Macroeconomic Policies and Objectives - Coursework Example

? Macroeconomic Policy And Objectives s The primary objective of a macroeconomic policy is to increase the overall growth in the economy by an increase in the national income, and therefore a better standard of living for the people of the country. This also increases utility in the economy as the amount of disposable income will rise. There are also some common secondary objectives of macroeconomic policies. One of these is sustainable growth. This means an increase in growth over a period of time and that which is not affected by the environment and other structural factors. The government also wants that the economy function at the full employment level, so that all the people who are capable and willing to work would be able to attain a job, however the natural rate of unemployment will never be zero due to seasonal, structural and other reasons. (McConnell & Brue, 1996) Zero inflation is considered bad for the economy; however, the inflation rate shouldn’t be too high or even too low in the economy and shouldn’t change rapidly. The government wants to sustain the inflation at a moderate and sustainable level. The prices and accordingly the demand of goods and services will vary according to the price level and therefore it is important that the general price level remain stable in the economy. Lastly, the government also aims at keeping their finances sound as well as the balance of payments account. (McConnell & Brue, 1996) However it is difficult to classify the objectives in order of their importance. And this makes the task of the government difficult due to clashing objectives and a tradeoff needs to be made. Such as a policy that would perhaps stimulate overall demand or aggregate demand in the short run may reduce unemployment but that may increase inflation in the long run and go against the government’s objective of maintaining moderate inflation rate. This may also lead to a worsening of the balance of payment position and the government needs to make a choice as to what is more important. At the same time, growth and inflation are considered to be of utmost importance because growth is what improves the standard of living for people and controlling inflation also leads to general price levels being stable and thus attaining the goal of sustainable growth. Inflation is supposed to be the most important goal to achieve since it is believed that the other aims would be difficult to achieve in the long run if the sustainable inflation rate is missed. (McConnell & Brue, 1996) Governments can employ two policies in times of a recession, that is, a decline in GDP as well in times of expansion, that is, a rise in the GDP level. And these are: fiscal and monetary policies. Fiscal policies involve government expenditure and taxes to increase or decrease the economic activity. There are two types of fiscal policies: contractionary and expansionary fiscal policies. Contractionary fiscal policy is when the government spends less that the tax revenue, that is, the taxes are higher and government spends less on the economy to finance their debt. They also try to increase public sector borrowing requirement. An expansionary fiscal policy is used to expand the economy when it is in recession by the government spending increasing and a reduction in taxes. This leaves people with more disposable income and consumption and spending in the economy increases overall. The figure for an expansionary fiscal policy is shown below: A situation where G=T is one where the overall tax revenue funds the overall government spending and this is called a neutral fiscal policy and is applied in an economy which is in equilibrium. Fiscal policies can help with the objectives of achieving a stable growth rate, full employment and price stability. However, government spending and borrowing can also lead to high interest rates, and when a debt is incurred, it may need to be facilitated from overseas, monetization or public borrowing. This can actually deter the purpose of increasing the aggregate demand if the policy is expansionary and lead to crowding out as the aggregate demand actually fall rather increases. However, it can be good for a liquidity trap since the effect of crowding out and rising or falling interest rates is minimal. It can also increase inflation rather than decrease it if for example if there are time gaps in the implementation of the policy. It doesn’t increase inflation if the resources that would otherwise have been wasted are used. But if it uses resources that would’ve been employed despite the policy, then the increased demand would actually lead to an increase in price level and inflation would soar above the moderate level. These policies of taxes and government expenditure however may not have time lags and are also referred to as automatic stabilizers. (Davis & Institute., 1992) Monetary policies use exchange rates, money supply and interest rates to change the pattern of economic activity as well as inflation. The government uses the interest rate to maintain a moderate rate inflation as supply side policies overall aim to increase the growth of an economy. Monetary policies aim to achieve the policies of stable growth and moving the economy towards full employment level. Again, there are two types of monetary policies: expansionary and contractionary. A contractionary policy is when the government increases the interest rate and the money supply is not allowed to grow or it only increases incrementally. This is the function of the Central Bank primarily. Expansionary monetary policy aims at reducing the interest rate and increasing the money supply in the economy so that there is more borrowing and more spending, and overall greater economic activity. The way to go about achieving this policy is primarily through open market operations. This is the buying and selling of financial instruments in the open market, be it treasury bills, government bonds, foreign currencies etc. Another policy is through a discount window that is, making those institutions that pass a certain criteria, eligible to borrow money from the central bank so that they can pay of certain short term issues with liquidity at a certain rate called the discount rate. The reserve requirement rate can also be changed, that is, the amount of reserves which the central bank makes compulsory for the commercial bank to hold. The graph for the expansionary monetary policy is as follows and this can be compared with the graph for an expansionary fiscal policy since the AS curves of both policies is different: (Davis & Institute., 1992) The two policies are usually used in combination with each other. Monetary policy can slow down the economy and fiscal policy can expand the economy and together they can stabilize the economy. The Federal, which is the central bank can work independently and faster however since the government needs to adhere to all the aspects of the type of policies being followed, it can slow down the process. Increasing interest rates deter people from borrowing and to do so, monetary policies are more effective than fiscal policies. Fiscal policies would have to resort to increasing tax rates or decreasing spending and this is less effective than supply side policies. However, in times of recession, people are reluctant to spend, no matter how low the interest rate is, and therefore in such scenarios, fiscal policies are more effective than monetary policies in stimulating demand in the economy. It is also banks which would be reluctant to lend and this grouped together with the people unwilling to borrow would lead to the monetary policies being ineffective and fiscal policies doing the trick. Also, once you cut down the interest rates, and they hit zero, there is nothing that can be done to improve the scenario and this is called the liquidity trap. If this doesn’t spur growth and demand, then fiscal policy is the best option. At this point, consumers are also willing to keep and save more than spend money which renders the monetary policy ineffective. When investment is extremely sensitive to interest rates, then the fiscal policy would be ineffective as consumers have the ability to offset the action by the government be it a change in spending or tax collection. There is also an ongoing debate that fiscal policies can be used for short term problems, and they should be quick and targeted to be effective, otherwise they lose their effect where as monetary policies take time to implement and are for short term solutions. Either way, both policies have the same objective of stabilizing the economy and achieving the aforementioned objectives of the government. (Walz & Schleich, 2009) References Davis, J. M. & Institute., I., 1992. Macroeconomic adjustment : policy instruments and issues. s.l.: International Monetary Fund. McConnell, C. R. & Brue, S. L., 1996. Economics : principles, problems, and policies. New York: McGraw-Hill. Walz, R. & Schleich, J., 2009. The economics of climate change policies : macroeconomic effects, structural adjustments and technological change. s.l.:Physica-Verlag. Read More