Rift Valley University

Macroeconomics

Offer for Accounting and

Business Management
 Chapter 4: Macroeconomic Problems
 There are two major macroeconomic problems: those
are inflation and unemployment

 Inflation is a general and ongoing rise in the level of

prices in an entire economy. It not a change in
relative prices.

 It also means that there is pressure for prices to rise

in most markets in the economy.

 Relative price increases in the supply-and-demand

model were one-time events.

 It implies an ongoing rise in prices. If it happened for

one year and then stopped, then it would not be
inflation any more
 History of inflation
 The greatest falls in the value of money came
during the mid-late 1970s and again in the late
1980s.

 This occur when there was acceleration in the

rate of inflation in the UK.

 In contrast, the last fifteen years have seen much

lower rates of inflation and as a result, money
has held value better.

 Japan has experienced negative inflation (price

deflation) over recent years in 2006.
Cont...
 The German economy has also come close to
experiencing deflation with inflation of less than
one percent.

 The current hyperinflation occur in Zimbabwe

that can be caused when price inflation spirals
out of control.

 Drastic action is need to stabilize an economy

suffering from high and volatile inflation and this
led to political and social instability.

 IMF is often brought into the process of

implementing economic reforms to reduce
Internal and external factors inflation
 Internal factors of inflation

 Large surge in property price

 An increase wage rate of worker

 An increase in the price of raw materials, such as oil

 Boom in credit and money supply

 Rise in business taxes such as VAT

 External factors of inflation

 An increase in world oil/gas price

 Inflation of global commodity price

 Depreciation of exchanges rate

 Higher inflation in other countries
The main cause of inflation interm of AD and AS
 The main causes of inflation are generally classified
as;
 Demand pull which caused by excess aggregate
demand and cost-push factors w/c caused by
(supply-side factors).

 Demand-pull inflation: it occur when there is a

positive output gap and AD is increased quickly. That
is AD is growing faster than AS (growth too rapid).

 Business can take advantage of high demand by

rising their profit to increase profit margin.

 Typically, demand pull inflation is associated with an

economic boom.
Graghically
Cont...
 Cost-push inflation: it occurs when business respond
to rising unit costs by rise price to protect their profit.

 It can become about from both domestic and external

source including;

 A fall in the external value of the exchange rate which

then, leads to rise in price of imported product,

 An example of cost-push inflation are the following;

1. Rising labor cost perhaps due to increase minimum

wage

2. Higher global price for components and raw material

including imported energy (oil) and foodstuff
 A depreciation in the external value of the exchanges
rate which then, causes rises in export price .

 An increase in indirect taxes such as higher VAT and

environment taxes such as carbon taxes.

 Expectations of inflation: It causes workers to

demand wage increases and firms to push up prices.


 Printing more money: If the Central Bank prints

more money, you would expect to see a rise in
inflation.

 Hyperinflation is usually caused by an extreme

increase in the money supply.
 Declining productivity: If firms become less
productive and allow costs to rise

 Profit push inflation: When firms push up

prices to get higher rates of inflation.

 This is more likely to occur during strong

economic growth.

 Monetary and fiscal policy: if there was an

increase in AD and the monetary authorities
accommodated this by increasing the money
supply
Graghically
Summary of cost push and demand pull inflaton
inflation rate in Ethiopia during 2021
Current inflation rate in Ethiopia
Cont’d
 Methods to Control Inflation
 Inflation is generally controlled by the Central
Bank and the government.

 The main policy used is monetary policy what we

call a contractionary monetary policy.

 Its main purpose is to reduce the money supply

within an economy by declining bond prices and
rise interest rates

 Higher rates make borrowing more expensive and

saving more attractive.

 This should lead to lower growth in consumer

spending and investment
Cont...
 Control of money supply: There is a close link b/n the
money supply and inflation, thus, controlling the money
supply can control inflation.

 If the Government decreases the supply of money, then

the demand will fall, leading to a fall in prices.

 Therefore, the Government may decide to withdraw

certain paper notes and/or coins from circulation.

 Major portion of the money supply lies with banks in the

form of deposits or bank credit.

 Therefore, by reducing the bank’s rate of lending

(amount of money offered as credit), the Government
can considerably..
 reduce the supply of money in the economy.

 Further, the Central Bank also starts issuing

Government securities to commercial banks.

 Therefore, these banks spent a significant portion of

their money on purchasing these securities and
reduce the credit supply to the general public.

 Supply-side policies – policies to increase the

competitiveness and efficiency of the economy,
putting downward pressure on long-term costs.
 Cont...
 When the aggregate demand exceeds the
aggregate supply, an inflationary gap arises.

 Thus, the Government can take these fiscal

measures to control inflation:

 Take steps to decrease the overall Government

expenditure and transfer payments

 Increase the rate of taxes causing individuals to

decrease their total expenditure

 This leads to a decrease in demand and a drop in

the money supply in the economy.
Cont...
 The government can also use a combination of the
two to obtain a reasonable control over inflation

 For instance, in order to control cost-push inflation,

the Government uses direct control measures.

 These include freezing the wages of workers,

putting upper limits on the prices of important
inputs like electricity, coal, steel, etc.

 While these steps can control the extent of

inflation, it is not a good ploy for the long term.
 Increasing imports to augment the supplies of
commodities in the domestic market.
 Cont.....
 Increasing domestic production, thought the
expansion of the industrial park

 What are some primary measures that the

government takes to control inflation?

 Answer: Primarily, the government uses monetary and

fiscal measures to control inflation.

 Under monetary measures, it takes various steps to

control the supply of money in the economy which
leads to a decrease in demand and thus, control over
inflation.

 Under fiscal measures, the government tries to

decrease its expenditure and increase its revenue.
 Unemployment
 The term unemployment refers to a situation when a
person who is actively searching for employment is
of unable to find work.

 The unemployment rate is the percent of the labor

force that is jobless

 It represents the number of unemployed as a

percentage of the labor force.

 Labor force data are restricted to people 16 years of

age and older and less than 65 years age are
employment

 Unemployment Rate in Ethiopia increased to 19.10

 Types unemployment
There are 6 types of unemployment. Those
unemployment's are;
 Frictional Unemployment

 Seasonal Unemployment

 Cyclical Unemployment

 Structural Unemployment

 Technological Unemployment

 Disguised Unemployment
 Causes of Unemployment
 Unemployment is caused by various reasons that
come from both the demand and supply side,

 Demand-side (employer): it is reductions may be

caused by high-interest rates, global recession,
and financial crisis.

 Supply side (worker): It causes frictional and

structural employment.
Chapter 5: Macroeconomic Policies
 Macroeconomic policies are government actions designed to
influence the performance of the economy as a whole.

 The goals of macroeconomists policy are include achieving

economic growth, inflation stability, and full employment.

 Policymakers always face three fundamental macroeconomic

questions. Those questions are;

 How can the rate of economic growth be raise and sustained?

 How can all types of unemployment be reduced?

 How can inflation be kept under control or below hyperinflat?

Cont...
 To find answers to these questions policymakers can use two
major types of macroeconomics policy.

 Those policies are; a) Fiscal policy, and b) Monetary policy

 Fiscal policy is known as budget policy that used by gov’t.

 Thus, it determine the government’s budget including the

amount and composition of gov’t expenditure and taxes

 Fiscal policy describes changes to government spending and

revenue behavior.
 The gov’t can impact the level of economic activity in the short
term by changing its level of spending and tax revenue.

 There are two types of fiscal policy; expansionary and

contractionary fiscal policy.

 Expansionary fiscal policy is a policy in w/c the federal gov’t

affects macroeconomic variables through an increase in G, a
decrease in tax revenue, or a combination of the two.

 Most of the times, federal government use this type policy

during a recession

 Aggregate demand (overall spending) in the economy falls

during recession
 Leads to slower wage growth, decreased employment, lower
business revenue, and lower business investment.

 Example, the current recession caused by the coronavirus

Disease 2019 (COVID-19) pandemic.

 The gov’t can replace some of the lost AD with the use of
fiscal stimulus.

 Government spending takes the form of both purchases of

goods and services

 In the short term, fiscal stimulus can lessen the negative

impacts of a recession or hasten recovery.
 However, the ability of fiscal stimulus to boost AD may be limited
due to its interaction with other economic processes.

 This including interest rates and investment, exchange rates and the
trade balance, and the rate of inflation.

 What are the effect of expansionary fiscal policy on economy?

 Increase interest rates and reduce investment due to gov’t must

increase the size of its deficit and borrow money

 Reduce inflation: fiscal stimulus rise inflation, it can counteract this

by increasing interest rates.

 The rise in interest rates results in a slowing of economic activity,

 Contradictionary fiscal policy
 It is also withdrawing fiscal stimulus. This policy cited to use
when the economy shifts from a recession into an expansion.

 During economic expansion inflation raise, unemployment

falls and wages and private spending increase

 To improving economic conditions, policymakers may

choose to begin withdrawing fiscal stimulus

 This is done through increasing taxes, and decreasing its

spending, or a combination of the two.

 This policy leads reduces AD in the economy, which again

temporarily slows economic growth
Cont....
 What are the effects of contradictionary fiscal policy?

 It lower interest rates and more investment, which encourages

spending and investment, increasing economic activity

 It also result in depreciation of currency and improved trade

balance with the rest of the world.

 Reduce Inflation: It reduce AD for goods and services in the

economy, which is expected to slow inflation

 The Federal Reserve has some ability to limit inflation by

implementing contractionary monetary policy.
 Monetary policy
 Monetary policy is conducted by a nation's central bank which
is the sole supplier of money

 Example , in U.S., monetary policy is carried out by the Fed.

 The Fed has three main tools that is used to conduct monetary
policy. Those tools are:

 Open market operations, changes in reserve requirements, and

changes in the discount rate.

 Open market operations involve when Fed either purchases or

sales government bonds
 When the Fed buy gov’t bonds, it increases the reserves of the
banking sector, and by rising deposit expansion, the Ms rise

 When the Fed sells some of its stock of gov’t bonds, the end
result is a decrease in the supply of money.

 If the Fed increases bank reserve requirements, the banking

sector's excess reserves are reduced, leading to a reduce Ms

 If decrease in reserve requirements induces an increase in the

supply of money.

 The discount rate is the interest rate the Fed charges banks that
need to borrow reserves in order to meet reserve requirements
 Expansionary monetary policy
 The Fed is engaging in this policy when it uses any of its tools
of monetary policy in such a way as increase in the Ms

 When the Federal Reserve increase supply of money?

 Central bank use this monetary policy during economic

recession and low aggregate demand.

 The main aims of using this type’s monetary policy to

stimulate the growth of a domestic economy.

 Since, the economic growth must be supported by additional

money supply.
Cont....
 There are tools for the use an expansionary monetary Policy
as follows:

 Lower short-term interest rates: leads to rise consumers spend

while businesses are encouraged to make capital investments.

 Reduce the reserve requirements: It increase the money

supply and reduces the value of the local currency inflation

 Expand open market operations: It may decide to buy large

amounts of the gov’t bonds from institutional investors.

 It reduces structural unemployment which caused by d/t b/n

the skills possessed by the unemployed population
 Contractionary Monetary Policy
 It is a monetary policy intended to reduce the rate of monetary
expansion.

 Central bank uses this instruments to affect a reduction in the

supply of money.

 Monetarists are often cite the this policy during the Great
depression, policies that they blame for deflation period.

 A contractionary monetary policy utilizes the following tools:

 Increase the short-term interest rate: This reduce consumers

spending, inflation and businesses activities
Cont...
 Raise the reserve requirements: It would decrease the money
supply in the economy.

 Expand open market operations (sell securities): this reduce

the money circulated in the economy by selling gov’t bond

 What are the effects of a contractionary monetary policy on

economy?

 It reduce inflation and stabilize the prices in the economy due

to reduce in money supply

 Slow down economic growth due to reducing in money

supply
Cont...
 As the money supply decreases; businesses halt major
investments and companies slow down their production.

 Increased unemployment: An unwanted side effect of a this

monetary policy is a rise in unemployment.

 The economic slowdown and lower production cause

companies to hire fewer employees

 Therefore, unemployment in the economy increases.



End of the course

Thank you very

much