5.

1 – Government Economic Policy

The public sector in every economy plays a major role, as a producer and employer. Here are
some functions of the government:

 To provide goods and services that are in the public interest. This will include public goods
and merit goods.
 To invest in national infrastructure (roads, railways, schools etc)
 To support agriculture and other prime industries
 To manage the macroeconomy
 To help vulnerable groups of people in the society.

The Macroeconomic Aims

The govt. has four major macroeconomic objectives:

 A low and stable rate of inflation– Inflation is the continuous rise in the average price
levels. If prices rise too quickly it can negatively affect the economy because it can:
1. Reduce people’s purchasing powers: people will be able to buy less with the money
they have now, than before.
2. Cause hardships for the poor.
3. Increase business costs especially as workers will demand for more wages to support
their livelihood.
4. Will make products more expensive than products of other countries with low inflation.
This will reduce exports.
 A high and stable level of employment. If there is a high level of unemployment in a
country, the following may happen:
1. The total national output (goods produced) will fall.
2. Government may have to give welfare payments (unemployment benefits) to the
unemployed, increasing public expenditure.
 Stable and good economic growth. Economic growth refers to the gross domestic product
(GDP) per head, i.e, the amount of goods and services available for every person in the
economy. More output means more economic growth. But if output falls over time
(economic recession), it can cause:
1. Employment, incomes and living standards of the people will fall.
2. The tax the govt. collects from goods and services and incomes will fall, which will, in
turn, lead to a cut in govt. spending.
3. The revenues and profits of firms will fall.
4. New investments will be very low, that is, people won’t invest in new firms
as economic conditions are poor and it will yield low profits.
 A stable balance of international trade and payment. Economiesexport (sell out)many of
their products to overseas residents, and receive other incomes and investments from
overseas by foreign investors (inward investments). This will bring in more incomes and
jobs into the economy. At the same time, economies also import (buy in) goods and
services from other economies, and make investments in other countries, to bring in more
goods and services for the people.
Exports > Imports = Surplus Exports < Imports = Deficit
All economies try to balance this inflow and outflow of international trade and payments
 and try to avoid any deficits because:
1. It may run out of foreign currency to buy imports.
2. The value of it’s currency may fall against other foreign currencies and make imports
more expensive to buy.

Another supporting aim is:

 Reduced inequality in income and wealth, along with low rates of poverty. A high rate of
poverty will mean:
1. A low standard of living, reflecting on the economy badly.

Macroeconomic Policies
These are policies used by the govt. to influence macroeconomic aims.

Demand-Side Policies:
These policies influence on demand in an economy.

Fiscal Policy: This policy uses govt. spending and taxation to influence
aggregate (total) demand which will eventually result in changes in the economic aims.
Expansionary fiscal policy is where govt. spending is increased and tax is cutto increase
aggregate demand. More govt. spending means more economic activity and usage of public
and merit goods and less taxation means more money for consumers to buy products and
less prices for products. All this will raise aggregate demand. Economic growth will rise
(as more output is produced), balance of payments will improve (more goods and services
will be available for exports), inflation will lower (prices lower), employment will rise (more
output,more job opportunities).
Contractionary fiscal policy is where govt. spending is cut and tax is increased to reduce
aggregate demand. Less govt. spending will reduce economic activity and high taxes will
result in higher prices and less disposable incomes for consumers. This will make a reduction
in aggregate demand. The opposite effects will befall the economic aims. But why would the
govt. reduce economic growth? A high economic growth usually brings about inflation and in
the long-run unemployment. This will be discussed later.

Monetary Policy: This policy uses interest rates and money supply to influence aggregate
demand and thus make changes in the economic aims.
Expansionary monetary policy is where the govt. increases money supply and cut interest
rates to increase aggregate demand. More money supply will mean more money being
circulated among the govt, producers and consumers, increasing economic activity. Low
interest rates will mean more people will resort to spending than saving, and businesses will
invest in more money, as they will only have to pay little interest. Economic growth and an
improvement in the balance of payments will be experienced, employment will rise.
 Contractionary fiscal policy cuts the money supply and increases interest rates to reduce
economic growth. The opposite effect will take place- low economic activity.

Supply-side Policies
These policies affect the supply in an economy, generally to increase output and thus
economic growth They are:

 Subsidies: more subsidies means more money for producers to produce more, thereby
increasing aggregate demand.
 Improving education and training: to improve the quality and quantity of labour ad
increase output produced.
 Privatization: transferring some public corporations to private ownership will increase
efficiency and increase output.
 Deregulation: removing burdens and unnecessary or difficult laws so that businesses can
operate and produce more output with reduced costs.
 Removing trade barriers: the govt. can reduce or withdraw import duties, taxes etc so
that more resources/ goods and services may be imported.
 Labour market reforms: making laws that would reduce trade union powers would reduce
business costs and increase output. Also, restrictions on labour supply could be reduced,
so more jobs will be open and increase output. Welfare payments like unemployment
benefit could be reduced so that more people would be motivated to look for jobs rather
than rely on the benefits only.

Policy Conflicts
The above mentioned macroeconomic policies can be difficult to achieve all at once- that is
they may conflict with one another.

Economic Growth & Full Employment VS Low and Stable Inflation

A high rate of economic growth and low rates of unemployment will boost incomes of
businesses and workers. This rise in income can cause firms to raise their prices- resulting in
inflation.
Economic Growth & Full Employment VS A Balance Of Payments
Once again as incomes rise due to economic growth and low unemployment, people will
import more foreign products and consume less of domestic products. This will cause a rise
in import values relative to export values and a margin for deficit may arise in the balance of
payments
Economic Growth VS Full Employment
In the long run, when economic growth is continuous, firms may start investing in more
capital (machinery/equipment). More capital-intensive production will make a lot of people
unemployed.