Macro-economic policy objectives

Stable prices

Maintaining a stable price level is an important macro-economic objective. Price stability means allowing small increases in price and hence keeping the rate of inflation within certain limits – typically, around 2% in any 12-month period. If this objective fails, then inflation or deflation are likely consequences. Both inflation and deflation cause many problems, the severity of which depends upon the rate of price change, and the length of time over which prices are unstable.

Full employment

Achieving full employment is a long standing objective and means that all those of working age who are willing and able to work can do so. However, some level of unemployment is accepted as inevitable, given that people will be changing jobs, and some will be temporarily unemployed as a result of business failures. Many have argued that there is a 'natural' rate of unemployment which is closely associated with the 'natural' rate of output of an economy.

Stable and sustainable growth

Maintaining stable and sustainable growth levels is a core macro-economic objective and is one that is essential for economic prosperity. Sustainable growth typically means an economy grows at a level which does not exhaust scarce resources or drive up the prices of resources. A common benchmark for stable growth is for GDP to increase at, or just above, the long-term trend-rate for an economy. Growth often goes through cycles triggered by changes in aggregate demand or supply-side shocks.

A balance of payments

Achieving a balance of payments with the rest of the world in terms of international trade is an important objective. However, because the balance of payments accounts for a country have different components, it is common to focus on just the 'current' account balance - which looks at trade in goods and services and income earned, and excludes long term investment flows recorded in the financial accounts.

Fiscal policy

Fiscal policy is the deliberate attempt by government to set and change tax rates and levels, government spending, and any necessary borrowing in order to achieve macro-economic objectives.

Fiscal policy targets the components of aggregate demand in order to alter consumer spending - through income tax changes - investment spending - through changes to company taxes - and, of course, directly through altering government spending.

It should be noted that while increasing spending may take a long time to have a desired effect, it is arguably more effective at times of recession than reducing taxes. This is because the additional disposable income from tax cuts may simply be transferred into increased savings. It should also be noted that spending on capital projects - such  as green technology - increases productive potential, and leaves a legacy, whereas increasing current spending may simply lead to pay rises and inflationary pressures.

Fiscal policy can be used to automatically stabilise the economy following a shock, as well as be used as a one-off policy instrument.

It should also be noted that tax policy can be used as a supply-side tool, especially to encourage work and enterprise.

Monetary policy

Monetary policy involves controlling the quantity of money in circulation, or altering the 'price' of money - the rate of interest - to achieve policy objectives.

There is a monetary transmission mechanism which starts with interest rate changes and then works through an economy, to influence the factors that create inflationary (or deflationary) pressure.

Quantity controls are also part of the monetary policy tool kit, and 'quantitative easing' has played an important role when interest rates approach zero.

Exchange rate policy

Exchange rates can be manipulated to help achieve several objectives - depending on the system used by a country. Even fixed rate systems may allow some small adjustments if needed.

Changes in the exchange rate alter the relative price of imports and exports and can have an impact on several economic objectives.

Supply-side policy

Supply-side policies are longer term policies designed to help an economy achieve long term objectives in terms of growth and development. Supply-side policies target factors that can improve productivity.

Supply-side policies are often categorised in terms of whether they try to enhance the workings of the free market economy, such as by deregulation and removing the constraints imposed by government, or whether they involve more intervention by government, such as increased spending on education and healthcare, and on infrastructure.

In terms of specific supply-side policies, reducing marginal tax rates can achieve an incentive effect as it can encourage people to work. The Laffer curve can help illustrate this effect. Improving labour productivity is also seen as a key supply-side objective. See below: