I would select these two tools for the following reasons: Taxation: I selected taxation because it can be used to have a direct as well as indirect impact on inflation. The two main sorts of taxation that can be utilized for this purpose are income taxes and corporate taxes. While income taxes could effect demand pull inflation, corporate taxes could be used to affect both, demand pull as well as cost push inflation depending upon the time frame available. Interest Rates: I selected interest rates because interest rates have a direct relationship with investments as well as consumption and that in turn effects inflation as well.
Whether its cost push inflation or demand pull inflation, interest rates do have their respective effects. My solution would solve the problem of inflation in the following way: Taxation: If the Reserve increases the income tax rates, disposable income would fall, leading to a decrease in aggregate demand. This would reduce pressure on price levels in case there is demand pull inflation. In the case of cost push inflation, the Reserve could reduce corporate taxation rates to reduce cost and hence pushing down price levels.
Reduced corporate taxation could also induce more people to invest, bringing about an increase in production and hence pushing up aggregate supply that would be able to meet the increasing aggregate demand in the case of demand pull inflation. Interest Rates: If interest rates were reduced, they would allow investors to borrow funds more easily and at lower costs, hence reducing costs of production and curbing cost push inflation. However, if the inflation is demand pull, then lower interest rates could have a dual effect.
They could allow more investors to invest; causing an increase in aggregate supply that could meet the exceeding aggregate demand and therefore push down inflationary prices. But in the short run, it would discourage people from saving and instead increase consumption expenditure, thus further worsening the inflationary pressures. But in the long run, it could work out well. The impact of my solution on key economic variables are: Taxation: Increased Income Tax GDP: People’s disposable income would reduce leading to a reduction in their savings as well.
This means lesser investments in the long run causing a fall in the GDP. However if the increased tax revenue is invested in the economy, GDP could rise. Unemployment: As income taxes increase, people at relatively low paying jobs may find it more convenient to stay home and receive unemployment benefits, rather than spending a large proportion of their income in taxation. This would increase unemployment. BoP: The balance of payments would remain fairly unaffected except for the fact that an increase in income tax would reduce purchasing power of the people, leading to less demand for imports and a more favorable BoP.
Budget Balance: Higher tax revenue means a better balance in the budgets. Reduced Corporate Tax GDP: since this could lead to greater investment in the long run, it would also have a positive impact on the GDP. Unemployment: And as investments would increase, employment opportunities would increase too leading to lower unemployment. BoP: Since costs of locally produced goods would fall, their demand would rise leading to a fall in the demand of their imported substitutes hence the BoP would become more favorable. Budget Balance: Reduced corporate taxation revenue could mean a worsening of the balance in the budgets.
Interest Rates: GDP: In the short run, the decreased investments would lead the GDP to fall but in the long run when savings rise and investments rise, GDP shall rise too. Unemployment: Similarly as above, in the short run, the unemployment will rise due to decreased investments but in the long run the increased investment will reduce unemployment. BoP: high interest rates would lead oto high savings and low consumption leading to lesser demand for goods including imports. This would improve the BoP. Q2. The tools that I would use to counter recession would be Government Expenditure
Interest Rates I selected these tools for the following reasons: Government Expenditure: Government expenditure can be used to boost up activity in the economy and counter recession. Interest Rates: Interest rates can be tweaked to encourage investments and induce economic activity to recover from a recession. My solution would solve the problem of recession in the following way: Government Expenditure: The government could inject funds into the economy and initiate investments. This would boost economic activity and provide employment opportunities to people.
As employment increase, consumption would increase, further boosting the economy to grow out of the recession. Interest Rates: By reducing interest rates, savings would fall, causing consumption to rise. This would increase aggregate demand, hence pushing prices up with an inflationary pressure and pulling the economy out of recession as investors begin to invest more to benefit from the increasing demands and prices. Lower interest rates would also allow investors to borrow more easily to invest causing investments to rise and counter recession.
The impact of my solution on key economic variables are: Government Expenditure GDP: As government expenditure induces investment, GDP shall rise too. Unemployment: As investment rises, unemployment shall fall as well. Inflation: Inflationary pressures are expected to increase as investment increase leading to lower unemployment and higher consumption. Budget Balance: Since government expenditure shall increase, the budget balance may worsen. Interest Rates GDP: As lower interest rates increase investment, GDP shall rise too.
Unemployment: as investment increase, unemployment will fall. Inflation: Inflation shall rise as investment increases, and unemployment falls causing increasing consumption expenditure to push up aggregate demand. Q3. Tools that I’ll use: Government Expenditure Interest Rates I would select these tools for the following reason: Government Expenditure: Government expenditure can be used to pull an economy out of recession, and deal with demand pull inflation simultaneously. And since this is intervention by the government, it can be monitored to optimize results.
Interest Rates: Interest rates can also be tweaked around with by the government to find the optimum balance between recession and inflation. My solution would solve the problem in the following way: Government Expenditure: If the government increases government expenditure to invest more heavily in the economy, especially since the financial sector had had a major hit too, and then activity in the economy would increase, causing more goods and services to be produced. This would deal with demand pull inflation while pulling the economy out of a recession as well.
If its cost push inflation, then government intervention would provide additional support to producers, causing their costs to go down and hence warding of inflationary pressures yet again. Interest Rates: The government could reduce interest rates to encourage investors to borrow and invest, hence pulling the economy of a recession and also meeting demand pull inflation. If inflation is cost push, then lower costs of capital in the form of lower interest rates would reduce cost of production too, causing cost push inflation to fall.