Question 5
• Expansionary Monetary Policy – Interest rate reduction (Extract 2)
o By theory, the fall in interest rate should work in the US – US has a large multiplier. Furthermore, it is a large economy, hence it is a price-setter in the funds market. Thus, when it reduces interest rate, other countries will follow suit. -> “UK also reduces its interest rates after the US did so.”
o However it may not work, does not solves sectoral unemployment. Monetary policy is generic, does not target at any particular sector.
o Interest inelasticity due to poor business outlook, hence fall in interest rates does not lead to a rise in investment expenditure. MEI curve will be relatively steep.
• US government and Central Bank are not actively combating unemployment – there is an observable improvement in labour productivity (see Question 3)
o The US government wants to continue to encourage technological advancement so that it leads to future potential growth.
o Capital accumulation may continue.
o Labour may undergo skills retraining – quality of labour improves in the long-term.
o Outsourcing – Reduction in cost of production for US. If foreign countries have comparative advantage, they can produce goods at lower opportunity cost, hence reducing the cost of production for the US.

• Evaluation for US’s policy of not doing anything:
o Does not solve unN in the short-term, hence the standard of living of households will continue to be eroded. AD will continue to be suppressed at a low level, and this will lead to lower economic growth. (firms are unwilling to invest due to poor business outlook, hence affecting potential growth.)
o In long-term, if unN had already been persistent for a long period of time, employment may not increase. (eg. A retrenched worker’s skills deteriorates after being unemployed for a period of time)
o Affects children’s education – hence affecting future labour productivity.

• Hence, policy of ‘doing nothing’ is being hindered by the high level of uncertainty involved. -> supply-side policy

• The government may adopt expansionary fiscal policy instead. Government may target spending on R&D in sun-set industries -> increase employment.
 However US may not be advised to carry out expansionary fiscal policy – already in a budget deficit.
 US is the largest debtor in the world.

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sidenote: I will forward to yi hui and edmund. Those who want a hard copy of this plus the marking scheme come and find me.

~zhongye