Introduction

Many hold that economic growth is the single most important factor influencing poverty and that macroeconomic stability is essential for growth, therefore it is widely suggested that macroeconomic stability should be promoted. Furthermore, because low inflation is good for the poor, macroeconomic stability is even more essential for poverty reduction. This study argues that such claims are incomplete. Without clarifying the effect of inflation on the poverty line and the repercussions of output fall on the incomes of poor households, the derived policy could be misleading. At the very least, it is too general to be useful for policymaking when poverty reduction is among the overall goals. The usual argument— “what really matters is quality of growth”—is also insufficient since it does not provide clear guidance as to how much tightening or expansion is needed and how to achieve it.

The literature on poverty and worldwide experience has also confirmed that income inequality matters, i.e., growth associated with progressive distributional changes will have a greater impact on poverty (World Bank, 2001). But again, this line of reasoning requires further explanation as to how the income distribution can be improved while simultaneously making the economy grow faster. The bottom line is that growth, stability, income inequality, and poverty are all endogenous and interrelated.

This study analyzes the link between macroeconomic policy and poverty by delving into the theoretical and empirical side of the link. The starting point was to measure the slopes of the aggregate supply (AS) and aggregate demand (AD) curves. Given the elasticity of the poverty line with respect to price level and of household incomes with respect to output, these slopes determined the resulting impact of macroeconomic policy shock on the poverty line and incomes of the poor. Since growth and income distribution are endogenous and the transmission mechanism from policy shock to these variables is unarguably complex, the empirical test to measure the two elasticities is based on a computable financial general equilibrium (CFGE) model that captures the intricate links between the financial sector and the real side of the economy. Thailand and Indonesia are used as case studies.

Interest in the study of the link between macroeconomic policy and poverty has been peaked and fallen numerous times. The most recent renewed interest was triggered, among other things, by the poverty impact of the macroeconomic and financial policy response to the crisis that spread across the globe during the 1990s. In its transcript on the Panel on Macroeconomic Policies and Poverty Reduction, the International Monetary Fund (IMF) stated, “While there is a great deal of literature and experience on poverty and poverty eradication, many of the links between macroeconomic policies and poverty are not well understood” (IMF, 2001). An IMF study by Cashin et.al (2001) also stated that key questions about the nature of crises responses and their impact on poverty are being asked but not researched, and as quoted by Bretton Woods Update (2001) "there appears to be little or no research so far exploring how or why the extent of worsening poverty differs across crisis-hit countries." This study is an attempt to fill that gap. In addition, a more fundamental goal of this study is to provide guidance for making poverty reduction an important additional target variable in the conduct of macroeconomic policy by identifying the nature of interrelations between macroeconomic stability, growth, and poverty, and by quantifying the extent of the trade-offs that may arise.

Section II of this paper discusses the effectiveness of AS and AD shocks in promoting growth and stabilization by estimating the slopes of the AS and AD curves. Two Asian countries, Thailand and Indonesia, are used as case studies. By adopting a decomposition technique, I found that the AS curves in both countries were flat, and got even flatter, after the Asian financial crisis; a negative AD policy was not effective to combat inflation under such a condition, but a positive AD shock would have been effective to stimulate noninflationary growth. Section III discusses the concept of how such findings relate to poverty measure, in which the transmission mechanisms from changes in general price levels and output to the poverty line and household income are explained by way of a general equilibrium model. Section IV addresses the analysis based on the results of model simulations that focus on the impacts of expansionary and contractionary policy on income inequality and poverty. Finally, Section V reports and examines the study’s conclusions.

Download this Discussion Paper [ PDF 978KB| 34 pages ].

Post a Comment

We welcome your feedback on this publication. Post a comment. ADBI is not obliged to acknowledge or publish comments and may abridge or edit them before web posting.

Comment(s)

There are [1] comment(s) for this entry. Post a comment.

1. Ruly
   (posted 11 July 2008 / 02:08:15 PM)
   
   This paper gives me a new insight about the real condition of my country economy, and how the authority (government) had applied many conventional economic policies, which is not suitable for Indonesian economy that has different characters and conditions from the west, the origin of these conventional policies..
   
   Furthermore, I was very lucky because the author presented this paper in my class as a guess lecturer about 2 months ago. For the first time after 1.5 years studying economics, a lot of my "unanswered" questions being answered, and I even didn't have to ask..