Assess macroeconomic policies which might be used to respond to rising commodity prices during a period of slow economic growth

Commodities are a raw material or primary good, and they are often fungible. There are three main types of macroeconomic policy. Fiscal policies use taxation and government spending to affect AD, monetary policy used interest rates to manipulate AD and supply side policies aim to increase the productive capacity of the economy. Policies in response to rising commodity prices may look to reduce the inflationary effect this will have, whilst preventing slow economic growth turning into a recession. One fiscal policy the UK government may use in response to commodity prices rising is to reduce the level of corporation tax, from 21% to 15%. Firms may use commodities in order to manufacture consumer or capital goods, such as the use of copper wires in electrical goods. Thus a rise in commodity prices will increase the factor input costs of production, raising firm’s average costs. This may force firms to raise their prices, creating inflationary pressure. However a decrease in corporation tax will see firms’ profits be maintained or even increase. Thus the firms will be able to keep their prices the same, thus protecting consumers, who do not experience a negative income effect, and other firms do not see the cost of capital goods rise, such as computers for a financial services firm, and so they maintain their profit margins. However, the government will see a fall in the revenues raised from corporation tax. This may mean that they are forced to reduce their spending, a component of AD. Thus AD will shift inwards, from AD1 to AD2. Whilst this may help to reduce the inflationary impact of rising commodity prices, as the price level falls from P1 to P1, the real output of the economy falls from Y1 to Y2, thus seeing economic growth fall and the economy may therefore fall into recession during this period of slow economic growth. Another macroeconomic policy the UK government may introduce would be to increase National Minimum Wage. As commodities are used to make consumer goods, a rise in their cost may see the cost of goods to the consumer rise also. Thus the consumer will see a negative income effect, seeing living standards fall as a consequence. By raising NMW closer to the living wage, consumers would see their incomes rise, and so the increased cost of living will be negated in real terms. Furthermore, increased wages will see consumption increase. As this will raise AD, economic growth may be stimulated an important consequence if the economy is stagnating. However, as not all consumers are either working or on the NMW, many will not see a rise in incomes. Workers on NMW may more likely be in the secondary sector, and so this may have a similar effect as rising commodity prices will on the firms. Thus raising NMW may enhance the inflationary pressure, seeing an overall fall in real incomes nationally. Governments in areas with large access to resources may wish to perform supply side policies through investing in these industries. For example the South Sudanese government may set up state owned oil companies, or subsidise firms in order to exploit the availability of oil in the region. By subsidising firms to increase their output of commodities, such as oil, these firms will expand and thus the government will see an increase in revenues from corporation tax. Furthermore, the expansion of these firms will see a positive multiplier effect in the country, increasing living standards as employment rises, and the government will also gain from increased income tax revenue. Yet, as commodity prices are highly volatile, this rise may only be short term, and thus the benefits of expanding this industry may be short lived. The high cost of these projects will also carry an opportunity cost, as countries like South Sudan may need to invest heavily in healthcare to combat diseases like AIDS and Malaria. Lastly, governments of countries with large access to commodities may wish to perform monetary policy by reducing its interest rates. Countries like Zambia with large copper stores may decrease interest rates in order to decrease the cost of loans to firms. This will see firms increasing their capital flows, and investing more into the production of commodities. They will thus see profits rise, and will thus be able to further invest into R and D, areas key to the sourcing and production of commodities. The firms may be able to find new oil fields, or invest in more efficient machinery for extracting minerals. Thus these firms will be able to grow and thus there will be benefits seen in these countries, as listed previously. However, in countries like Zambia, there may not be the infrastructure in place to implement monetary policies, due to a lack of coordination by the limited financial institutions in place. Firms may thus be unaffected by these changes, and furthermore they may be foreign owned by countries such as China. This will thus see a repatriation of profits, limiting benefits seen by the host country.