Discuss the extent to which a government’s macroeconomic policy decisions are affected by the country’s national debt.

Discuss the extent to which a government’s macroeconomic policy decisions are affected by the country’s national debt. [25]

Introduction

National debt refers to debt that is owed by the central government of a country and is usually accumulated through budget deficits each year.

HOW MACROECONOMIC POLICY DECISIONS ARE AFFECTED 

01 Fiscal policy

·      In periods of low economic growth / recession, expansionary fiscal policy may be carried out to achieve the objectives of sustained economic growth and low unemployment.

·      (illustrated inFigure 32) Increase G / Decrease T (to increase C and I) àincrease AD àincrease NY (via k process) àincrease economic growth and reduce unemployment 

Figure 32: Increase in AD

If there is already high national debt, the government may not be able to borrow more to finance their deficit spending. (e.g. in the case of many countries in the Eurozone such as Greece/Spain/Italy). This results in a failure to carry out such a policy, demonstrating how the presence of national debt may limit the usage of such a policy.

02 Supply side policy

Supply side policies may be carried out to improve the supply side potential of the economy, especially in areas such as improving productivity, retraining or R&D which may serve to achieve objectives such as healthy BOP through improving net exports, sustained economic growth, low unemployment and low inflation.

·       Such measures typically requires government funding through subsidies and tax incentives provided

·       Again, the government may be restricted in carrying out such policies if the national debt is already too high, preventing it from borrowing more to finance such schemes

HOW MACROECONOMIC POLICY DECISIONS MAY NOT BE AFFECTED 

·       Contractionary fiscal policies carried out to deal with the problems of inflation and worsening BOP typically improves the budget position as well (since the government is cutting spending and increasing tax revenue!) and therefore are not directly affected by the level of the national debt.

·       Other policy instruments like the exchange rates and interest rates may be used to deal with similar problems. 

Ø  Depreciation of the ER (to boost exports)

Ø  Decreasing interest rates to boost the economy 

·       Dependent on state and nature of the economy

Conclusion

(RWA) Macroeconomic policy decisions can be largely influenced by the national debt. This is evident by how limited the policy options that countries in the Eurozone and the U.S. can adopt to deal with their macroeconomic problems (slow growth) are. They currently use expansionary monetary policy to achieve these objectives, resulting in an abundance of liquidity in the world markets right now. Singapore was also able to swiftly act on dealing with major crisis like the GFC 2008 with the Resilience Package due to healthy government reserves instead of significant debt.

(RWA) If we take an even longer-term perspective of this issue, we can consider how in Singapore’s case – a lack of a national debt and in its place, having huge reserves allows us to make use of returns from the investment of such reserves. This significantly expands our ability to spend each year and allows for broader options when it comes to fiscal policy.