Government Objectives and Policies

The macroeconomic objectives

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Objectives often conflict, and saying so is a reliable way to earn evaluation marks:

• Growth versus inflation: growing too fast pushes prices up.
• Growth versus the balance of payments: as incomes rise, people buy more imports.
• Growth versus the environment: more output usually means more pollution.
• Unemployment versus inflation: cutting unemployment tends to push wages and prices up.
• Fairness versus incentives: high taxes on the rich fund help for the poor, but may discourage work and enterprise.

Fiscal policy

Fiscal policy is the use of government spending and taxation to influence the economy.

• Expansionary fiscal policy: spend more and/or tax less. This puts money into the economy, raising total demand. Used when growth is weak or unemployment is high.
• Contractionary fiscal policy: spend less and/or tax more. This takes money out, reducing demand. Used when inflation is too high.

Types of tax:

• Direct taxes are paid on income and profits, income tax, corporation tax.
• Indirect taxes are paid on spending, VAT, duties on fuel, alcohol and tobacco.

Government spending goes on healthcare, education, defence, infrastructure, and benefits and pensions.

Strengths: it can be targeted at particular groups, regions or industries, and spending on schools, training and infrastructure improves the economy's long-term capacity as well as demand.

Weaknesses: it takes time to plan and deliver; higher spending may mean government borrowing, which has to be repaid with interest; and higher taxes may discourage work.

Monetary policy

Monetary policy is controlling the interest rate and the money supply. In most countries it is run by the central bank rather than the government.

1. Lowering interest rates
2. borrowing is cheaper and saving is less rewarding
3. people borrow and spend more, firms invest more
4. total demand rises
5. output and employment rise, but prices may rise too.

1. Raising interest rates
2. borrowing costs more and saving pays better
3. people and firms spend less
4. total demand falls
5. inflation eases, but growth slows and unemployment may rise.

Strengths: it can be changed quickly, and small adjustments can be made at any time.

Weaknesses: it is a blunt tool, one interest rate applies to the whole country, hitting people with mortgages and loans hardest while barely affecting others. It also takes many months to have its full effect, and rates cannot be cut far below zero.

Supply-side policies

Supply-side policies aim to increase the economy's ability to produce, raising the quantity or quality of resources, or how efficiently they are used.

• Education and training, raising workers' skills and productivity.
• Infrastructure: roads, ports, broadband, which lowers costs for every firm.
• Lower income tax, to encourage people to work.
• Reducing benefits, to sharpen the incentive to take a job.
• Privatisation and deregulation, to increase competition and efficiency.
• Support for new businesses, through grants and simpler rules.

Supply-side policy is the only kind that can raise output and ease inflation at the same time, because it increases what the economy is able to produce rather than just how much is being spent.

Weaknesses: it is very slow, education takes a generation to work through the workforce; it is expensive, and measures like cutting benefits can increase inequality and cause hardship.

Worked example

An economy is in recession: growth is negative and unemployment is rising.

Fiscal response:

1. The government increases spending on building new schools and hospitals
2. construction firms are paid and hire workers
3. those workers have wages to spend
4. shops and suppliers gain business and hire more staff
5. total demand rises
6. output rises and unemployment falls.

The schools and hospitals also improve the economy's long-term capacity.

Monetary response:

1. The central bank cuts interest rates
2. loans and mortgages become cheaper
3. households have more to spend and firms find investment more affordable
4. demand rises
5. output and employment rise.

Evaluation.

• The government spending has to be paid for, either by borrowing (which must be repaid with interest) or by higher taxes later.
• Large building projects take years to plan and complete, so the boost may arrive after the recession has already ended.
• Cutting interest rates works faster, but if people are worried about losing their jobs they may save rather than spend, however cheap borrowing is.
• Both policies risk inflation if demand rises faster than the economy can produce, though in a recession, with spare factories and unemployed workers, that risk is small.
• Supply-side policies would raise capacity permanently, but take far too long to help with a recession happening now.

Judgement: in a recession, fiscal and monetary policy together are the right response because they work within months rather than years. Supply-side policy should run alongside them to raise the economy's capacity for the longer term.

Common exam mistakes

• Confusing fiscal (government spending and tax) with monetary (interest rates) policy.
• Confusing direct taxes (on income) with indirect taxes (on spending).
• Saying expansionary policy always creates jobs, ignoring the risk of inflation.
• Suggesting supply-side policy as a quick fix for a recession; it is the slowest of the three.
• Forgetting that objectives conflict with one another.
• Saying the government sets interest rates; in most countries the central bank does.

Exam technique

Name the policy type and give a specific example, "expansionary fiscal policy, such as increasing spending on infrastructure", rather than saying "the government could help the economy".

Then trace the chain: the policy → what people or firms do differently → the effect on demand → the effect on output, jobs and prices. That chain is where the marks are.

For evaluation, use time lags (how long it takes), cost (who pays), and conflicts with other objectives.

Quick revision

• Objectives: growth, low unemployment, low inflation, balance of payments, fair income distribution, the environment.
• Objectives conflict, growth versus inflation, growth versus the environment, fairness versus incentives.
• Fiscal policy = government spending and taxation. Expansionary = spend more, tax less.
• Direct taxes on income; indirect taxes on spending.
• Monetary policy = interest rates and money supply, run by the central bank.
• Lower interest rates → more borrowing and spending → higher demand.
• Supply-side policy raises the economy's ability to produce: education, training, infrastructure, tax incentives, privatisation.
• Supply-side uniquely raises output and eases inflation, but is very slow.

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