Macroeconomic Policies

Importance of Macroeconomic policies

An awareness of Macroeconomic Policies is important because it helps businesses in planning and decision-making. For example, the Government may decide to raise interest rates, it is important that businesses know how this will affect financing investment opportunities if they rely on loans etc.

Macroeconomic Policy

Macroeconomic Policies are tools used by the Government to manage and influence the performance and behaviour of the economy. These are important because they affect the economy in which businesses operate.

The Key objectives of Macroeconomic policies are:

  • Full employment of resources (Full and Stable Employment)
  • Price Stability (little or no inflation putting upward pressure on price)
  • Economic Growth (National Income)
  • Balance of Payments Stability (Payment Surplus/deficit)
  • Appropriate distribution of Income and Wealth

To achieve these objectives can be very difficult because conflicts between macroeconomic objectives exist. For example, the achievement of full employment may lead to excessive inflation because of the increase of level of aggregate demand within an economy.

Macroeconomic policies can influence the economy and businesses through three instruments monetary policies, fiscal policies and exchange rates.

 Fiscal policies

The government can manipulate budgets to influence the level of aggregate demand and activity in the economy and this refers to fiscal policies. It covers:

  • Government Spending
  • Taxation (Direct and Indirect Taxes)
  • Government Borrowing (illiquid debt – National Savings certificates or liquid debt – Treasury bills)

The role of the Chancellor of the Exchequer in the UK is to balance the budget in two circumstances:

  1. Deficit- Additional spending financed through borrowings
  2. Surplus- Spare funds use to pay off public debts

The two key issues with fiscal policies are ‘crowding out’ and ‘incentive effects of taxation’. Financial crowding out refers to Government borrowings leading to a fall in private investment because high interest creates a greater demand for money & loanable funds. The private sector due to its sensitivity to interest rates will reduce investments because of lower returns which will impact the economy.

The incentive effects of taxation refer to the specific effects of taxation having an adverse impact on the economy. For example, the employer national insurance (NI) payments raise the cost of labour which also reduces employment in particular for small businesses.

Monetary policies

Monetary policy is used to influence the rate of interest and the money supply in an economy. Monetary policies impact:

  • Availability of finance
  • Cost of finance
  • Level of consumer demand
  • Level of exchange rates
  • Level of inflation

The Government is careful when changing interest rates as the effects are uncertain. For example if interest rates were raised, this would discourage expenditure due to the rise in cost of credit. However effects will vary because they might affect some sectors of business greater than others because credit-based purchases are typically consumer durable goods and houses, this may result in instability in some sectors.

Exchange Rates

Exchange rates are one country’s currency in exchange for another country’s currency. Exchange rates are determined by supply and demand. If the demand of the £ increases, its “price” rises and vice versa. The demand and supply of a currency can be affected by:

  • Comparative inflation rates
  • Comparative interest rates
  • Balance of payments
  • Speculation
  • Government policy
  • Current level of output in economy
  • Money supply

There are three main aspects to the European Economic and Monetary Union (EMU):

  1. Single (Common) Currency
  2. Single central bank (European Central Bank)
  3. Common (centralised) monetary policy (Central Government in charge of economic policy)