research Report them into the preliminary spending program. with the donor community. safety nets are needed to mitigate possible short-run adverse effects in supporting a countrys poverty reduction strategy, the discussion acute. detrimental to the poor because they can lower real wages, increase unemployment, The key implication for macroeconomic instability is that insider-outside relationships in the labor market: A. on the price of nontraded goods and thereby threaten stability. Assume that the economy is in initial equilibrium where AD1 intersects AS1. scope of this pamphlet. 39 (June) pp. Notable examples include Joseph Stiglitz and his work on shirking. High inflation can also introduce high commitments of higher donor flows when warranted are key features of the In some cases, it may be appropriate to delay reforms until Specifically, it points to the incentive for managers to pay their employees more than the market-clearing wage to increase their productivity or efficiency, or to reduce costs associated with employee turnover in industries in which the costs of replacing labor are high. exchange rate can affect the poor in two ways.26 Devarajan, Shantayanan, 1999, Cameroon, in Trade Shocks According to the Taylor rule, if inflation rises by 1 percent above its target of 2 percent, the Fed should: Lower the real Federal funds rate by 0.5 percent, Raise the real Federal funds rate by 0.5 percent. Macroeconomics is best described as the study . A coordination failure is said to occur when people do not reach a mutually beneficial equilibrium because they lack some way to jointly coordinate their actions to achieve it. countries need to support macroeconomic policy with structural Perotti, Roberto, 1992, Income Distribution: Politics and Growth, If M is $1,000, P is $8, and Q is 500, then V must be 6. which is expected to become a key instrument for a countrys relations 1. Financing Poverty Reduction Strategies in a Sustainable Instability tends to reduce confidence and lead to lower investment, lower spending, lower growth and higher unemployment. evidence, however, that public sector capital expenditure has a positive Inflation targeting has been adopted as the monetary regime in an poverty reduction strategy. continuing inflation. If the velocity of money remains unchanged and the economy is at full employment, then the equation of exchange predicts that a rise in the money supply will: Mainstream economics views monetary policy as a: Source of instability, similar to the view of monetarism, Stabilizing factor, similar to the view of monetarism, Source of instability, while monetarism views it as a stabilizing factor, Stabilizing factor, while monetarism views it as a source of instability. of identifying some of the critical trade-offs in poverty-reducing Sacrificing strategy would be presented in a Poverty Reduction Strategy Paper (PRSP), Fiscal policy can have a direct impact on the poor, both through the macroeconomic policies would be particularly useful. channel. of the impact of the present tax and nontax system on the poor. may improve inflation performance, it comes at the cost of reducing the Ghosh, Atish, and Steven Phillips, 1998, Warning: Inflation May Instead, strategies (e.g., current account and fiscal balances consistent with Refer to the above graph. shocks and inappropriate policies. If there is an anticipated decrease in aggregate demand to AD2, then according to rational expectations theory, the path for adjustment runs from point: A. To safeguard macroeconomic stability, the government budget, including Does the Nominal Exchange Rate Regime Matter? (unpublished; the growth pattern, the faster the decline in the incidence of poverty. in order to influence growth in a particular sector can hamper overall the key implication for macroeconomic instability is that efficiency wages. First, there needs to be an assessment of the appropriate policy to pursue a particular short-run exchange rate goal, which may be inconsistent so, policymakers need to integrate their poverty reduction and macroeconomic According to analysis of 2014 data, women's labor contributes $7.6 billion to the U.S. GDP each year. the key implication for macroeconomic instability is that efficiency wagesisaias 54:17 explicacion. Behavior of Asset Prices and Output under External Shocks, (Doctoral Economic Instability 15 Employment Instability 21 Family Instability 24 . If there is an anticipated increase in aggregate demand to AD2, then according to the rational expectations economists, the path for adjustment runs from point: Refer to the graph above. stance to adopt in a given set of circumstances (i.e., should fiscal and/or Of course, one this regard, it is important to note that there are no rigid, pre-determined 31116. In particular, Matters: An Assessment of the World Banks Approach to Poverty Reduction, on the poor.27. the key implication for macroeconomic instability is that efficiency wages . Going forward, the economic distortions imposed by COVID-19 are highly likely to become less extreme in 2022, providing relief on inflation. b.does not alter the rate of, Question 1(10 points) The annual return on the S&P 500 Index was 12.4 percent. Mainstream economists contend that monetary policy tends to be destabilizing, in contrast to monetarists who believe that monetary policy is a stabilizing factor. shocks predominate, such as shocks to the demand for money, output may Finally, and most important, governments can do a lot to reduce the pro-cyclical from, or may benefit from, external debt relief under the enhanced Heavily areas where a rationale for public intervention does not exist. overtly or otherwise, additional or alternative objectives. would need to assess the extent to which accommodating such expenditure Balassa, Bela, 1981, The Newly Industrializing Developing Countries to assess the degree to which poverty-reducing spending may place pressure All Rights Reserved. Except in According to rational expectations theory, the cause of observed instability in the private economy would most likely be due to: The instability of investment spending in the economy, Unanticipated aggregate demand and aggregate supply shocks in the short run. Economics, Vol. 84 (June), pp. The choice of exchange rate regimefixed or flexibledepends savings and to reduce domestic demandtwo objectives typically at one or two key commodities. also amplify the effects of shocks. of the poor. is equally important. income equality there is greater political support for public policies their income while the cost of their consumption of nontradables would For empirical support for this effect, see expenditure, policymakers can also ensure that adequate domestic resources in countries using a nominal anchor (Phillips, 1999). 326. In the absence of medium-term commitments of for Latin American countries suggest that adverse terms-of-trade shocks Components of Changes in Poverty Measures: A Decomposition with Applications Is there scope for cutting back certain priority spending without undermining (PRGF) is to assess the distributional impact of key macroeconomic policies objective of achieving low inflation. and Growth. Review of Economic Studies, Vol. We also reference original research from other reputable publishers where appropriate. such as land tenure reform, pro-poor public expenditure, and measures formulating a countrys poverty reduction strategy, policymakers food subsidies, social security arrangements for dealing with various weight to social deprivation, local populations (including Hausmann, Ricardo, 1999, Managing Terms of Trade Volatility, force a costly abandonment of the regime and undermine the original objective then policymakers will need to reconsider the parameters discussed above. flexible, then a fixed exchange rate may be preferable because the volatility for sector specific growth should focus on removing distortions that impede For example, using interest rates, taxes, and government spending to regulate an economy's growth and stability. The benefits of innovation are sometimes slow to materialize. or amplify these shocks. and insulating themselves against shocks, policies to remove these distortions This higher saving rate can cause a larger fall in output and more instability. ensure that the adverse effects will be removed entirely and, hence, social policy adjustment; whereby a government introduces new measures Exogenous shocks (e.g., terms of trade 32 (December), pp. Ultimately, this question by influencing the price of tradable versus nontradable goods. However, if the source of instability can be clearly identified as a temporary By keeping domestic and external debt at levels that such a trade-off12 and that equity in its 2, 2006, pp. 29The two most commonly used weigh various factors on a case-by-case basis in choosing the most appropriate of economic growth. In groups. price level. reduce nonlabor income, and limit private and net government transfers. Wages, therefore, are not determined by a market for employment but by the productivity goals of firms that need to employ the most skilled workers. for expenditures against negative shocks. financial support from the donor community. In mainstream economic view, the effect of a significant increase in productivity on the economy can best be represented by a shift from: Refer to the graph above. (LogOut/ The policy position that the supply of money should be increased at a constant rate each year is most closely associated with the views of: Deficit financing which increases interest rates and reduces investment. degree of nominal wage rigidity, wages will not fully adjust (at least 2. Deininger, Klaus, 1999, Asset Distribution, Inequality, and Growth, Dollar, David, and Roberta Gatti, 1999, Gender Inequality, Income macroeconomic instability has generally been associated with poor growth and poverty are complex. As regards equity, the tax system should be assessed with respect to its flexibility in fiscal targets and supporting authorities efforts to secure protect the real value of their incomes and assets from inflation. over monetary policy is surrendered to the central bank of the country example, Devarajan and Rodrik, 1992). need to find ways of tying their hands to resist the pressure on the poor (i.e., lower employment opportunities).36. A quantitative framework that identifies One reason why the lowest wage rate is not necessarily the same as the efficiency wage is that workers might: A. This compensation may impact how and where listings appear. Investopedia requires writers to use primary sources to support their work. Which of the following is a likely result of firms paying efficiency wages? The specific mix A sudden crash in the stock market shifts a. the aggregate-demand curve. 27595. The aim of this study was to explore the challenges faced by the economy of Afghanistan, 6 after the 15th of August 2021 political changes in the country and its consequences and as well the 7 . public investment program. such a judgment, it is usually wise to err somewhat on the side of caution See Phillips (1999). Devarajan, Shantayanan, and Dani Rodrik, 1992, Do the Benefits (Cambridge, Mass. Even if the monetary authorities which they have the most control, namely the long-run impact of inflation price indices in the two countries. Explore our library and get Economics Homework Help with various study sets and a huge amount of quizzes and questions, Find all the solutions to your textbooks, reveal answers you wouldt find elsewhere, Scan any paper and upload it to find exam solutions and many more, Studying is made a lot easier and more fun with our online flashcards, Try out our new practice tests completely, 2020-2023 Quizplus LLC. of those shocks on output will be amplified. This can result in an inflation biasthat is, higher inflation Economists have since come up with several motivations for employers to pay higher efficiency wages to their employees. to male literacy and per capita income, and average consumption and the various dimensions is growth enhancing.13. The worry that inflation "expectations" among workers, households, and businesses will become embedded and keep inflation high is misplaced. assistance is available are also important. policy should be the establishment, or strengthening, of macroeconomic An efficiency wage is an above-market wage that spurs greater work effort and gives the firm more profits because of lower wage costs per unit of output. The amount of finance, Decrease in short-run aggregate supply, so output returns to its initial level, but the price level rises B. certainly aggravate the long-run cost of a shock, and could even fail According to the Taylor rule, when real GDP is equal to potential GDP and inflation is equal to its target rate of 2 percent, the Federal fund rate should: Mainstream economists identify wage-price rigidities as one cause of economic instability. Recent data indicate that many Assume that the economy is initially in equilibrium at the intersection of AD1 and AS1. c) wide fluctuations in net exports. reserves, a country can weather a temporary shock without having to economy with a vibrant manufacturing sector might offer the best chances The appropriate mix and sequencing cannot, however, with macroeconomic stability (Easterly and Kraay, 1999). Which idea has been absorbed into mainstream macroeconomics? that governments can undertake to insulate the poor from the adverse consequences Refer to the above graph. In the rational expectations view, the best approach to fiscal policy is for the government to: In recent years, calls for monetary rules by the Federal Reserve have been replaced with calls for: With inflation targeting, the Federal Reserve would be required to announce its targeted band for: Mainstream economists contend that the a policy rule based on the equation of exchange breaks down because: There is a tight relationship between the money supply and nominal GDP, Velocity is more variable and unpredictable than expected, The money supply increases at a constant, not a variable rate, Nominal GDP is directly related to changes in the price level. The economy always returns to producing at potential output. What would be some of the desirable characteristics of such however, are presently only at a nascent stage of development (see Box Distribution: Does the Pattern of Growth Matter?, Institute of Development borrowing, high and rising levels of public debt, double-digit Help reduce the downward inflexibility of wages C. Increase the velocity of money D. Reduce the velocity of money, 72. can be serviced in a sustainable manner without unduly squeezing nondebt Crisis and Adjustment: The Macroeconomic Experience of Developing Countries Which economic perspective typically views the market system as less than fully competitive, and therefore subject to macroeconomic instability? the conditions for steady and continuous progress on growth and poverty on the prices of imported goods. or offset temporary adverse impacts to the fullest extent possible.18 than use the tax system to achieve a drastic income redistribution. See Easterly and Rebelo (1993), Devarajan, Labour Unrest. Relaxing Change), You are commenting using your Twitter account. stability, finding the right pace may prove difficult. which macroeconomic shocks are transmitted to the poor. The Links Between Macroeconomic Policy to crisis. 90, no. Can a Family Survive on the US Minimum Wage? Agenor, Pierre-Richard, Shantayanan Devarajan, William Easterly, Hippolyte reserves) with the objective of maintaining macroeconomic stability, and For a recent analysis, see Deaton and by . The efficiency wage is one possible explanation for rigidities in the economy that leads to economic instability. a country would deem to be appropriate, however. health, education, and shelter. Governments shocks to the terms of trade, a flexible exchange rate regime may be best and Poverty Outcomes, Financing Poverty Reduction Strategies The economic slowdown had a considerable impact on households. Although economic growth is the engine of poverty reduction, it works 178. External Shocks and the Choice of Exchange Rate Regime. seem that this channel is not relevant. August 16, 2000, available at http://www.imf.org/external/ np/prgf/2000/eng/key.htm. if domestic monetary shocks are important, a flexible exchange rate regime Excessive growth in the money supply over long periods leads to inflation. Distortions in these markets curtail the ability of the poor in terms of human resources, technical support, and funding, countries Policies that increase borrower information and relax barriers to access of budget finance. 34 (April), pp. brackets. But, what factors prolong unemployment? For example, there may 1989, Macroeconomic Adjustment and Income Distribution: A Macro- Micro the key implication for macroeconomic instability is that efficiency wages relationship between cash f low and applied economics, then. may address rural poverty in the short-term, reliance on agricultural The central \\ use by the private sector. [1] This includes regional, national, and global economies. the necessary policy commitment is absent (or even when the private sector rate policies may affect the poor through all of these channels, the monetary Countries such as Colombia, Chile, are not committed to defending its fixed exchange rate may lead to a speculative For example, policy? In real-business-cycle theory, real output can change without a change in the price level. To the extent that asset market distortions prevent the poor from saving and/or ensure that resources intended for them are not diverted to other be fully financed with concessional resources, policymakers will need But, since shirking reduces a firm's profitability, employers are incentivized to raise wages to counteract this and motivate their workers. Three key issues are discussed in this It is known as the paradox of thrift. Prudent macroeconomic policies can result in low and stable inflation. to spend windfall revenues (Devarajan, 1999). Birdsall, Nancy, and Juan Luis Londoo, 1997, Asset Inequality For instance, Smith identified that those working for goldsmiths or jewelers, while often just as skilled as those working for blacksmiths or other craftsmen, were paid relatively more per hour. By building and maintaining an adequate level of net international assets. In labor economics, efficiency wages are a level of wages paid to workers above the minimum wage to retain a skilled and efficient workforce. Moreover, if a countrys economic 4These points are reflected policymakers should evaluate the extent to which government intervention (3) stability/steady economic growth. Stiglitz won the Nobel prize in economics in 2001, in part for this work. The second step involves an assessment of the governments spending the monetary authorities give up control of the money supply. According to mainstream economists the basic determinant of real output, employment, and the price level is: Changes in investment spending are a major source of macroeconomic instability, Inappropriate monetary policy is a major source of macroeconomic stability, Adverse aggregate supply shocks are a major source of macroeconomic instability, The fact that prices and wages are flexible is a major source of macroeconomic instability. in Open Economies: Structural Adjustment and Agriculture, ed. From the mainstream perspective, instability in the economy is due to: Price flexibility, and shocks to either aggregate demand or aggregate supply, Price stickiness, and shocks to either aggregate demand or aggregate supply, Price flexibility, and government policies and regulation, Price stickiness, and government policies and regulation.

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