Economic Policy

NotesQuizCBEMock

THE MAIN TYPES OF ECONOMIC POLICY

Economic policy objectives:

A macro-economic policy relates to economic growth, inflation, unemployment and the balance of payments.

The objectives are:

  1. Achieve economic growth

  2. Control price inflation

  3. Achieve full employment

  4. Achieve balance between import and export

THE IMPACT OF FISCAL AND MONETARY POLICY

  1. Fiscal policy (Keynesian view)

    Fiscal policy (Keynesian view) has to do with the government’s decisions about spending and taxes.  

    This provides a method of managing aggregated demand in the economy.  

    There are several elements to the fiscal policy and that of the budget:

    • Expenditure

      The government spends money both nationally and regionally on such things as health services, educational, roads, policing.  

      It also provides commercial incentives to the private sector through grants.

    • Revenues

      To spend the money on public services the government needs an income. 

      The majority of the income comes from taxes although some come from direct charges like National Health Service charges. 

      A regressive tax takes a higher proportion of a poor person’s salary than a rich person’s. 

      Example - road tax. 

      A proportional tax takes the same proportion of income in tax from all levels of income. 

      A progressive tax takes a higher proportion of income in tax as income rises. Example – Income tax.

    • Borrowing

      Should a governments’ spending exceed its income then it must borrow. 

      The amount it must borrow is known as the PUBLIC SECTOR NET CASH REQUIREMENT (PSNCR)

      This has a profound effect of the fiscal policy as a whole.

  2. Budget Surplus and Budget Deficit

    Should the government use its fiscal policy to influence demand in the economy then it needs to choose either expenditure changes or tax changes, as its policy instruments, or a combination of both. The government could:

    Increase demand by directly spending more itself, for example, future investment and spending on the health service or employing more people. If the government was to influence demand by spending more, this would have to be financed either through increasing taxes or borrowing. However, by increasing taxes, organisations, households and individuals would have less to spend.

    Increase demand indirectly by reducing taxation - Tax cuts are often followed by cuts in government spending. Therefore, total demand will not be stimulated within the economy. Again, tax cuts could also be funded by an increase in government borrowing.  Should the government decide to lower tax then organisations, households and individuals would have more money after tax thus have the ability to spend more.

    When the government is running a budget deficit it means that total public expenditure exceeds revenue. As a result, the government has to borrow through the issue of government debt.  

    If the government sector is taking in more revenue than it is spending, there is a budget surplus allowing the government to repay some of the accumulated debt, of perhaps cut the burden of tax or raise government expenditure.

  3. Monetary Policy

    Monetary Policy looks at the supply of money, the monetary system, interest rates, exchange rates and the availability of credit. 

    All of which are highly important to organisations, households and individuals.  Businesses can be affected by governments' taxation policies outlined within the fiscal policy AND equally affected by high interest rates set out within the monetary policy.

    In the UK, the ultimate objective of monetary policy in recent years has been principally to reduce the rate of inflation to a sustainable low level.  

    The intermediate objectives of monetary policy have related to the level of interest rates, growth in the money supply, the exchange rate of sterling, the expansion of credit and the growth of national income.

  4. Money Supply within the Monetary Policy (Moneterists view)

    This is an intermediate target and should be seen as a medium term target

    The argument is that by increasing money supply this will raise prices and incomes and this will increase the demand for money to spend.

    There are however three short-term unpredictable effects:

    • May cause erratic (sudden) interest rates

    • Time lag. It takes time to cut government spending!

    • Time lag before control over money supply alters expectations

  5. Interest Rates within the Monetary Policy

    There are suggestions that there is a direct relationship between interest rates and the levels of expenditure in the economy or put simply, between interest rates and inflation. 

    A rise in interest rates will raise the price of borrowing

    This could lead to a reduction in investments through the economy should organisations perceive the high rate to be relatively permanent.  

    Profits would fall due to higher borrowing rates and organisations may have to consider a reduction in inventory levels. 

    For individuals, there is less likelihood of borrowing for house purchases.  

    A strong reason for pursuing an interest rate policy is that it can be implemented rapidly compared to other target policies.

  6. The Exchange Rate within the Monetary Policy

    There are few reasons why the exchange rate plays an important part of the monetary policy

    • If exchange rates fall, exports become cheaper to overseas buyers and so more competitive in export markets. However, imports will become more expensive. 

      Therefore, a fall in exchange rates might be good for a domestic economy, by giving a stimulus to exports and reducing demand for imports.

    • An increase in exchange rates will have the opposite effect, with dearer exports and cheaper imports. If this happens, there should be a reduction in the rate of domestic inflation. 

      However, the opposite would happen with a fall in exchange rates therefore, adding to the rate of domestic inflation.

      Rates of domestic inflation need to be controlled prior to introducing a robust target for the exchange rates due to some country’s being heavily dependent on overseas trade

  7. Monetary & Fiscal Policy

    Monetary policy can act as a subsidiary to fiscal policy.  As a budget is usually a once a year event, the government may need to use non-fiscal measures to control the economy. 

    These are typically:

    • Low interest rates or lack of credit control to stimulate bank lending

    • High interest rates to stop bank lending

    • Strict credit control to reduce lending and reduce demand on the economy

Supply-side economic policies are mainly designed to improve the supply-side potential for an economy, make markets and industries operate more efficiently and thereby contribute a faster rate of growth of real national output.  There are two broad approaches to the supply-side.

Firstly policies focused on product markets where goods and services are produced and sold to consumers and secondly the labour market is bought and sold.

NotesQuizCBEMock