MACROECONOMIC

POLIC

IES

BY

AN

TO

AN

D D

AV

I D

DEMAND SIDE POLICIES

Include

Fiscal PolicyMonetary Policy

FISCAL POLICY

Fiscal Policy is defined as the set of a government’s policies relating to its spending and taxation rates. Direct and Indirect Taxes can be raised or lowered to alter the amount of disposable income consumers have.

There are two kinds of Fiscal Policy, one is expansionary fiscal policy to increase aggregate demand and contractionary, fiscal policy to reduce aggregate demand.

EXPANSIONARY FISCAL POLICY

If a government would like to encourage greater consumption then it can lower income taxes to increase disposable income. This is likely to increase AD, if a government would like to encourage greater investment, then it can lower corporate taxes so that firms enjoy higher after-tax profits that can be used for investment. This is likely to increase AD.

CONTRACTIONARY FISCAL POLICY

If a government wants to fix the inflationary problems then it will decrease in government purchases, an increase in taxes, and/or a decrease in transfer payments are used to correct the inflationary problems of a business-cycle expansion. The goal of contractionary fiscal policy is to close an inflationary gap, restrain the economy, and decrease the inflation rate.

MONETARY POLICY

Monetary policy is defined as the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.

Like Fiscal Policy there are also two types of Monetary Policy

EXPANSIONARY MONETARY POLICY

An expansionary policy increases the total supply of money in the economy and is traditionally used to combat unemployment in a recession by lowering interest rates. Lowered interest rates encourage the household and the firms to increase their consumption and investment respectively. This will shift the AD to the right and result in higher real output and more employment.

CONTRACTIONARY MONETARY POLICY

Contractionary policy decreases the total money supply and involves raising interest rates in order to combat inflation. The result will be that investment will fall, and consumption will fall. All of these changes will shift the AD to the left.

SUPPLY SIDE POLICIES

Interventionistvs

Market-Based

INTERVENTIONIST POLICY

Interventionist Policy is defined as the government’s direct intervention into the economy.

There are many types of interventionist policy and we will explore them one by one

• Investment in human capital

• Research and Development

• Provision and Maintenance of Infrastructure

• Direct Support for Business/Industrial Infrastructure

INVESTMENT IN HUMAN CAPITAL

Education and better trained labor force is the main goal of this policy.

Education leads to higher quality citizens that can advance to higher quality jobs and therefore increase the overall economy of the country.

Better trained labor increases the efficiency of the labor force, and increases potential output

RESEARCH AND DEVELOPMENT (R&D)

Research and Development aims to improve methods of production and consequently increase potential output

The government may give tax incentives to initiate this policy. This is to encourage the firms to start their own R&D.

The government may also choose to directly fund researches and development

PROVISION AND MAINTENANCE OF INFRASTRUCTUREProvision and maintenance of infrastructure allows economic

activity to take place efficiently.

Infrastructure, such as: roads, airports, railways, and others, are essential for economic activity to take place. In other words it is the basis of all other economic activities.

By maintaining the infrastructure, government can ensure further investment and steady growth in economy

DIRECT SUPPORT FOR BUSINESSES

Direct support for businesses aims to advance certain industries that the government find attractive

Government may directly support a business by improving competitive nature/decreasing competition, supporting businesses in their access to markets abroad.

MARKET-BASED POLICIES

Market-based policy focuses on allowing the invisible hand of the market to solve all the problems in the market

There are numerous market-based policies, but we will group them into the following groups

• Reduction in taxes

• Labor market reform

• Weakening government control

REDUCTION IN TAXES

These policies include reducing household taxes and corporate taxes.

Reducing household and corporate taxes can encourage the workers to work harder and the firms to increase their budget for production and research and development.

LABOR MARKET REFORMS

This policy aims to provide more benefit for the firms so the output from the firms may increase.

This policy aims to reduce minimum wages so firms can become more competitive. It also can include the reduction of unemployment benefits to help the firm from the burden of unemployment.

WEAKENING GOVERNMENT CONTROL

These policies include deregulation and privatization and increasing competition.

By reducing regulation and encouraging privatization competition is encouraged in the market. It is assumed that competition will lead the market to market equilibrium that is fair for both buyers and sellers.

SOURCES

Text book

http://www.investopedia.com/

http://www.dineshbakshi.com/ib-economics/macroeconomics/165-revision-notes/1899-monetary-policy-and-the-economy