ECONOMIC POLICIES OBJECTIVES AND INSTRUMENTS 1 ECONOMIC POLICIES

ECONOMIC POLICIES: OBJECTIVES AND INSTRUMENTS 1

ECONOMIC POLICIES: OBJECTIVES AND INSTRUMENTS • Economic policy implemented by government is a critical factor influencing economic success or failures of nations. 2

ECONOMIC POLICIES: OBJECTIVES AND INSTRUMENTS • The most important variables in the explanation of the performance of national economies are – national income (production), – employment, – İnflation (price stability), – and foreign balance. • Thus, they are the central goals of economic analysis and policy. 3

ECONOMIC POLICIES: OBJECTIVES AND INSTRUMENTS • The instruments used for these goals are – fiscal policy, – monetary policy, – incomes policy, – and foreign economic policies. 4

ECONOMIC POLICIES: OBJECTIVES AND INSTRUMENTS • In this lesson, we will discuss each, and illustrate some key questions that confront economics and the ways of their solutions. 5

OBJECTIVES OF ECONOMIC POLICIES 6

OBJECTIVES OF ECONOMIC POLICIES • Four areas are central to a good economic performance: – output, – employment, – prices, – and the foreign economic relations. 7

Output 8

Output • As we have seen in Chapter 8, national income is the measure of output. • The ultimate measure of economic success is a country’s ability to generate a high level and rapid growth in national income. 9

Output • The principal objective of economic policies, therefore, is to increase national income rapidly, both in the short and long run, and improve the living standards of the society. 10

Employment 11

Employment • High employment, or low unemployment, is one of the main objectives of macroeconomic policies. • People want to be able to find good jobs at a high pay and to find them easily. 12

Employment • Attaining high employment is more than a purely economic goal: It has also psychological, social and political dimensions. 13

Employment • Employment is a relationship between employer and employee. • It is usually based on a contract where the work of employee is paid for by employer. 14

Employment • In modern economies employers are – profit-seeking private firms, – non-profit organizations – and governments. • In a capitalist economy most of the employers are profit-seeking firms. 15

Employment • Employment and unemployment are related to total number of jobs available and the number of people competing for them. • The rate of unemployment is calculated as a percentage of unemployed people to total number of people seeking a job. 16

Employment • Unemployment usually moves in tandem with output. • Firms hire workers to produce goods. • When the demand for goods increases, firms hire more workers and additional jobs are created; the number of employed people rises. 17

Employment • As output falls because of decreasing demand, firms need fewer labor inputs, so new workers are not hired and some of the current workers are laid off; unemployment rises. 18

Employment • Therefore, total employment depends, firstly, on – the investment – and production decisions of private firms. • In other words, total employment depends on the demand for labor from investing and producing firms. 19

Employment • If there is not enough investment and production to employ all willing workers, then unemployment will exist. • This can occur even if national income continues to slowly expand. 20

Employment • Indeed, national income must grow, at least, as fast as the sum of population growth and productivity growth, or else the unemployment rate will rise. • Unemployment is a normal feature of the capitalist labor market. 21

Price Stability 22

Price Stability • The third major economic objective is to ensure price stability. • Price stability is low and stable inflation. • Inflation means the rate of increase in the general price level during a period. 23

Price Stability • Every marketed product has a money price (or absolute price), measured in units of money. • Prices help buyers to compare one commodity to another to see which one is the best deal. • This comparison gives buyers the relative prices: that is, the price of one commodity relative to another. 24

Price Stability • For example, if the price of a passenger car is 60, 000 liras and the price of a personal computer (PC) is 2000 liras, a car costs 30 times as much as a PC. 25

Price Stability • The overall level of absolute prices prevailing in an economy is called the price level. • A persistent increase in the absolute price level is called inflation. 26

Price Stability • Since the rates of increases in the prices of different goods are not equal, relative prices will also change. • Prices of some commodities increase more slowly than average (thus becoming less expensive in relative terms), while others increase more rapidly (becoming relatively more expensive). 27

Price Stability • Declines in the general price level over time are called deflation. • Deflation usually occurs during severe economic recession or crisis, when companies are desperate to sell products. 28

Price Stability • Low, steady and anticipated inflation may not be a problem. • But, high inflation may be destructive. • An unexpected burst of inflation or period of deflation may bring big problems and costs. 29

Price Stability • An unexpected inflation or deflation: – redistributes income and wealth, – and affects efficiency and output negatively. 30

Price Stability • If every price and every flow of income experienced inflation at the same rate, it would have no real economic impact, and there would be no winners or losers. 31

Price Stability • In real life, however, inflation is never so even-handed or predictable. • Some prices rise faster than others. • Some incomes keep up with inflation, or even surpass it; others lag behind. 32

Price Stability • Inflation and changes in the rate of inflation create uncertainty in the minds of companies, investors, and households; this can be stressful, and in some cases can impede investment. 33

Price Stability • People try to protect themselves against inflation by indexing their incomes to the price level. • But, some sectors lose from inflation. 34

Price Stability 1) Individuals who live on incomes that are fixed in money terms lose purchasing power when overall prices rise. 2) Workers who are unable to win wage increases to keep up with inflation also lose real purchasing power. 3) Lenders who loan money at a fixed rate of interest will see the real value of their loan and future interest payments are reduced by inflation. 4) Owners of financial wealth lose some of their real wealth with every increase in prices. 35

Price Stability • Meanwhile, some other sectors benefit from inflation. • Borrowers are the biggest winners: the real burden of their loan is eaten away by higher prices. 36

Price Stability • Inflation distorts the use of money. • In inflationist periods, money in pocket loses its purchasing power, so people hold less money • They either increase their spending on consumption goods or transform money into other assets. 37

Price Stability • This may have a positive effect on the total product and employment for some time. • But this positive relationship between the price level and total output is unsustainable in the long run. 38

Price Stability • Unpredictable inflation or deflation diverts resources from productive activities to speculation. • It can become more profitable to forecast the inflation or deflation rate correctly than to invent a new product. 39

Price Stability • People can make themselves better off, not by specialization in the profession for which they have been trained but by speculating in financial markets. 40

Price Stability • From a social perspective, the diversion of talent that results from unpredictable inflation is like wasting valuable resources. • This waste of resources is a cost of inflation. 41

Foreign Balance 42

Foreign Balance • Countries make foreign trade; export and import goods and services. • One of the main purposes of macroeconomics is foreign trade balance. • There is an interaction between the exchange rate and foreign trade balance. 43

Foreign Balance • Exchange rate is the price of a national currency in terms of another national currency. • It is a significant factor determining the price of imported and exported goods. • Therefore, exchange rate has a critical role in reaching both foreign trade balance and price stability. 44

INSTRUMENTS OF ECONIMIC POLICIES 45

INSTRUMENTS • Instruments of economic policy are: – Fiscal policy – Monetary policy – Incomes policy – Foreign economic policies 46

Fiscal Policy 47

Fiscal Policy • Fiscal policy is related to – total government expenditures, – distribution of government expenditures, – and sources of these expenditures: taxes and other sources. 48

Fiscal Policy • The main sources of government revenues are taxes. • For government, taxing and spending are also a way of influencing economic activities. • Government collects taxes from individuals and firms and uses tax revenue to undertake many different functions. 49

Fiscal Policy • It can affect aggregate consumption and investment demand by changing tax burden and its expenditure. 50

Fiscal Policy • At any time, if the government wants to increase total demand, it may increase its own expenditures and promote consumption and investment expenditures by lowering the tax rate. 51

Fiscal Policy • If the government wants to decrease total demand it may lower its own expenditures and implements policies contracting private consumption and investment expenditures. 52

Fiscal Policy • Changes in tax rates affect the profitability of private investment, and hence production. • If taxes are too high on businesses, their investment spending is likely to weaken, and this would influence production negatively. 53

Fiscal Policy • A part of tax income may be used for transfer payments to low-income households and individuals. • Distribution of income will be changed by taxing and transfer payments. 54

Fiscal Policy • The budget policy also has important consequences on the economy. • A government deficit occurs when incoming tax revenues are insufficient to pay for outgoing expenses. • And, a surplus occurs when tax revenues are larger than expenses. 55

Fiscal Policy • A short-term, low-rate deficit is no cause for concern. • On the other hand, large and chronic deficits that persist year after year are a cause for concern. 56

Fiscal Policy • A deficit in any given year must be financed by government borrowing. • Deficits, therefore, increase government’s outstanding debt. 57

Fiscal Policy • Large consecutive deficits produce an ongoing and rapid accumulation of public debt, which can have negative economic and financial consequences. • A rapidly growing and large public debt would create a pressure on both interest rates and the exchange rate. 58

Fiscal Policy • As the public debt grows, interest payments eat up a larger proportion of total government revenues. 59

Fiscal Policy • This would produce financial and economic instability; including higher interest rates, exchange rate instability, and even an outflow of financial capital from the country. • So, government debt is acceptable within limits. 60

Monetary Policy 61

Monetary Policy • Monetary policy is the way of influencing economy by changing – the quantity of money – and interest rate. 62

Monetary Policy • The state institution responsible for setting and implementing monetary policy is the Central Bank (CB). • Interest rate is determined in money market by the supply of and demand for money. 63

Monetary Policy • If the CB increases the quantity of money in the economy this would lower the rate of interest; if it reduces money supply interest rate would rise. • There is, generally, a negative relationship between the interest rate and consumption and investment expenditures. 64

Monetary Policy • So, a fall in the quantity of money would raise the rate of interest and lower aggregate demand. • And an increase in the quantity of money would have just the opposite effects: interest rate would fall and aggregate demand would rise. 65

Incomes Policies 66

Incomes Policies • Incomes policies are related to changing wages and salaries by the government. • The main concern may be either to control inflation and stabilize prices or to change the distribution of income between labor incomes and capital incomes. 67

Foreign Economic Policies 68

Foreign Economic Policies • Foreign economic policies include foreign trade and exchange rate policies. • The main purpose of foreign economic policies is foreign balance and exchange rate stability. 69