Suggested Answers of BT2 Revision Package - ASKnLearn

Explain how policies bring about actual growth work.1) Expansionary fiscal policy to raise ADInvolves raising government expenditure and/or reducing taxes to increase AD and leadingto a multiple rise in NY.Consider the appropriateness of the policy.Less effective for small and open economies like Singapore where G, domestic C and I aresmall relative to X. The extent of change in AD is therefore smaller. Also, there is a weakmultiplier effect due to high leakages because of high MPS and/or MPM. Whereas for largeeconomies like the United States fiscal policy is much more effective in stimulating economicgrowth as it has a large proportion of G and domestic C, I relative to X and a large multiplier.As such, Singapore uses fiscal policy to deliver supply-side initiatives to promote potentialgrowth. For example during the 2009 Financial Crisis.In a recession, fiscal policy is more effective than monetary policy in stimulating growth asgovernment spending is a direct injection into the economy and it can be targeted. But thenagain there are other limitations like time-lag and crowding out effect. Also in a recession,large tax cuts may not bring about huge private investment if business expectations arepoor.2) Expansionary monetary policy to raise ADInvolves increasing money supply or lowering interest rate to encourage C and I thusincreasing AD.Consider the appropriateness of the policySuch a policy is ineffective for a small and open economy like Singapore which is an interestrate taker. Whereas for large economies, monetary policy is more appropriate given a largedomestic economy.In a recession, due to low consumer and business confidence, C and I may not increase withfall in interest rate. Thus, fiscal policy is more effective. But a decreased interest rate willallow the government to borrow to finance a deficit budget. Thus, expansionary monetaryand fiscal policies in a recession can well complement one another.