jc2 h2 prelim 2013 9732/01 csq 2 post mortem. the eurozone crisis

JC2 H2 Prelim 20139732/01 CSQ 2 Post Mortem

The Eurozone Crisis

(c) Discuss the view expressed by protestors in Extract 4 that EU’s standard of living will worsen as a result of the austerity measures. [8]

Two sided answer; reasoned conclusion, evaluation

Material & Non-material aspects

Cut in spending (G), rise in tax rates

EU’s SOL will worsen as a result of the austerity measures (Thesis)

(c) Discuss the view expressed by protestors in Extract 4 that EU’s standard of living will worsen as a result of the austerity measures. [8] Common errors:1. No comment on non-material SOL2. One-sided argument3. Not understanding what the purpose of austerity measures is

ended up explaining the impacts of contractionary FP

What are austerity measures and when are they usually implemented?

• Describes policies that are generally implemented to reduce government budget deficits and debts if not, banks and investors may lose trust in the government’s ability and/or willingness to pay their debts

• Include government spending cuts, tax increases or both.

• Usually implemented so that governments can improve their credit rating, to prove that they can honour their debt liabilities.

(c) Discuss the view expressed by protestors in Extract 4 that EU’s standard of living will worsen as a result of the austerity measures. [8] Answer:

IntroductionDefine standard of living:Material SOL: quantity of goods and services enjoyed by an individualNon-material SOL: environmental factors e.g. crime rates, degree of urban crowding; socio-economic factors e.g. life expectancy, infant mortality rates, quantity of leisure, etc Austerity measures imply an increase in taxation and cuts in government spending. This has been implemented in the EU in order to reduce government debt. Austerity measures adopted by the Eurozone would have both positive and negative impacts on the standard of living in the EU.

(c) Discuss the view expressed by protestors in Extract 4 that EU’s standard of living will worsen as a result of the austerity measures. [8] Thesis: EU’s standard of living will

worsenExplain how austerity measures will impact AD (either through a fall in G, or increase in T): With spending cuts (↓G) and raised taxes, AD will fall. With an increase in personal income tax, disposable income of households is reduced purchasing power falls Cd falls. An increase in corporate income tax results in a fall in post-tax profits lower incentive for investments I falls. The fall in AD due to fall in Cd, I, and G will cause a multiplied fall in real national income.

The fall in real national income/real output will lead to a fall in the aggregate demand for labour (fall in ADL from ADL1 to ADL2 ) and assuming that wages are sticky downwards due to contractual agreements, lead to demand-deficient unemployment of N2N1.

Link to impact on material SOL: A fall in real NY means a decrease in the amount of goods and services available to the citizens in the country, holding price levels and population size constant this would mean a fall in material well-being in the country.

(c) Discuss the view expressed by protestors in Extract 4 that EU’s standard of living will worsen as a result of the austerity measures. [8] Thesis (continued)Fall in non-material SOL:• Rise in unemployment lack of job security decreasing non-material

welfare.

• Decreases in government spending may mean decreased expenditures in education or healthcare deprive citizens of better learning facilities or healthcare services fall in non-material standard of living.

• Decrease in employment + increase in personal income tax may increase social unrest due to protests in the EU (Extract 4) disruptions to work due to protests would further affect production levels, hindering economic recovery


Anti-thesis: EU’s SOL may not worsenExplain how the austerity measures may increase AD in the long run: When austerity measures are implemented and are successful reduce govt budget deficit and reduce debt credit rating of the country improves improves investment climate in the country. When the EU adopts austerity measures to generate revenue in order to reduce government debt (Extract 4), this may help to maintain investors’ confidence in the economy. This will encourage FDI inflows and hence ensure long-term sustained economic growth of the country. Increases in FDI can lead to increases in both AD and AS as shown below, where real output can increase from Y1 to Y2 with increases in productive capacity as AS increases from Yf to Yf1.


Employment levels can also increase as demand for labour increases to produce more output. When there is a rise in real output and employment levels, the amount of goods and services available for consumption in the country increases, thereby increasing the material SOL of the EU.

Conclusion + Evaluation:Take a stand: Austerity measures may prove to be more harmful to the Eurozone in the short run given the extent of the various consequences analysed above with the main cost being worsening economic recovery although its benefits are for ensuring long-term economic growth.


Evaluate: the effectiveness of the policy is dependent largely on the appropriateness of fiscal measures selected in minimizing the disincentive effects of increased taxation and reduced government spending. For instance, • To reduce the disincentive effects of increased taxation on labour

productivity, the government may want to increase the tax revenue from other tax sources i.e. indirect taxes instead which do not have disincentive effects on work.

• Government spending should also be cut and directed on spending that will aid economic recovery i.e. boosting productivity gains such as grants for re-training and innovation purposes which will lead to both increases in AD and AS, hence ensuring a more sustained economic recovery.

(d) To what extent does Singapore’s approach to international trade require adjustment in

response to the Eurozone crisis? [8]

Requires some discussion to make a reasoned conclusion and judgment

Explain the current approaches to

international trade

How will the Eurozone crisis impact Singapore?

Should the approach(es) continue

to be used? Are any changes needed in light of the crisis?

(d) To what extent does Singapore’s approach to international trade require adjustment in response to the Eurozone crisis? [10]

Common errors:1. Not explaining the impact on Singapore due to the Eurozone

crisis first, to set the context2. Incorrect interpretation of the question3. Not explaining what the current approaches to international

trade are, before suggesting the adjustments/changes 4. Answering the question as if it was a pure policy question i.e.

what policies should be implemented5. Explained policies that were unrelated to SG’s approaches to

INTERNATIONAL TRADE e.g. wrote at length on policies to promote growth, etc


Answer:

IntroductionComment on Singapore’s context: Singapore is a small and open economy, which is highly dependent on exports for her economic growth. External demand is estimated to make up about 75% of Singapore’s demand. The trade to GDP ratio is about 300%, which also suggest the importance of trade to the economy. EU is one of Singapore’s top export destinations in 2013. Singapore’s trade-driven economy contracted by 1.1% in the second quarter from the previous three-months due to a slowdown in global demand, which stems from the Eurozone crisis. Other major economies like China and the US, which used to export aggressively to the EU also suffered as a result.


Development 1: Impact on Singapore’s economy due to Eurozone crisis EU’s response to the crisis: Growth in protectionist measures (Extract 4) to tackle unemployment and recession due to austerity measures

OR

Fall in disposable income and recession in EU (Extract 3)

Both impacts will lead to a fall in export revenue in Singapore. As EU imports less, this will result in a fall in aggregate demand in the Singapore economy. The larger the fall in exports, the larger the leftward shift of the AD, and this reduces real output (Fig 2). This will lead to a fall in employment, as firms lay off workers due to reduced output. National income of the country will also be reduced by a multiplied amount through the multiplier process.

(AD-AS model)


Development 2: Singapore’s approach to int’l trade + assessment of extent to which the approach to trade needs to be adjusted due to Eurozone crisis

(Describe Singapore’s approach to trade) Singapore aims to continue to keep its exports competitive through a variety of means: A slight appreciation of the currency, supply side policies and lastly by signing Free Trade Agreements (FTAs). By doing so, it will allow the country to continue to have high growth driven by the country’s exports.


Explain reason for gradual appreciation of S$)

• Allows the country to curb imported inflation Singapore lacks natural resources and needs to import raw materials for production An increase in cost of raw materials will reduce the price competiveness of domestically produced goods.

• However, if the SGD were to appreciate too much, Singapore would also lose its export price competitiveness, as the price of the exports in foreign currency will be relatively higher to foreign countries.

Extent of change necessary- In light of falling export revenue, SG should consider making adjustments to its current policy of a gradual appreciation of its domestic currency to one of zero appreciation or depreciation of the domestic currency. With a policy of depreciation of the SGD, this will allow the price of Singapore’s exports to be cheaper in terms of foreign currency. Assuming that the demand for exports is price elastic, this would mean a more than proportionate increase in the quantity of exports, increasing export revenue.


(Explain an example of S’pore’s SS side policies)

• Singapore also uses supply side policies to improve price competitiveness and non-price competiveness e.g. improving the labour productivity through skills upgrading and retraining

• An improvement in labour productivity low Unit Labour Cost (ULC), which will raise the price competitiveness of goods produced in Singapore

• Policies to encourage innovation of newer products incentive for firms to innovate so that they can continue to create new and better products and services to ensure that the country maintains its comparative advantage in a variety of high value-added sectors

• This is particularly important, as producing affordable and high quality exports would be a priority amidst global recession.

Extent of change necessary - Supply side policies should continue to be of importance to Singapore to maintain its price and non-price competitiveness and innovation. However, the cost of such policies will continue to be high, as the government will have to subsidise or provide grants to firms or workers.


(Explain the benefits of Signing FTAs)

• FTAs are binding agreements between countries to reduce or remove trade barriers to facilitate cross border movement of goods and services

• Singapore has many FTAs in place already including bilateral FTAs with Japan, Korea and the United States and also regional FTAs between ASEAN and other countries

• Signing of FTAs with other countries results in a larger export market for Singapore’s firms further growth of the economy

• Increased export volume will also allow firms to benefit from economies of scale through large-scale production

• This is especially important since the traditional export destinations are seeing a contraction of their economies. Seeking new and non-traditional destinations for Singapore exports would be of great importance.Extent of change necessary – In the event of a recession in Singapore’s

export destinations, signing of FTAs with new countries will be necessary to negate or minimize the impacts Eurozone crisis on Singapore’s exports. However, the success rates of the FTAs depends on the take up rates by firms.


Conclusion:As a result of recession in EU, EU might further protect their domestic economy; with increasing protectionism, this can have a large impact on Singapore’s national income. To counter this phenomenon, Singapore needs to continue in its approach to trade. Though the types of policies that implemented should not change, more resources should be directed towards negotiating FTAs among the countries that Singapore exports to. In addition, while Singapore should adjust its policies to adapt to changes in the global economy, there also needs to be policies to develop the domestic market, so that we become less dependent on trade with Western economies like the EU and US which are less stable. Singapore also needs to start to develop regional trade and our domestic economy, and shift our focus away from export-led growth to productivity-led growth.

(b) “U.S. Federal Reserve official urged the European Central Bank (ECB) on Tuesday to consider employing a U.S.-style quantitative easing programme to counter slowing inflation and recession in the euro zone.”

(i) Using a diagram, explain how quantitative easing can possibly resolve the recession in the EU. [3]

Common errors:1. Not paying attention during lecture 2. Commenting on the impact on the Euro increase in money supply

due to QE =/= increase in the supply of Euros in the Forex market!!3. Writing too much for a 3 mark question adjustment process not

necessary in this case

(b)(i) Using a diagram, explain how quantitative easing can possibly resolve the recession in the EU. [3]

Answer:Explain what the policy is:The policy of quantitative easing is designed to inject money into the economy, through the purchase of assets by the Central Bank. Most of the assets purchased are government bonds. (Extract 5) Explain how the policy increases Cd and/or I:There will be an increase in the availability of credit financial institutions now have more money that can be used to lend out to firms or households on more favourable terms, which increases the amount of investment and domestic consumption in the economy ORAn increase in money supply will lead to a fall in interest rates. This will lower the cost of borrowing which then leads to an increase in borrowing by firms and households increase in Cd and increase in I.

(b)(i) Using a diagram, explain how quantitative easing can possibly resolve the recession in the EU. [3]

Link to increase in AD + diagram:This will lead to an increase in AD from AD1 to AD2 increase in real output from Y1 to Y2 actual growth achieved resolving recession

(b)(ii) Using appropriate data, explain the significance of the multiplier in determining whether quantitative easing should be employed by the EU. [6]

Common errors:1. No comment on the implication of a high MPW on the multiplier

effect• Very mathematical answers: high MPW therefore small

multiplier2. No comment on the implication of a small k on the use of QE

Answer:

Definition of the multiplier• An increase in AE will lead to a multiplied increase in national income

through the multiplier process ΔNY = k x ΔAE• Hence the size of the multiplier in an economy determines the

effectiveness of demand management policies like Quantitative Easing in raising the national income to correct a recession.

• The size of multiplier is calculated by K = 1/ MPW [must include formula]. Thus, the smaller the MPW, the greater the size of multiplier


Implication of the multiplier on policy making decisionKnowing the size of the multiplier will allow EU to decide how much to increase the money supply in order to bring about the desired outcome in the economy.

Using data from Extract 5

• In Extract 5 it is mentioned that there are high leakages as a result of increasing tax rates (increase in MRT) due to the austerity measures and EU’s tradition as the largest world importer of goods and services with a forecast import of goods and services at 43% (high MPM) of GDP in 2013.


Significance of the multiplier

[Highlighting the implications of high leakages] Since MPW is high, this would mean large amounts of leakages with increases in national income. As such, with each increase in national income, there would be lesser money being passed around in the economy in the inner flow. [Policy implication of a small multiplier] This would mean that the EU has a small multiplier and thus would require a large increase in money supply in order to attain a large increase in real GDP. This might not be feasible, as it requires the government to buy large amounts of bonds and financial assets from commercial banks at a time when most of its governments are in budget deficit.


Evaluation (if the direction word is “evaluate”):

However there are other criteria that need to be considered, for example, the business outlook in the economy. If business outlook is poor, then increases in money supply with the aim of increasing Cd and I may be futile

OR

There is not enough data to determine the size of the multiplier and more information is required.

(a)(i) Using Table 1, describe the trend of real GDP growth rate in Eurozone from 2007 to 2012. [1]

Some common errors:1. Commenting on real GDP instead of real GDP growth rate2. Writing too much for a 1 mark question3. Commenting that real GDP growth has worsened doesn’t

explain trend

Answer:

Real GDP growth rate shows a decreasing trend in Eurozone from the period 2007 to 2012.

Year 2007 2008 2009 2010 2011 2012Change in nominal GDP (%)

5.4 2.4 -3.5 2.8 2.7 0.7

Inflation rate (%) 2.1 3.3 0.3 1.6 2.7 2.5

Unemployment rate (%) 7.6 7.6 9.6 10.1 10.2 11.4

Change in real GDP (%) 3.3 -0.9 -3.8 1.2 0 -1.8

NOTE: real GDP growth rate = nominal GDP growth rate – inflation rate

(a)(ii) Explain the link that exists between real GDP and unemployment rate for Eurozone between 2010 and 2012. [2]

Common errors:1. Looking at nominal GDP growth rates instead of calculating real GDP

growth rates ended up commenting that “real” GDP was increasing2. Cause and effect incorrectly identified increasing unemployment

therefore falling real GDP3. Not explaining why the relationship exists, just merely quotation of

data

Year 2007 2008 2009 2010 2011 2012Change in nominal GDP (%)

5.4 2.4 -3.5 2.8 2.7 0.7

Inflation rate (%) 2.1 3.3 0.3 1.6 2.7 2.5

Unemployment rate (%) 7.6 7.6 9.6 10.1 10.2 11.4

Change in real GDP (%) 3.3 -0.9 -3.8 1.2 0 -1.8

Real GDP is falling

Unemployment rate is increasing

(a)(ii) Explain the link that exists between real GDP and unemployment rate for Eurozone between 2010 and 2012. [2]

Common errors:1. Looking at nominal GDP growth rates instead of calculating real GDP

growth rates ended up commenting that “real” GDP was increasing2. Cause and effect incorrectly identified increasing unemployment

therefore falling real GDP3. Not explaining why the relationship exists, just merely quotation of

data

Answer:Identify the relationship [1m]:There is an inverse relationship between real GDP and unemployment rate. ORA fall in real GDP leads to an increase in unemployment rate. Explain the relationship [1m]:As real GDP falls, real income of the households and firms in the economy also fall, leading to a fall in real output in the economy. As labour is a derived demand, there would be a corresponding fall in the ADL. Given that there are sticky wages in the labour market, this would lead to an increase in demand-deficient unemployment.

jc2 h2 prelim 2013 9732/01 csq 2 post mortem. the eurozone crisis

Documents

eus standard of living

purpose of austerity

material sol

labour fall

multiplied fall

tax rates eus sol

evaluation material

material aspects