Macroeconomics[Problems & Policies]

Policies to solve Unemployment

Fiscal Policy:
Solution for demand-deficient recession
was for the government to spend on the
peoples behalf. Eg. Singapore governments
2009 budget of $20.5 billion and US$787 billion
fiscal stimulus in the USA in 2008.
In addition, income tax cuts are adopted to
raise peoples disposable income, and hence
domestic consumption. Corporate tax
rates are reduced to increase after-tax
profit of the firms, and increase their expected
rate of returns, hence encouraging more
investment. Given an autonomous increase in
investment, it will increase the level of AE
and lead to an unplanned decrease in stocks.
As firms increase production to raise stock
levels back to the desired levels, they will hire
more workers, thus employment levels rise.
This will generate income for households
employed by firms in the capital goods
industry. These households tend to spend a
proportion of their additional income on
consumption, depending on their MPC. This
further creates additional income on
consumption. This cycle of spending and respending on consumption will continue until
increase in income becomes negligible. The
eventual increase in NI is several times the
initial increase in AE. The multiplier k thus
represents how many times the NI increases
will respect to the initial change in AE.
Limitations
Size of multiplier: In Singapore, due to very
high withdrawals from the circular flow in the
form of savings and import expenditure,
the size of the multiplier is very small. High
savings in Singapore is caused in part by the

Fiscal Policy is defined as

the use of government
spending and/or taxation
to influence the level of
economic activity through
the aggregate demand
(AD)
Monetary Policy is the
deliberate attempt by the
Central Bank to regulate
the money supply or
manipulate the interest
rate or exchange rate to
influence the level of
economic activity so as to
achieve economic and
social objectives such as
maintaining full
employment, curbing
inflation, attaining
economic growth and a
satisfactory balance of
payments position
Supply-side policies are
mainly micro-economic
policies designed to
improve the supply-side
potential of an economy,
make markets and
industries operate more
efficiently and thereby
contribute to a faster rate
of growth of real national
output
SR SSP: reduce
business costs during

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Macroeconomics[Problems & Policies]

Central Provident Fund scheme, which enforces over 30% of earned income by
households to be saved, and in part due to conservative finance by the
government, keeping the budget almost always in surplus. The high level of
imports has been a result of limited resources and hence most of our inputs
for production as well as consumption are imported. The resultant small
size of the multiplier meant that even if the government were to raise its
spending, the eventual effect on NI would be rather limited.
Small proportion of government spending: given the relatively small size
of government spending relative to other components of AD, a fall in export
revenue of say 5% would require an increased government spending by some
100%, as export revenue is more than 20 times government spending.
This alone makes fiscal policy infeasible as a demand management policy tool.
Time Lags: There is often a serious time lag between the identification of
the problem to be dealt with and the time when the fiscal measures
begin to take effect. This may mean that fiscal policy takes effect at the
wrong time. Hence, fiscal policy could even be destabilising when such time
lags are considerable. For example, expansionary fiscal policy to stimulate
unemployment may not come into effect until the economy has recovered. This
may result in an overheated economy instead.
Crowding-out effect: If the government chooses to finance their increased
expenditure through borrowing from the banking system, there will be an
increase demand for loanable funds, and hence an increase in interest
rate. As a result, private businesses will cut back on investment. Hence
government spending crowds out private spending consumption and
investment. Therefore, the increased government spending may simply be
offset by lower private household consumption and lower private sector
investment.
Evaluation: Although fiscal policy may not be as effective for an economy with
low multiplier like Singapore, given NI= AE x k, even k is small for
Singapore, an increase in AE will still lead to increase in NI, which is better than
no increment at all to offset the falling NI during recession. Thus, knowing k is
small due to huge leakages, the Singapore government still uses fiscal
stimulus with a supply-side slant and spend on projects such as training
and infrastructure.

Monetary Policy: i/r

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Macroeconomics[Problems & Policies]

Generally, an expansionary monetary policy is adopted when the

government, through the Central Bank, seeks to reduce interest rates. This
will in turn encourage consumption and investment since the cost of
borrowing is lower ie. AD will rise and real output will increase, creating more
employment. Alternatively, the Central Bank will increase the money supply
in the economy by buying bonds or printing money, which will lead to a fall in
interest rates, to stimulate production and to increase the level of economic
activity.
Exemplification: Generally during times of recession and high
unemployment, central banks tend to keep interest rates low. One way
interest rates can be kept low is by injecting liquidity into the economy via the
purchase of bonds from the public through the workings of the open
market operations or a reduction in the banks liquidity ratio.
With the interest rates remaining low, this means that the cost of borrowing
for the firms will be reduced and hence the expected rate of return on
private investments will increase, leading to a greater incentive for firms to
increase their level of investment. At the same time, the cost of borrowing
for the average household is reduced, and this will lead to an increase in
autonomous consumption.
Moreover, there will be an outflow of hot money as short term investors
convert US$ for foreign currency to earn arbitrage from the speculation
exercise, thus leading to an increase in the supply of US$ in the foreign
exchange market. As a result, the value of US$ drops, and exports will be
encouraged while imports discouraged. Assuming Marshall-Lerner condition
holds, net exports will increase
With an increase in domestic consumption, net exports, and investment, AD
will rise, leading to unplanned fall in stocks. Producers will thus demand more
factors of production during the next round of production to maintain stock
levels and hire more workers. This will reduce cyclical unemployment.
Limitations: depends on interest elasticity of C & I. Changes in C and I are
greatly influenced by consumers and investors economic outlook. Generally,
a pessimistic outlook among producers and consumers will limit the growth in C
or I even though interest rate is kept at a low level.
Also, even when the Federal Reserve reduces the interest rate, commercial
banks which are saddled with bad debts will scrutinize the borrowers and will
be unwilling to give out loans easily.

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Macroeconomics[Problems & Policies]

Moreover, a low interest rate may not be effective to stimulate a pickup in

employment if the problem of unemployment is due to structural rigidities.
In light of the financial crisis, US firms had outsourced jobs to lower wage
countries such as India or China to reduce cost. This source of unemployment is
unlikely to be affected by changes in interest rates. Also, in the case of a
liquidity trap in Japan, interest rates are regarded to be lowest possible rate,
and everyone only expects it to increase. This makes any expansionary MP
ineffective to stimulate C & I.
Monetary Policy: Exchange Rate
Monetary Authority of Singapore (MAS) adopts a gradual and modest
appreciation of S$ to ensure price stability which will lead to economic
growth. However, during times of high unemployment, MAS has shifted its
stance. By depreciating the S$, it makes Singapores exports cheaper in
terms of foreign currency, and hence allow the exports to gain price
competitiveness. Assuming PEDx > 1, quantity demanded of Singapores
exports will rise more than proportionately and hence increase export revenue
(X), improving trade of balance, and subsequently an increase in AD. Since
there are unplanned fall in stocks, producers will hire more workers to meet this
shortfall and hence cyclical unemployment will be solved.
Limitation: However, considering that Singapores exported goods PEDx
might be <1 due to the nature of our exports and lack of substitutes:
high value-added capital intensive goods such as microchips and refined oil,
with few substitutes. Hence given a fall in price, quantity demanded may only
rise by less than proportionately, leading to an actual fall in X instead.
Moreover, Singapores PEDm is also likely to be less than 1, due to the fact
that she has limited natural resources and needs to import for
consumption and production of exports. Hence, depreciation of S$ will
lead to a less than proportionate fall in quantity demanded for imports and
overall increase in M. Hence, net exports will fall, leading to a fall in AD
and hence worsening of the unemployment situation.
It may also lead to import price push inflation in SG due to Singapores exports
having high import content.
Evaluation: However, as long as the Marshall-Lerner condition holds, net
exports will still increase, though one has to take note of the J-curve effect
which shows that depreciation will first worsen the BOT before eventually
improving it due to the less responsiveness of both quantity of exports and

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Macroeconomics[Problems & Policies]

imports to price change at the beginning as time is needed for people to adjust
to try out new alternatives and some contractual obligation.
Supply-side policies: Cyclical Unemployment
CPF system
The CPF system is a compulsory savings plan requiring both the employees as
well as the employers to make monthly contributions to each employees CPF
account. During 1985 recession, the government reduced the employers CPF
contribution from 25% to 10%, effectively lowering labour costs of all firms
without hurting employees take home pay. This helped trim costs of
productions significantly, allowing many firms to retain a large portion of their
work force with minimal retrenchments. By changing the size of the wedge,
the government is able to lower labour costs and hence production costs
without affecting disposable income, thereby cushioning the effects of a
falling aggregate demand on cyclical unemployment. Also, other cost cutting
measures such as corporate tax rebates, utilities rebates, and rental rebates
were adopted in 1999 to help firms stay in the black.
Flexible Wage System:
The system was to replace the need for the government to initiate wage cuts or
wage freezes necessary to counter cyclical unemployment. This system
incorporated an annual wage supplement (AWS) and a monthly variable
component (MVC) that varied with the performance of the economy as well as
the firm. These flexibilities allowed firms to adjust labour cost by adjusting
wages so that they could avoid having to retrench workers as much as
possible.
Supply-side policies: Structural Unemployment
Unemployed workers often do not have the skills demanded by employers.
Structural unemployment arises when changes in technology or international
competition change the skills needed to perform jobs or change the location of
jobs. People are made redundant in one sector of the economy cannot
immediately find jobs elsewhere because they either do not have the
necessary skills or are unwilling to move to another area where prospects are
better(occupational and geographical immobility of labour).
The result of structural decline of industries and changing skill requirements
result in a mismatch between the workers skills and job requirements. Such a
structural change can arise from demand side or supply side:
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Macroeconomics[Problems & Policies]

1. There is a permanent fall in the demand for the product of a particular

industry, output is reduced
2. Supply is not forthcoming
3. More capital is used to substitute for labour (technological
unemployment)
Exemplification: caused by structural changes in the SG economy coupled with
occupational immobility of labour. Unlike cyclical unemployment, this is
typically industry specific as structural changes may arise due to shifting
comparative advantage or industry specific technological advancements. For
example, in recent years, the restructuring of the Singapore economy towards
a KBE has led to the demise of many labour intensive and low-end capital
intensive industries in Singapore. Many of the workers who were displaced in
these sunset industries found that while the job market had other vacancies,
they did not possess the necessary skills to take on those jobs and hence
remained unemployed.
Retraining
The government focuses its spending on retraining of workers displaced from
these industries, helping them acquire new skills to enter the new industries
which had arisen as a result of shifts in comparative advantage, thereby easing
structural unemployment. For Singapore, firms could tap on the Skills
Development Fund (SDF), as well as the Skills Programme for Upgrading and
Resilience (SPUR) which was implemented during the 2009 Budget. These
initiatives provide subsidies to firms who sent their workers for re-training or
upgrading course so as to raise labour productivity and retain their
employability.
Limitations: Given the changing requirement for labour skills, many of the
redundant workers for the older industries are simply not qualified for new jobs
that are created. What is more, the longer people are unemployed, the more
demoralised they become. Employers would probably be prepared to pay only
very low wages to such workers. To persuade these unemployed workers to
take low-paid jobs, the welfare benefits would have to be slashed. Moreover,
the cost of providing or subsidising training can impose a burden on the
government budget. There is also great resistance in acquirement of new skills,
especially among old workers. Furthermore, workers who are lacking in basic
education and literacy may find the acquisition of new skills to be extremely
difficult.
Supply-side policies: Frictional Unemployment: arises because of imperfect
information in the labour market as it takes time for workers to be matched
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Macroeconomics[Problems & Policies]

with suitable jobs. Aka search unemployment. Since both employee and
employer spend time searching for what they believe will be the best match
available, frictional unemployment arises.
Exemplification: In Singapore, this is caused by imperfect information in the
labour market. Workers typically require time to go through the job search
process. Inefficiency of information exacerbates this delay, and jobseekers who
are frictionally unemployed are usually unemployed for short periods of time. In
SG, school leavers typically take on average 3 to 6 months to get a job. It
should be noted that frictional unemployment will be made worse by cyclical
unemployment, where they are fewer jobs on the market.
Limitations: much of the success of policies that focus on improving labour
market information lies with the attitude of the job seekers, whether they are
keen to get employed sooner. Moreover, with the job fairs, frictional
unemployment may not be solved quickly since workers have more choices of
employers to choose from and vice versa. This would have lengthened the job
searching process.

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