Link between weak wage growth and weak short term economic growth

MACROECONOMICS 1
MACROECONOMICS
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MACROECONOMICS 2
Question1 An explanation of the link between the weak wage growth and the weak short term
economic growth by the use of aggregate expenditure model
An aggregate expenditure model incorporates the spending components in explaining economic
growth. It generally involves four components namely the consumption, investment, government
expenditure and the net exports (Robinson 2013, p.1). In the short run period, holding the
prevailing price for goods and services in the economy constant, the spending level as depicted
by the aggregate expenditure model gives an indication of economic activity level in an
economy.
Consumption: weak wage growth means that consumers in an economy have less income to
spend on their daily needs. This, therefore, means that the consumer demand for goods and
services decreases due to less income. Businesses, on the other hand, reduce their production
level as the demand for their commodities decreases. As a result, the total output in the economy
decreases as the aggregate demand decreases and as a result, the economic growth deteriorates.
Investment: weak wage growth leaves consumers with little to spend and as a result, they
decrease their expenditure on goods and services. This means that the demand for business goods
and services decreases and hence they have to lower their production volume and cut their
investment which they may have intended to expand their productivity (Justiniano, Primiceri and
Tambalotti 2010, p.132). This lowers a nation’s aggregate supply. The decline in investment and
low productivity lower a nation’s total output and this makes its economic growth decline.
Net exports: this is the difference between a nation’s exports and imports. Weak wage growth
leaves consumers with little income to spend on imports. The little income also makes businesses
to lower their productivity and cut down their investment. This means that the nation’s exports

MACROECONOMICS 3
decline due to reduced productivity and investment by businesses. As a result, the nation’s net
exports decrease and hence its economic growth declines.
The link between the weak wage growth and the government expenditure exists in that it is lower
government spending that leads to weak wage growth (Dao 2012, p.177). Lower government
spending leads to a decline in investment by making it difficult for businesses to invest in various
sectors of the economy. This leads consumers with lower wages and hence they have to lower
their consumption. The decline in consumption in the economy leads to weak economic growth.
Question2 Effects of cutting interest rates
The effects of cutting interest rates have been discussed based on various factors which include
inflation, wage growth, real interest rates, business investment, productivity improvement, and
economic growth.
A cut in interest rates avails money to borrowers cheaply in that they are charged lower interest
rates. This encourages businesses and individuals to borrow and as a result, more money
circulates in the economy. As a result, inflation occurs but also economic growth increases as the
total output produced increases (Hördahl and Tristani 2012, p.634).
A cut in interest rates increases the total consumption in the economy and hence businesses
make more profit from increased sales due to an increase in aggregate demand. An increase in
businesses’ profits translates to higher wage rates as employees demand wage increase (Keynes
2018, p.145).
A cut in interest rates maintains the real interest rates low and hence encourages businesses and
individuals to borrow more capital for investment and expenditure (Cochrane 2011, p.1047).