Macroeconomic

Policies

• Strategies used to achieve

Macroeconomic Objectives are
known as Macroeconomic
Policies. Following
Macroeconomic Policies are used
to achieve previously mentioned
Macroeconomic Objectives:

1.Fiscal Policy

2.Monetary Policy

3.Supply Side Policies

 Macroeconomic
Policies
• Unlike developing economies where
government intervention is
generally more prevalent,
government involvement in
developed economies is often just
limited to legislation, regulation
and formation of necessary
institutions.

• Sometimes, governments use mix of

Macroeconomic Policies to achieve
their Macroeconomic Objectives.
 Fiscal Policy

• Fiscal Policy as devised through

governments’ annual budgets
makes use of taxes and
government spending to affect
the national output.

• Governments run either budget

deficits or surpluses or balanced
budget. Unlike surpluses where

taxation is greater than

expenditure, for deficits
government expenditure exceeds

total taxation revenue.

 Fiscal Policy

• To run budget deficit

governments need to borrow
which is financed through local
and international borrowing.
 Types of Fiscal Policies

• Discretionary Fiscal Policy: is when

governments deliberately alter tax
rates and government spending to
manipulate economy’s outcome.
• Automatic Stabilizers: unlike
discretionary fiscal policy for which
governments use national taxation
and its spending instruments to
artificially adjust national income
(GDP), automatic stabilizers is
when tax revenue and government
spending levels automatically
change following a change in
economy’s national income.
 Automatic Stabilizer
• During recessionary periods
government spending
automatically increase due to its
increased spending on social
security payments including
unemployment benefits and
government tax revenue falls
due to lower national income.
 Automatic Stabilizer

• Similarly opposite is true during

periods of high economic
activity, also known as Boom,
when government spending falls
due to lesser spending on social
security payments and higher
tax revenue is collected due to
economy’s higher activity levels.
 Fiscal Policy as
Supply Side
Instrument
Economies can also use Fiscal
Policy to influence economy’s
supply side conditions. Policies
targeted at enhancing
economies’ production
potential are collectively known
as Supply-Side Policies.

1.Investment in human capital,

provision of subsidy on capital
goods etc are some examples of
supply-side policies.
 Fiscal Policy as
Supply Side
Instrument
2. Similarly governments tax
cuts are expected to
encourage higher investments
due to higher expected profits.

3. Government increased
spending on infrastructure,
education and health care etc
will increase the economy’s
supply of educated labor force.
 Challenges of Fiscal
Policy

• Apart from difficulty to alter

government spending levels
and tax rates due to political
reasons sometimes changes in
taxes and government spending
take longer than expected to
have the desired effect on the
economy.
 Challenges of Fiscal
Policy
• At times governments prefer to
invest in sectors for which
benefits are evident over shorter
time periods like infrastructure.
This shorter term vision of
governments will result in
massive opportunity cost in
terms of lost well-being due to
lower investment in sectors such
as education / health care for
which benefits occurs over much
longer time periods.
 Challenges of Fiscal
Policy

• Similarly a lot of government

spending is continued out of
fear that their discontinuation
will result in reduced popularity
of political party. This is why
nationalization of inefficient
state owned firms might be
politically unpopular decision.
 Challenges of Fiscal
Policy

• Similarly governments are often

conscious of not adversely
affecting disposable income
levels of citizens for that too is
not taken very positively by
consumers and therefore there
is fear that such a step might
negatively affect political
party’s popularity.
 Monetary Policy
• Alteration of economy’s money supply
and / or interest rates to manipulate
its economic outcome is known as
Monetary policy. Monetary Policy is
solely determined by economies’
Central Banks.

• Expansionary Monetary Policy is used

to combat economies’ low economic
growth. Increased aggregate spending
due to low interest rates is expected
to boost economic growth. On the
contrary Contractionary Monetary
Policy is used to reduce economics
activity by increasing interest rates.
 Monetary Policy

• Interest rates are also expected to

affect portfolio / indirect
investment flows between countries
and so affect their exchange rates.

• Higher interest rates are expected

to appreciate country’s exchange
rate due to higher cash inflows
and with lower interest rates the
exchange rate is expected to
depreciate due to cash outflows.

• However the relationship explained

between monetary policy and
economy’s exchange rate might
not be very strong.
 Supply-Side Policies

• Policies aimed at enhancing

economies’ production potential
are known as Supply-Side Policies.

• Enhanced production potential is

important for economy to
increase its growth rates.

1.Increased investment in human

capital through availability of better
educational and health care services
can improve labor productivity and
so is one possible supply-side policy.
 Supply-Side Policies

2. Similarly provision of
economic incentives and more
equal access to capital is
expected to boost economy’s
investment levels.
 Supply-Side Policies

• Unlike Demand Side Policies

namely Fiscal and Monetary
Policy that are generally easier
to implement and have shorter
time lags. Supply-Side Policies
often involve more complexities
and have longer time lags.
 Supply-Side Policies

• Effects of investment in human

capital just like other type of
investment generally take
longer time to work through the
economy as compared to
changes in tax rates,
government spending and
interest rates.
 Fiscal Policy as Policy
Instrument
How effective is Fiscal Policy in
achieving different
macroeconomic objectives?

• After from being able to stabilize

economic turns (periods of high
and low economic activity),
fiscal policy can also be useful for
correcting economies BOP
disequilibrium.
 Fiscal Policy as
Policy Instrument
• Use of expenditure dampening
strategy to reduce aggregate
demand is one possible way of
reducing economy’s current
account deficit. High tax rates
combined with low government
spending on imported goods is
expected to be effective strategy
to reduce economies’ import
expenditure.
 Fiscal Policy as Policy
Instrument
• Moreover use of tariffs and other
protectionist tools can significantly
limit economies’ import and hence
will help them combat temporary
current account deficits.

• Though fiscal policy might be useful

in eliminating small and temporary
current account deficits but such
measures in no way provide
sustainable solution to economies’
current account deficit that basically
indicates economies’ products’ lack
of competitiveness.
 Fiscal Policy as
Policy Instrument
• Hence use of appropriate supply
side strategies that are expected
to enhance domestic products’
competitiveness is only effective
strategy to combat economies’
permanent BOP disequilibrium.
 Monetary Policy as
Policy Instrument

• Moreover monetary policy can

also serve as useful supply side
policy instrument. Increased
availability of cheap loans for
investment purposes can
significantly improve economy’s
production potential.
 Conflicts between
Macroeconomic
Objectives
• As you might have noticed by
now, often there is conflict
between macroeconomic
objectives. Hence economies
often need to prioritize between
different macroeconomic
objectives. As depicted through
Phillips Curve, unemployment
and demand pull inflation are
often inversely related to each
other.
 Conflicts between
Macroeconomic
Objectives
• Stronger exchange rates can
negatively affect economies
BOP position reducing exports
and increasing imports.
 International
Development
Organizations
• World Bank or International
Bank for Reconstruction and
Development (IBRD) as it was
formerly known and
International Monetary Fund
also known as IMF were
established at the end of
Bretton Woods Conference by
the end of World War II in
1944.
 International
Development
Organizations
• World Bank and IMF finance
developing economies for specific
projects and purposes. Unlike
IMF that focuses on financing
economies struggling from
Balance of Payments deficits,
World Bank primarily focuses on
providing developmental loans
and aids to poor / developing
economies.
 International
Monetary Fund
• IMF issues loan to economies
struggling with Balance of
Payments disequilibrium.

• Countries suffering from persistent

BOP deficits are expected to
experience exchange rate
depreciation due to their currencies
reduced demand on international
markets. To prevent excessive cost-
push inflation that is inevitable
consequence of economy’s expensive
imports requires improvement of
economy’s exchange rate.
 International
Monetary Fund
• Sufficient amounts of foreign
currency reserves are needed to
artificially increase currency’s
demand to stabilize economy’s
exchange rate. Lack of foreign
currency reserves require
developing economies to rely on
international financing options
to stabilize their economies’
exchange rates.
 World Bank

• Though development of
developing economies is World
Bank’s one of the key priorities
but often their finance is not
free of charge.

• Proponents of this strategy claim

that interest-free loans or aids
might not compel beneficiaries to
make the most productive use of
developmental grants.
 World Bank

• However some critics of World

Bank claim that its stringent
requirements for economies to
qualify for developmental loans
and its strict loan usage policies
significantly affect economies’
ability to benefit from such
developmental loans / grants.
 World Bank:
Specialization Areas
• Though World Bank unlike IMF has
much wider development scope but
there are certain priority areas /
sectors that are more heavily
financed by World Bank that other
sectors / areas which include:
1.Agriculture and Rural Development
2.Access to clean drinking water and
sanitation
3.Environmental Protection
4.Health and Education
5.Infrastructure Development
6.Governance: research to
improve institutional framework
of developing economies
Criticism of World Bank
• As mentioned earlier, World

Bank’s excessive requirements

concerning implementation of
various structural and institutional
framework limits economies’
ability to make most productive
use of developmental loans.

• Moreover, World Bank’s forces

loan recipient countries to
undertake certain structural
changes which are not best aligned
with these countries factor
endowments and state of
technology.