1.

Explain why financing a fiscal deficit will either cause: 1) inflation; 2) the 
crowding out effect which reduces economic growth and or; 3) chronic 
exchange rate depreciation. In addition, why does Central Bank money creation 
allow the government to accumulate more debts and become bigger? Why 
does this lead to more inflation and taxation in the long run? 
 
- Fiscal deficit or budget deficit, which is the phenomenon where government 
spending exceeds the tax collected from consumers, causes three primary 
effects;  
1. Inflation - As fiscal deficits occur, in order for the government to 
continue their projects, this will require and result in them 
borrowing money from the central bank which in turn requires the 
bank to print out more money which then increases the money 
supply in circulation. And with the surplus of money creation, this 
would cause a faster growth for total demand than total supply 
consequently causing an inflation problem which reduces the value 
of money the public uses to purchase goods and services, thereby 
lowering living standards 
2. The crowding out effect - On the other hand is the theory that 
through rising public sector spending, this drives down or 
eliminates private sector spending which is somewhat related to 
inflation. As public sector spending increases, this requires more 
money supply in circulation. And to make up for this increased 
public sector spending would either need to increase taxes 
imposed to consumers or again, borrow more money from the 
central bank. By increasing taxes, this would consequently lead to 
a reduced purchase capacity for consumers as they are fined more 
taxes for government projects. By borrowing money from the 
central bank on the other hand, money in circulation rises later 
causing inflation which would consequently reduce the value of the 
public’s money, thereby reducing private sector spending. 
3. Chronic exchange rate depreciation - Lastly, fiscal deficits may also 
cause chronic exchange rate depreciation. Chronicle exchange 
rate depreciation which is defined as the decrease in value of a 
currency occurs as fiscal deficits cause spontaneous decreasing 
changes in monetary value of an economy due to inflation and the 
crowding out effect. Consequently, this downward leading 
currency scares potential investors due to its potential to further 
decrease monetary value. 
Caused by continuous government spending and borrowing, Central banks’ money 
creation allows the government to accumulate more debt which leads to the 
government being bigger. By letting the government borrow more money, this 
requires the bank to print out more money, thereby increasing the money supply in 
circulation which causes inflation in the long run. As government loans increase on the 
other hand, the government continues to grow, and to decrease these loans, the 
government passes it on to the consumers through taxation. This consequently leads 
to increased taxes on the consumers.  
 
 
2. Discuss the four objectives behind macroeconomic stability and explain how the 
attainment of each objective is expected to improve living standards for everyone. In 
addition, how is an economy’s performance under each objective measured, and 
what should be the ideal target for each of the objectives? 
 
By achieving the four objectives of macroeconomic stability this leads to an 
improvement in living standards for everyone through…  
1. Sustained economic growth 
- By achieving sustained economic growth where increases in real GDP are 
at a rate of 5 - 7%, this helps improve living standards through the 
productivity of the economy. By achieving this sustained growth, an 
economy is freed from potential significant economic problems by 
reducing the need for trade-offs as a country achieves a sustained 
growth. Meaning that they are able to grow in a sustainable manner 
where trade-offs for increased growth which may also lead to negative 
effects in the future are not required . Furthermore, the increase in real 
GDP roughly helps indicate an improvement in people’s standards of 
living as this points out to more economic activity within the economy. 
2. Price stability 
- By achieving price stability or low inflation rates of 2-3%, living standards 
are improved as consumers are able to afford and purchase and pursue 
their own interests, necessities and luxuries at the optimal value of their 
own money.  
3. Reduced Unemployment 
- By having most of the population employed, this increases productivity 
and economic activity. Consequently, by working, people are paid which 
basically allows them to improve their own living standards as they 
achieve the capability to supply their own necessities and luxuries for 
themselves and their families. This would also continue for the future 
 generations as children are able to go to educational institutions which 
allows for learning and development which leads to employment in the 
future, hence creating a cycle where employment is reduced.  
4. Manageable balance of payments 
-  
 
3. Explain how achieving the goal of economic efficiency and equity is going to 
improve living standards for everyone and discuss the reasons why these goals are 
better accomplished under a free market as compared to a central planning system 
where the government directly produces the goods and services in the economy. 
  
- By achieving economic efficiency and equity, competitive or free markets are 
technically born as this removes hindrances to opportunities. By removing 
potential barriers or restrictions, people are allowed to pursue their own profit 
incentivized goals. This would lead to the free entry of businesses and firms in 
the market spurring increased competition all the while allowing for increased 
employment opportunities. As people pursue their own interests with profit as 
the primary motivator, they are then further incentivized to improve and 
contribute more of their work as a means of increasing profit, which in turn also 
improves work output and production. This in turn benefits everyone as living 
standards continuously improve as they pursue profit-oriented goals, thus 
allowing for better lifestyles and standards. 
 
On the other hand, if heavy government intervention were to occur, this would 
lead to decreased incentives on work which would cause a continuous effect on 
work output leading to a decreased living standard. 
 
4. By referring to the macroeconomic equation: Y=C+I+G+X-M, explain how each of 
the five types of macroeconomic policies will generate economic growth by identifying 
which expenditure variable is directly affected by a particular type of macroeconomic 
policy and its corresponding instruments or tools.  
1. Trade Liberalization - Allows for economic growth through the reduction of tariff 
rates, quotas and non-tariff barriers to encourage exports and allow for market 
expansion for local firms. ALong with foreing investment liberalization, with local 
goods improving, export quality improves as well which allows for a more 
competitive output quality. 
2. Foreign Investment liberalization - Directly attributable to the X variable of 
exports, this generates economic growth by allowing for competition and the 
entry of foreign investors and firms in the country. Consequently, this spurs job 
 growth and employment, innovation, competition and expansions or 
improvements in production capacity of a certain industry of a country. 
3. FInancial Liberalization - Attributable to the C variable or consumption  
4. Privatization - By selling government owned and controlled corporations, this 
consequently leaves the corporations to a competitive market, thus, these firms 
and companies must then find the initiative to improve and better their products 
to best their competitors. This would also lead to a more efficient output as 
these entities become profit-oriented or incentivized contrary to being 
government owned which leads to complatecny  
5. Deregulation - By removing price controls subsidies and the dismantlement of 
government owned monopolies, this spurs competition in a specific industry 
which leads to economic growth as firms must improve their output of goods 
 
 
5. Explain how each of the following forms of government intervention create more 
bad outcomes despite their good intentions and discuss how these affect 
macroeconomic stability: 
  
 
5.1 Protecting local industries from imports by imposing high tariffs, quotas and 
non-tariff barriers 
- Through high tariff protections, quotas and non-tariff barriers, although local 
industries are protected, this leads to a greater negative impact on economic 
outcomes. With local industries being protected through the prevention of 
imported goods, consumers are forced to purchase local products of inferior 
quality. Knowing that they are protected on the other hand, local firms become 
complacent with their own outputs which leads to a stagnant industry as goods 
are neither improved nor bested by competitors due to the lack of competition. 
By preventing imports, this also prevents the entry of new ideas for local 
industries which in turn slows down innovation and industrial development, 
hence, leaving local industries at a disadvantage, inferior quality of goods and a 
lesser efficient rate of production, contrary to industries from other countries. 
 
5.2 Subsidizing farmers and government owned and controlled firms in industry 
- By subsidizing farmers and government owned and controlled firms in the 
industry, similar to the protection of local industries, the subsidy on farmers 
leads to a lesser quality of output. Although they have been receiving financial 
support, the industry ceases to develop and grow meaning there is no 
practicality in the financial support towards farmers. Subsidizing government 
 owned and controlled firms on the other hand acts the same way. By subsidizing 
government owned firms, firms became complacent as well leading to a 
stagnant industry knowing they are financially supported either way. 
 
5.3 Providing free cash to the unemployed, single mothers, free housing, and free 
food 
- Through the provision of short term benefits, although this instantly improves 
consumer living standards, this causes a negative impact on the long run as this 
causes increased state dependency. 
 
5.4 Providing free public education at all levels and generous social security benefits 
to the elderly. 
- By providing free public education at all levels, like any other industry without 
competition, educational institutions find no need to improve quality of output 
given that they are publicly funded and run. Contrary to private education where 
profit is an incentive to improve work and education quality, public education 
lessens educational standards. This goes the same with generous social security 
benefits where people may also become complacent on the benefits of the 
government leading to a less incentivized worker.