In the previous session, you were introduced to the macroeconomy and macroeconomic indicators, as well as provided with an overview of their evolution.

The government and the central bank have a variety of economic management strategies at their disposal.

This session examines the available macroeconomic policies and their effects on the economy as a whole. Do you have any thoughts on macroeconomic policy?


 Let’s enjoy this session together

By the end of this session, you would have answers to these questions.

Objectives By the end of this session you should be able to:

(a) distinguish between monetary policy and fiscal policy

(b) differentiate between demand-side policies and supply-side policies with examples

(c) mention and explain the various policy options available;

(d) describe when a particular policy could be used and its effect on the economy

(e) state the importance of these macroeconomic policies

Now read on …

  1. Session 1: Macroeconomics and Business
  2. Session 3: Government and the Economy
  3. Session 4: National Income Accounting
  4. Session 5: Factors Influencing the Size of National
  5. Session 6: Circular Flow of Income

2.1   Macroeconomic Policies

The economic policy options available to governments (including central banks) are summarized below.

2.1.1 Fiscal Policy

Fiscal policy is concerned with the composition of and changes in the levels of government expenditure and taxation. Changes in fiscal policy are generally announced once a year in most countries.

Given the scale of government spending (both central and local) in economies and the corresponding scale of taxation (both personal and corporate), fiscal policy may be used as a powerful tool to directly influence national expenditure and, therefore, the level of economic activity. In this context, fiscal policy is an important instrument of demand management.

2.1.2 Monetary Policy

Monetary policy is defined as measures taken by governments and central banks to influence the cost of borrowing (i.e. the rate of interest) and availability of credit and liquidity in the economy, thereby affecting the overall demand for and supply of money. While fiscal policy changes are usually announced annually in national budget statements, monetary policy changes are more continuous.

For example, the authorities may announce interest rate changes at any time, and these rapidly affect the level and structure of competing interest rates generally (such as bank lending and savings rates). Have you noticed how the Treasury bill rate changes from time to time?

2.1.3 Exchange-Rate Policy

Exchange rate policy refers to government and central bank intervention in the foreign exchange markets to influence the level and direction of the external value of a country’s currency.

The degree of intervention in the foreign exchange markets depends upon the country’s specific exchange rate objective: whether to have a fixed, freely floating, pegged or managed rate and, where the exchange rate is fixed or managed, at what level to ‘peg’ the rate.

Exchange rate policy has important implications for international trade and capital flows in and out of a country, i.e. for the current and capital accounts of the balance of payments.

It also has an impact on domestic monetary policy because interest rate levels may have to be set to influence international capital flows with the objective of supporting the exchange rate.

2.1.4 International Trade Policy

International trade policy involves measures taken by the government, in addition to exchange rate policy, to influence the magnitude and direction of foreign trade.

There may be many reasons for these measures, notably correction of balance of payments problems (i.e. deficits or surpluses), preserving domestic employment, encouraging economic growth and promoting foreign cooperation [e.g. within trade blocs such as the Common Market for Eastern and Southern Africa (COMESA), The West African Common Industrial Policy (WACIP) and so on].

The measures may take the form of subsidies for exports, tariffs (duties) on imports and other protectionist measures such as import quotas and embargos.

2.1.5 Supply-side Policy

Supply-side economics refers to those government measures that are directed at tackling problems involving the growth and sustainability of a nation’s total or aggregate supply (i.e. national production) of goods and services in the economy over time.

Supply-side policy, therefore, contrasts with the policies described above, especially fiscal and monetary policies, which are usually concerned with affecting the level of total or aggregate demand for goods and services, i.e. the demand side of the economy.

Supply-side measures are directed specifically at influencing a country’s productivity and output. These may involve the introduction of new technology, the encouragement of competition and enterprise, the privatization of state-owned assets, efforts to increase labour efficiency and mobility and other measures to improve competitiveness in the international market economy.

2.1.6 Prices and Incomes Policies

Prices and income policies are examples of direct intervention by the government in the working of a market economy concerned with the setting of prices for goods and services and wage settlements.

These policies have two fundamental aims: control over general inflation and the protection of jobs in the domestic economy.

In addition, prices and income policies can have a significant impact on the distribution of national income between the owners of land, capital and labour (i.e. the workforce).

There is a general view among economists, however, that prices and income policies should be regarded only as temporary or emergency measures since, by definition, they distort the operation of markets by undermining wage and price levels and therefore the demand for and supply of goods, services and labour.

 2.1.7 Employment Policy

Employment policy is concerned with government efforts to create jobs and thereby reduce unemployment.

The policy may be implemented either indirectly, via stimulation of aggregate demand in the economy, or directly through supply-side measures such as job creation schemes and the provision of training programs.

There is a large degree of overlap between the various policies defined above and their impact on the macroeconomic variables listed earlier.

These interrelationships are emphasized and explored throughout this course. We now consider the overriding economic problem that faces governments, individuals and firms from which the study of economics has evolved.

In this session, we have been able to look at the various policies that governments can choose from in the management of the economy. These policies range from fiscal to monetary and other economic policies which the government and the central bank can use to stimulate economic activity

Self-Assessment Questions

 Exercise 1.2

Answer the following questions as a way of assessing what you have learnt in this session. 

  1. What do you understand by the following terms:
  • fiscal policy
  • monetary policy
  • merit good
  • supply-side policies e. economic growth
  • opportunity cost
  1. In what ways, would you expect changes in exchange rate policy and international trade policy to affect the macroeconomy?



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