Macro-economic policy objectives

The main four (core) macro-economic policy objectives are:

Policy objective
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.

More on inflation
Policy objective
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.

More on unemployment
Policy objective
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.

More on growth
Policy objective
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.

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Other objectives

In addition to these core objectives, policy makers can set targets to control pollution and other negative externalities, and to achieve greater equity through reduction in inequality and poverty.

In recent years the control and management of public finances is seen as an increasingly important objective, especially following the financial crash of 2008 to 2010.

Policy instruments

To achieve these objectives, policy makers can select the policy tools they expect will help them best achieve the chosen objective.

Policies can be put into one of two main categories – those that influence demand and those that influence supply – commonly called demand-side and supply-side policy.

Policy instrument
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.

More on fiscal policy
Policy instrument
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.

AD schedule - hypothetical

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

More on monetary policy
Policy instrument
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.

More on exchange rates
Policy instrument
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:

More on supply-side policy

Productivity improvements

Productivity is measured either as output per worker, or output per hour worked. Three factors stand out as key areas for an economy to improve:

  1. Firstly, improving the level of education and skill of the work-force. Given that education is a merit good, it is unlikely that the free market will supply a sufficient quantity of education, hence the significance of state involvement.
  2. Secondly, improving the flexibility of labour to be able to adapt to changes in the demand for labour. Again, education can help this, as can incentives to retrain, and subsidies and grants to firms to engage in training. Labour mobility is a key component of flexibility. When labour is geographically immobile, government may subsidise public transport or provide re-location assistance. In the case of occupational immobility, improving education and skills, and providing better information to job-seekers can help. Reducing barriers to entry into the labour market can also help improve mobility and flexibility, such as encouraging more part-time work.
  3. Thirdly, industrial and technology policy can help encourage an economy to improve the efficiency and competitiveness of its industries. Finally, improvements in a country’s infrastructure, including its transport and communications networks, can help improve factor productivity.

It should be noted that objectives may be in conflict with each other, such as the inflation-unemployment conflict as identified in the Phillips curve.

Video on macro-economic policy

Aggregate demand

Aggregate demand and the AD curve.

Aggregate demand
Fiscal policy

How can fiscal policy influence aggregate demand?

Fiscal policy
Monetary policy

How effective is supply-side policy?

Supply-side policy

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