Question

Please answer 3 (or all) of the 5 questions below the background information: THIS IS ALL THE INFORMATION AVAILABLE

Background: Some years back policy makers in the Kingdom of Bahrain were faced with rising inflation caused by the fall in the value of the US dollar relative to other currencies. The Kingdom’s currency unit, the Bahraini dinar (BD), is pegged to the dollar, so when the dollar goes down in value the BD goes down as well. A weaker dollar/dinar means that anything and everything Bahrainis buy from overseas cost them more dinars. The dramatic fall in the dollar/dinar essentially made all Bahrainis poorer in terms of what their money would buy. To soften the effect of the peg the government agreed at the time to give each low-income Bahraini household (but not non-Bahraini residents, who represent 52.7% of the Kingdom’s population and 70%-plus of its workforce) BD50 (equal to $133) monthly to make it easier to buy what food and other necessities. We can’t forget, however, that inflation can be caused by putting too much money into the economy and that a rise in the general price of necessities can hurt consumers, especially those with low incomes. The fall in the currency could be compounded with price increases due to the injection of more money.

Given this background, your task is to provide an outline of your plan to determine whether or not this policy makes sense.

1. Behavior matters. What role, if any, will marginalism and incentives play in the questions you ask and the inferences you make in determining whether or not a policy makes sense? For example, what do you assume regarding the economic behavior of those receiving the money? Why might these assumptions matter?

2. Should we address the effects over different timeframes? If so, why does time matter if the problem is likely short lived?

3. What importance, if any, should you apply to the policy stipulation that different groups are treated differently? In short, do non-citizens matter, and if so, why?

4. What questions would you ask of those who drafted the policy for the government, and why?

5. What data might you need to gather, in general, to analyze the proposed policy?

Answer 1

1. While making this policy decision, one might assume that the people who are receiving this money spend it on goods and services so that they have access to such commodities and that the poor people are able to afford goods through these incentives. The value of the dollar shouldn't decline further otherwise the income won't prove sufficient. Thus the assumptions are that the money is sufficient for the people, and that the value of the currency doesn't depreciate further.

2. Yes, we should address the effect over different timeframes cause one should take the long run effects into consideration. If government increases the payment by a large quantum then the debt burden of government might increase. This might lead to more economic stress. Short run solutions have long term consequences which are irrevocable. Thus solving one problem might lead to other problems.

3. One should give much more importance to the implications of policy stipulation as non-citizens do matter because they make up 70% of the workforce, their labour is driving output and if they are not paid or given incentives, it might lead to higher chances of hoarding and non-citizens moving out of the country, which will leave the country with factories but limited labour to propel output.

4. I would ask the questions regarding how the problem of depreciation is going to solve the issue of giving cash in the hands of the low-income, yes it is a short term solution, but this might lead to higher inflation, which would ultimately lead to further decline in the value of the currency. What were the motives behind providing relief to citizens and not the non-citizens because if it is given to the wrong people, it might increase financial distress, how are they expected to solve the long run problem, is pegging the currency to dollar turning out to be effective, can they de-peg the currency.

5. I would need to gather data on how many goods and services are available for $133 monthly. If at the current stage living costs themselves cost $150, then how will $133 be useful. How many people of those low-income households spend on goods and services. How many people will benefit and have no other sources of income. Is the policy being targeted towards the right audience. Expenditure trends of different households.