Review of the previous lecture

1. Review of the previous lecture • At the macro level, economic growth implies greater availability of public resources to improve the quantity and quality of education, health and other services. • At the micro level, economic growth creates employment opportunities, increases the income of the people and therefore, reduces poverty. • Poverty is generally defined as lack of command over resources to satisfy basic needs, mainly food, shelter and clothing. This approach is basically an income approach as it measures the degree of lowness of income or consumption in the society.

2. Review of the previous lecture • A relative poverty line is set at around 50% of the average per capita income of the country. • The subjective poverty line refers to that level of income at which people feels that their income is just equal to the minimum income required to meet end need. • The absolute poverty line is defined as a minimum socially acceptable level of income or consumption used to distinguish the poor from non-poor.

3. Lecture 27 Part I : Poverty Part II: Five Debates Over Macroeconomic Policy Instructor: Prof.Dr.Qaisar Abbas Course code: ECO 400

4. Lecture 27 Part I Poverty

5. Part I Lecture Outline • Methodologies used in Pakistan • Poverty reduction strategy • Various indicators

6. Methodology used in Pakistan • After two days of extensive consultation organized by the Planning Commission with all the experts on poverty in Pakistan in 2001 a consensus was emerged on the methodology to be followed in Pakistan. • These include: • Calorie intake approach • 2350 calories per adult equivalence • Consumption basked that includes food and non-food items (50% food + 50% non-food) • Nutrition based adult equivalence scale with 0.8 weight for person less than 18 years old and 1.0 far all other individuals • Poverty line be updated by using CPI-based inflation

7. Calories Intake Calories Intake: Poverty Lines Used in the region

8. Poverty Reduction Strategy followed by Pakistan

9. Real GDP grew at an average rate of 7% p.a in the last five years Barring two years real GDP grew at an average rate of 3.8% p.a. in the 1990s

10. Unemployment Declined as growth accelerated

11. Pace of Job Creation Increased: 11.8 million jobs created in six and a half years

12. Social Sector and Poverty Related Expenditure (Rs. In Bln)

13. Poverty Indicators 1998-99, 2000-01, 2004-05 & 2005-06 In absolute numbers, 13.0 million people were brought out of poverty

14. How Serious is Poverty in Pakistan (% of population)

15. Comparison of Living Conditions: 1998-2004-05

16. Comparison of Selected Social Indicators %

17. Literacy and Adult Literacy

18. Health Indicators

19. Unequal States

20. Summary of Part I: Poverty • As growth accelerated, unemployment and poverty have declined. • Over 13 million people were brought out of poverty during 2001-08. • 13.5 million jobs were created in 7 years. • Unemployment rate decline from 8.3 percent in 2001-02 to 5.2 percent 2007-08. • Living conditions of the people have also improved. • Inequality increased only marginally during 2001 and 2006 but declined in 2007-08 • Pakistan is one of the least unequal countries in the world. • Consistency and continuity in policies will sustain economic growth and further reduce poverty.

21. Lecture 27 Part II Five Debates Over Macroeconomic Policy

22. Five Debates over Macroeconomic Policy • Should monetary and fiscal policymakers try to stabilize the economy? • Should monetary policy be made by rule rather than by discretion? • Should the central bank aim for zero inflation? • Should the government balance its budget? 5. Should the tax laws be reformed to encourage saving?

23. Five Debates over Macroeconomic Policy Debate I Should monetary and fiscal policymakers try to stabilize the economy?

24. Pro: Policymakers should try to stabilize the economy • The economy is inherently unstable, and left on its own will fluctuate. • Policy can manage aggregate demand in order to offset this inherent instability and reduce the severity of economic fluctuations. • There is no reason for society to suffer through the booms and busts of the business cycle. • Monetary and fiscal policy can stabilize aggregate demand and, thereby, production and employment.

25. Con: Policymakers should not try to stabilize the economy • Monetary policy affects the economy with long and unpredictable lags between the need to act and the time that it takes for these policies to work. • Many studies indicate that changes in monetary policy have little effect on aggregate demand until about six months after the change is made. • Fiscal policy works with a lag because of the long political process that governs changes in spending and taxes. • It can take years to propose, pass, and implement a major change in fiscal policy. • All too often policymakers can inadvertently exacerbate rather than mitigate the magnitude of economic fluctuations. • It might be desirable if policy makers could eliminate all economic fluctuations, but this is not a realistic goal.

26. Five Debates over Macroeconomic Policy Debate II Should monetary policy be made by rule rather than by discretion?

27. Pro: Monetary policy should be made by rule • Discretionary monetary policy can suffer from incompetence and abuse of power. • To the extent that central bankers ally themselves with politicians, discretionary policy can lead to economic fluctuations that reflect the electoral calendar—the political business cycle. • There may be a discrepancy between what policymakers say they will do and what they actually do—called time inconsistency of policy. • Because policymakers are so often time inconsistent, people are skeptical when central bankers announce their intentions to reduce the rate of inflation. • Committing the Fed to a moderate and steady growth of the money supply would limit incompetence, abuse of power, and time inconsistency.

28. Con: Monetary policy should not be made by rule • An important advantage of discretionary monetary policy is its flexibility. • Inflexible policies will limit the ability of policymakers to respond to changing economic circumstances. • The alleged problems with discretion and abuse of power are largely hypothetical. • Also, the importance of the political business cycle is far from clear.

29. Five Debates over Macroeconomic Policy Debate III Should the central bank aim for zero inflation?

30. Pro: The central bank should aim for zero inflation • Inflation confers no benefit to society, but it imposes several real costs. • Shoeleather costs • Menu costs • Increased variability of relative prices • Unintended changes in tax liabilities • Confusion and inconvenience • Arbitrary redistribution of wealth • Reducing inflation is a policy with temporary costs and permanent benefits. • Once the disinflationary recession is over, the benefits of zero inflation would persist.

31. Con: The central bank should not aim for zero inflation • Zero inflation is probably unattainable, and to get there involves output, unemployment, and social costs that are too high. • Policymakers can reduce many of the costs of inflation without actually reducing inflation.

32. Five Debates over Macroeconomic Policy Debate IV Should fiscal policymakers reduce the government debt?

33. Pro: The government should balance its budget • Budget deficits impose an unjustifiable burden on future generations by raising their taxes and lowering their incomes. • When the debts and accumulated interest come due, future taxpayers will face a difficult choice: • They can pay higher taxes, enjoy less government spending, or both. • By shifting the cost of current government benefits to future generations, there is a bias against future taxpayers. • Deficits reduce national saving, leading to a smaller stock of capital, which reduces productivity and growth.

34. Con: The government should not balance its budget • The problem with the deficit is often exaggerated. • The transfer of debt to the future may be justified because some government purchases produce benefits well into the future. • The government debt can continue to rise because population growth and technological progress increase the nation’s ability to pay the interest on the debt.

35. Five Debates over Macroeconomic Policy Debate V Should the tax laws be reformed to encourage saving?

36. Pro: Tax laws should be reformed to encourage saving • A nation’s saving rate is a key determinant of its long-run economic prosperity. • A nation’s productive capability is determined largely by how much it saves and invests for the future. • When the saving rate is higher, more resources are available for investment in new plant and equipment. • The U.S. tax system discourages saving in many ways, such as by heavily taxing the income from capital and by reducing benefits for those who have accumulated wealth.

37. Pro: Tax laws should be reformed to encourage saving • The consequences of high capital income tax policies are reduced saving, reduced capital accumulation, lower labor productivity, and reduced economic growth. • An alternative to current tax policies advocated by many economists is a consumption tax. • With a consumption tax, a household pays taxes based on what it spends not on what it earns. • Income that is saved is exempt from taxation until the saving is later withdrawn and spent on consumption goods.

38. Con: Tax laws should not be reformed to encourage saving • Many of the changes in tax laws to stimulate saving would primarily benefit the wealthy. • High-income households save a higher fraction of their income than low-income households. • Any tax change that favors people who save will also tend to favor people with high incomes. • Reducing the tax burden on the wealthy would lead to a less egalitarian society. • This would also force the government to raise the tax burden on the poor. • Raising public saving by eliminating the government’s budget deficit would provide a more direct and equitable way to increase national saving.

39. Summary of Part II: Five Debates Over Macroeconomic Policy • Advocates of active monetary and fiscal policy view the economy as inherently unstable and believe policy can be used to offset this inherent instability. • Critics of active policy emphasize that policy affects the economy with a lag and our ability to forecast future economic conditions is poor, both of which can lead to policy being destabilizing. • Advocates of rules for monetary policy argue that discretionary policy can suffer from incompetence, abuse of power, and time inconsistency. • Critics of rules for monetary policy argue that discretionary policy is more flexible in responding to economic circumstances.

40. Summary of Part II: Five Debates Over Macroeconomic Policy • Advocates of a zero-inflation target emphasize that inflation has many costs and few if any benefits. • Critics of a zero-inflation target claim that moderate inflation imposes only small costs on society, whereas the recession necessary to reduce inflation is quite costly. • Advocates of reducing the government debt argue that the debt imposes a burden on future generations by raising their taxes and lowering their incomes. • Critics of reducing the government debt argue that the debt is only one small piece of fiscal policy.

41. Summary of Part II: Five Debates Over Macroeconomic Policy • Advocates of tax incentives for saving point out that our society discourages saving in many ways such as taxing income from capital and reducing benefits for those who have accumulated wealth. • Critics of tax incentives argue that many proposed changes to stimulate saving would primarily benefit the wealthy and also might have only a small effect on private saving.