Monetary and Supply-Side Policy: Question 9
Syllabus 4.4
Northgate's government funds the construction of a new national high-speed rail network connecting its major cities, cutting journey times and transport costs for firms and workers across the country.
Which macroeconomic effect would this investment be most likely to have in the long run?
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Worked solution
Step 1: Classify the type of policy
Building a national high-speed rail network is government spending aimed at improving the country’s transport infrastructure. This is a classic example of supply-side policy. It is designed to raise the economy’s productive capacity, not to manage the interest rate, money supply or exchange rate (monetary policy), and it is not primarily aimed at managing demand from year to year (fiscal policy’s usual role).
Step 2: Trace the long-run effect
By cutting journey times and transport costs, the new rail network lets firms move goods and access workers more efficiently, and lets workers reach a wider range of job opportunities. Over the long run, this raises the economy’s productive capacity. The total quantity of goods and services Northgate is capable of producing.
Step 3: Why the other options are wrong
- B: The interest rate is a monetary policy tool set independently by the central bank; infrastructure projects do not have to be financed by raising it.
- C: Infrastructure spending is a supply-side measure, not a monetary policy measure, so it does not work through the exchange rate in this way.
- D: While infrastructure spending can have short-run demand effects, its defining long-run effect is raising productive capacity, not merely a temporary rise in prices.
Final answer
The most likely long-run effect is an increase in the economy’s productive capacity, option A.