1. 1
TABLE OF CONTENTS
TITLE PAGE
Introduction 2
Contents
Introduction of Inflation 3
Intoduction of Journal Article 4
Impact Of The Issues 5
How Government Overcome 7
Graph Or Statistic 9
Conclusion 14
Reference 15
2. 2
INTRODUCTION OF MACROECONOMICS
Macroeconomics is an analysis of a country’s economic performance and structure. It also
analyses the government’s policies in affecting its economic conditions. Economists are
interested in knowing the factors that contribute towards a country’s economic growth because
if the economy progresses, it will provide more job opportunities, goods and services and
eventually raise the people’s standard of living. These factors include level of employment or
unemployment, gross balance of payments position and deflation or inflation.
Macroeconomics can progress as it tests a particular theory to see how the overall economy
functions, whereby the theory is used to forecast the effects of a particular policy or event.
Since a century ago, developed nations have achieved a high rate of economic growth, which
in turn had raised growth in their people’s standard of living. Macroeconomics examines the
reasons behind the speedy economic in the developed nations and understands the reason
why this growth is different between the various countries. Among the issues involved in the
analysis are a country’s real output, productivity, economic growth rate, unemployment rate
and inflation rate.
The study of macroeconomics relates to the economic growth of a country. Although many
factors, such as natural resources, human resources, capital stocks, technology, and people’s
choice of economy, contribute towards economic growth, government policies also play an
important role. Therefore, it is also important for us to understand the effects of the many
government policies on the economy and the need to develop better policies as this is an
important aim in macroeconomics.
Macroeconomic policies affect the overall performance of the economy. There are two main
macroeconomic policies. They are financial or monetary policies and fiscal policies. However,
there are also other policies that could be used by the government to influence the economic
performance of a country. They are income policies and supply side policies.
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INTRODUCTION OF INFLATION
Inflation is a quantitative measure of the rate at which the average price level of a basket of
selected goods and services in an economy increases over a period of time. It is the constant
rise in the general level of prices where a unit of currency buys less than it did in prior periods.
Often expressed as a percentage, inflation indicates a decrease in the purchasing power of a
nation’s currency.
Inflation has a major effect on the entire country's economy. It impacts not only the
government, but the little things in the average person's daily life. Both a cause and effect of
how the economy is doing, inflation has both its fans and detractors. Many think that certain
amounts of inflation are good for a thriving economy, but that larger rates raise concerns. It
can devalue the currency significantly and, at worse, has been a key component to recessions.
Inflation, as mentioned, is the rate a price rises, and essentially how much the dollar is worth
at a given moment with regards to purchasing. The idea behind inflation being a force for good
in the economy is that a manageable enough rate can spur economic growth without devaluing
the currency so much that it becomes nearly worthless.
There are many different types of inflation, depending not only on what good is being priced
but what the inflation rate actually is. For example, what happens if the inflation rate is well
above the Fed's intended target? At a higher rate, yet still in the single digits, that's known as
walking inflation. It is seen as concerning yet manageable.
4. 4
INTRODUCTION JOURNAL ARTICLE
Based on article written by The Star Online, dated 16 Jan 2017, Economics issues preoccupy
Malaysians. This article is taking about our economy in Malaysia. In Malaysia, a major talking
point is the state of the economy. Three issues are worrying the ordinary Malaysian – rising
prices, the fall of the ringgit and the outflow of capital. Each is an issue in its own right, but
they are also all interlinked.
Inflation has become a hot issue because it is accelerating and will continue to do so. There
are one-off factors influencing retail prices, such as the removal of the cooking oil subsidy, the
weather affecting vegetable output or the slight recovery of the world oil price.
Malaysia is very dependent on imports for a wide range of products, from food and household
utensils to machinery and components for making cars, computers and all kinds of other
goods. As the most recent ringgit plunge started in mid November, prices of products that
have high import content may not have fully risen yet because the shops are still clearing
stocks bought earlier. But you can expect the new prices to kick in more and more.
However, domestic policies to respond to the problems are crucial and there should be a
comprehensive plan to tackle these issues, since they may persist as 2017 progresses.
5. 5
IMPACT OF THE ISSUES
When prices rise for energy, food, commodities, and other goods and services, the entire
economy is affected. Rising prices, known as inflation, impact the cost of living, the cost of
doing business, borrowing money, mortgages, corporate and government bond yields, and
every other facet of the economy.
Inflation can be both beneficial to economic recovery and, in some cases, negative. If inflation
becomes too high the economy can suffer; conversely, if inflation is controlled and at
reasonable levels, the economy may prosper. With controlled, lower inflation, employment
increases. Consumers have more money to buy goods and services, and the economy
benefits and grows. However, the impact of inflation on economic recovery cannot be
assessed with complete accuracy. Some background details will explain why the economic
results of inflation will differ as the inflation rate varies.
Income redistribution is one of inflation effect. One risk of higher inflation is that it has
a regressive effect on lower-income families and older people in society. This happen when
prices for food and domestic utilities such as water and heating rises at a rapid rate next, falling
real incomes, with millions of people facing a cut in their wages or at best a pay freeze, rising
inflation leads to a fall in real incomes.
Negative real interest rates also the impact of inflation. If interest rates on savings accounts
are lower than the rate of inflation, then people who rely on interest from their savings will be
poorer. Then, the cost of borrowing. High inflation may also lead to higher borrowing costs for
businesses and people needing loans and mortgages as financial markets protect themselves
against rising prices and increase the cost of borrowing on short and longer-term debt. There
is also pressure on the government to increase the value of the state pension and
unemployment benefits and other welfare payments as the cost of living climbs higher.
Lastly, Risks of wage inflation. High inflation can lead to an increase in pay claims as people
look to protect their real incomes. This can lead to a rise in unit labour costs and lower profits
for businesses
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Economic growth is measured in gross domestic product (GDP), or the total value of all goods
and services produced. The percentage of growth or decline, compared to the previous year,
is adjusted for inflation. Therefore, if growth was 5% and inflation was 2%, GDP would be
reported at 3%. As prices rise, the value of the dollar declines, as its purchasing power erodes
with each increase in the price of basic goods and services.
Overall, a high and volatile rate of inflation is widely considered to be damaging for an
economy that trades in international markets. In your analysis focus on the impact on
uncertainty / business and consumer confidence and the competitiveness of producers in
international markets, the effects on the real standard of living and the possible impact on
levels of income inequality
7. 7
HOW GOVERNMENT OVERCOME
Inflation occurs when an economy grows due to increased spending. Prices rise, and money
loses value because it won’t buy as much as before. Inflation can be controlled without causing
a recession using contractionary monetary policies.
If the rate of inflation in the economy goes beyond a rate that is uncontrollable, the government
has to intervene with policies to help stabilize the economy. Since inflation is the result of too
much expenditure on the economy, the policies are created to restrict the growth of money.
There are three ways the government can control the inflation- the monetary policy, the fiscal
policy, and the exchange rate.
Firstly, the monetary policy is the way for government use to overcome the inflation.
Monetary policy is a tool used by the government to control the amount of money circulated
in the economy. This includes paper money, coins and bank deposits held by businesses
and individuals in the economy. Monetary policy uses interest rates to control the quantity of
money in the economy.
Next, open market operations. When there is high inflation in the economy, the amount of
money created by financial institutions needs to be restricted. The Federal Reserve Bank
lowers the supply of money by selling their large securities to the public, specifically to
security dealers. The buyers pay for the securities by writing checks on the deposits they
hold in the commercial banks. This is an effective way to control the supply of money as the
deposits of the commercial banks at the Federal Reserve Bank are the legal reserve for the
banks. With the sale of securities, the banks are forced to restrict their lending and security
buying, therefore reducing the quantity of money in the economy.
The reserve requirement is also the way for government overcome inflation. Its refers to the
amount of money that the commercial banks are required to have on deposit with the Federal
Reserve Bank. A low reserve requirement means banks have more money to lend out which
can increase the money supply. But when there is high inflation in the economy, the
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government increases the reserve requirement which restrains the growth of money and even
reduces it.
The decrease in government spending. Sending by the government constitutes a large part
of the circular flow of income in the economy. During periods of high inflation, the
government can reduce the spending to decrease the amount of money in circulation. In
many instances, high government spending is the root cause of inflation. However, it is often
hard for governments to differentiate between essential and non-essential expenditure so,
the spending policy should be augmented by taxation.
An increase in the level of taxes reduces the amount of money that people have to spend on
good and services. The effect of the tax can vary with the kind of tax imposed, but any
increase in tax would reduce spending in the economy. An increase in tax combined with a
decrease in government spending can have a double-barrelled effect on the supply of
money in the economy.
Lastly, increase in saving. Another theory derived by Keynes was his belief in compulsory
savings or deferred payments. In order to achieve this, the government should introduce public
loans with a high rate of interest, attractive saving schemes and provident or pension funds.
These measures lock people’s income into savings accounts for an extended period of time
and are an effective way to control inflation.
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GRAPH OR STATISTIC
The Phillips curve
The Phillips curve shows the relationship between unemployment and inflation in an economy.
Since its ‘discovery’ by British economist AW Phillips, it has become an essential tool to
analyse macro-economic policy.
The Phillips curve and fiscal policy
After 1945, fiscal demand management became the general tool for managing the trade cycle.
The consensus was that policy makers should stimulate aggregate demand (AD) when faced
with recession and unemployment, and constrain it when experiencing inflation. It was also
generally believed that economies faced either inflation or unemployment, but not together -
and whichever existed would dictate which macro-economic policy objective to pursue at any
given time. In addition, the accepted wisdom was that it was possible to target one objective,
without having a negative effect on the other. However, following publication of Phillips’
research in 1958, both of these assumptions were called into question.
Phillips analysed annual wage inflation and unemployment rates in the UK for the period 1860
– 1957, and then plotted them on a scatter diagram. The data appeared to demonstrate
an inverse and stable relationship between wage inflation and unemployment. Later
economists substituted price inflation for wage inflation and the Phillips curve was born. When
economists from other countries undertook similar research, they also found very similar
curves for their own economies.
Phillips analysed annual wage inflation and unemployment rates in the UK for the period 1860
– 1957, and then plotted them on a scatter diagram.
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Explaining the Phillips curve
The curve suggested that changes in the level of unemployment have a direct and
predictable effect on the level of price inflation. The accepted explanation during the 1960’s
was that a fiscal stimulus, and increase in AD, would trigger the following sequence of
responses:
1. An increase in the demand for labour as government spending generates growth.
2. The pool of unemployed will fall.
3. Firms must compete for fewer workers by raising nominal wages.
4. Workers have greater bargaining power to seek out increases in nominal wages.
5. Wage costs will rise.
6. Faced with rising wage costs, firms pass on these cost increases in higher prices.
Exploiting the Phillips curve
It quickly became accepted that policy-makers could exploit the trade off between
unemployment and inflation - a little more unemployment meant a little less inflation.
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During the 1960s and 70s, it was common practice for governments around the world to select
a rate of inflation they wished to achieve, and then expand or contract the economy to obtain
this target rate. This policy became known as stop-go, and relied strongly on fiscal policy to
create the expansions and contractions required.
The breakdown of the Phillips curve
By the mid 1970s, it appeared that the Phillips Curve trade off no longer existed - there no
longer seemed a stable pattern. The stable relationship between unemployment and inflation
appeared to have broken down. It was possible to have a number of inflation rates for any
given unemployment rate.
American economists Friedman and Phelps offered one explanation - namely that there is not
one Phillips curve, but a series of short run Phillips Curves and a long run Phillips Curve, which
exists at the natural rate of unemployment (NRU). Indeed, in the long-run, there is no trade-
off between unemployment and inflation.
The new-Classical explanation – the importance of expectations
Although there are disagreements between new-Classical economists andmonetarists, the
general line of argument about the breakdown of the Phillips curve runs as follows.
Assume that the economy starts from an equilibrium position at point A, with inflation currently
at zero, and unemployment at the natural rate of 10% (NRU = 10%). Secondly, given the
public’s concern with unemployment, assume the government attempts to expand the
economy quickly by way of a fiscal (or monetary) stimulus, so that AD increases and
unemployment falls.
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Initially, the economy moves to B, and there is a fall in unemployment to 3% (at U1
) as jobs
are created in the short term. Having more bargaining power, workers bid-up their nominal
wages. As wage costs rise, prices are driven-up to 2% (at P1
). The effects of the stimulus to
AD quickly wear out as inflation erodes any gains by households and firms. Real spending
and output return to their previous levels, at the NRU.
According to the new-Classical view, what happens next depends upon whether the price
inflation has been understood and expected – in which case there is no money illusion – or
whether it is not expected – in which case, money illusion exists. If workers have bid-up their
wages in nominal terms only, they have suffered from money illusion, falsely believing they
will be better off – in this case, the economy will move back to point A at the NRU, but with
inflation only a temporary phenomenon. However, if they understand that price inflation will
erode the value of their nominal wage increases, they will bargain for a wage rise that
compensates them for the price rise. Again, the economy will move back to the NRU (with
unemployment at 10%), but this time carrying with it the embedded inflation rate of 2% an
move to point C. The economy will hop to SRPC2
(which has a higher level of expected
inflation – i.e. 2%, rather than 0%). Any further attempt to expand the economy by increasing
AD will move the economy temporarily to D. However, in the long-run the economy will
inevitably move back to the NRU.
The conclusion drawn was that any attempt to push unemployment below its natural rate
would cause accelerating inflation, with no long-term job gains. The only way to reverse this
process would be to raise unemployment above the NRU so that workers revised their
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expectations of inflation downwards, and the economy moved to a lower short-run Phillips
curve
Using AD/AS to demonstrate the Phillips Curve effect
This process can also be explained through AD-AS analysis.
Assume the economy is at a stable equilibrium, at Y. An increase in government spending will
shift AD from AD to AD1, leading to a rise in income to Y1, and a fall in unemployment, in the
short term.
However, households will successfully predict the higher price level, and build these
expectations into their wage bargaining.
As a result, wage costs rise and the AS shifts up to AS1 and the economy now moves back
to Y, but with a higher price level of P2.
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CONCLUSION
Inflation can have a major impact on the economy and can affect the government, investments
and the purchasing power of people. A high rate of inflation for an extended period of time can
lead an economy into a recession. Fortunately, the government has the ability to use the
monetary and fiscal policies to help control the supply of money in the economy. When used
in the conjunction, the policies can help achieve a lower rate of inflation and a more stabilized
and balanced economy. However, domestic policies to respond to the problems are crucial
and there should be a comprehensive plan to tackle these issues, since they may persist as
2017 progresses.
