Government macro intervention
The main government macroeconomic policy aims are:
● Full employment
● Low and stable inflation
● Balance of payments equilibrium
● Steady and sustained economic growth
● Avoidance of exchange rate fluctuations
● Sustainable economic development
Types of policy
Fiscal policy
Fiscal policy: The use of taxation and government spending to influence aggregate
demand.
Reflationary or expansionary fiscal policy is designed to increase aggregate demand
by decreasing taxation and/or increasing government spending.
Deflationary or contractionary fiscal policy is designed to decrease aggregate
demand by increasing taxation and/or decreasing government spending.
Discretionary fiscal policy: Deliberate changes in government spending and
taxation.
Automatic stabilisers: Changes in government spending and taxation that occur to
reduce fluctuations in aggregate demand without any alteration in government policy.
Budget position
Budget: An annual statement in which the government outlines plans for its
spending and tax revenue.
Cyclical budget deficit: A budget deficit caused by changes in economic activity.
Structural budget deficit: A budget deficit caused by imbalance between
government spending and taxation.
Monetary policy
, Monetary policy: The use of interest rates, direct control of the money supply and
the exchange rate to influence aggregate demand.
Interest rate: The price of borrowing money and the reward for saving.
Money supply: The total amount of money in a country.
Reflationary or expansionary monetary policy seeks to increase aggregate demand
by a cut in interest rates, an increase in the money supply and a reduction in the
foreign exchange rate.
Deflationary or contractionary monetary policy seeks to decrease aggregate demand
by a rise in interest rates, a decrease in the money supply and an increase in the
foreign exchange rate.
Monetary policy measures are usually implemented by the central bank of a country
or area. The central bank may target interest rates and the money supply; by
influencing lending by commercial banks. This is because such lending is a major
cause of changes in the money supply. Exchange rate measures include
government decisions on what type of exchange rate system to operate and, in the
case of a managed and fixed exchange rate, at what rate to set the exchange rate.
Supply side policy
Supply side policy: Measures designed to increase aggregate supply.
Supply side policy measures are designed to increase aggregate supply by
improving the workings of product and factor markets. They may involve reducing
government intervention or increasing it.
Supply side policies:
● Cutting corporation tax: May encourage investment, as firms will have more
funds to invest and they will know they can keep more profit.
● Cutting income tax: May encourage workers to increase their working hours
and accept promotion and greater responsibility. It may enlarge the labour
force by less people wanting to retire and more people wanting to join.
● Reducing welfare payments: This may encourage unemployed people to
put more effort into looking for a job.
● Increasing spending on education: Raises the quality of education,
workers’ skills and productivity may increase as well as their flexibility and
mobility.
● Training programmes: Raises the quality of training.
● Increasing spending on infrastructure: May reduce firms’ transport costs.
The main government macroeconomic policy aims are:
● Full employment
● Low and stable inflation
● Balance of payments equilibrium
● Steady and sustained economic growth
● Avoidance of exchange rate fluctuations
● Sustainable economic development
Types of policy
Fiscal policy
Fiscal policy: The use of taxation and government spending to influence aggregate
demand.
Reflationary or expansionary fiscal policy is designed to increase aggregate demand
by decreasing taxation and/or increasing government spending.
Deflationary or contractionary fiscal policy is designed to decrease aggregate
demand by increasing taxation and/or decreasing government spending.
Discretionary fiscal policy: Deliberate changes in government spending and
taxation.
Automatic stabilisers: Changes in government spending and taxation that occur to
reduce fluctuations in aggregate demand without any alteration in government policy.
Budget position
Budget: An annual statement in which the government outlines plans for its
spending and tax revenue.
Cyclical budget deficit: A budget deficit caused by changes in economic activity.
Structural budget deficit: A budget deficit caused by imbalance between
government spending and taxation.
Monetary policy
, Monetary policy: The use of interest rates, direct control of the money supply and
the exchange rate to influence aggregate demand.
Interest rate: The price of borrowing money and the reward for saving.
Money supply: The total amount of money in a country.
Reflationary or expansionary monetary policy seeks to increase aggregate demand
by a cut in interest rates, an increase in the money supply and a reduction in the
foreign exchange rate.
Deflationary or contractionary monetary policy seeks to decrease aggregate demand
by a rise in interest rates, a decrease in the money supply and an increase in the
foreign exchange rate.
Monetary policy measures are usually implemented by the central bank of a country
or area. The central bank may target interest rates and the money supply; by
influencing lending by commercial banks. This is because such lending is a major
cause of changes in the money supply. Exchange rate measures include
government decisions on what type of exchange rate system to operate and, in the
case of a managed and fixed exchange rate, at what rate to set the exchange rate.
Supply side policy
Supply side policy: Measures designed to increase aggregate supply.
Supply side policy measures are designed to increase aggregate supply by
improving the workings of product and factor markets. They may involve reducing
government intervention or increasing it.
Supply side policies:
● Cutting corporation tax: May encourage investment, as firms will have more
funds to invest and they will know they can keep more profit.
● Cutting income tax: May encourage workers to increase their working hours
and accept promotion and greater responsibility. It may enlarge the labour
force by less people wanting to retire and more people wanting to join.
● Reducing welfare payments: This may encourage unemployed people to
put more effort into looking for a job.
● Increasing spending on education: Raises the quality of education,
workers’ skills and productivity may increase as well as their flexibility and
mobility.
● Training programmes: Raises the quality of training.
● Increasing spending on infrastructure: May reduce firms’ transport costs.
