Objectives and instruments of macro policy

  • Created by: Elise D
  • Created on: 16-05-15 14:22

Policy objectives vs policy instruments

A policy objective is a target or goal that a government wishes to achieve or 'hit'.

By contrast, a policy instrument is a tool/set of tools that the government uses to try to hit it's policy objectives.  

There are three main types of policy instruments at the UK government's disposal:

- Monetary policy, including the interest rate and money supply (both governed by Bank of England)

- Fiscal policy, including taxes and government spending (implemented by the government, specifically the Treasury)

- Supply-side policy, trying to make individual markets/industries more competitive and efficient (implemented by many ministries/departments, main one being the Department for Business, Innovations and Skills)

Five main governemnt policy objectives:

- Creating and mainting full employment or low unemployment

- Economic growth and improved living standards and levels of economic welfare

- An acceptable/fair distribution of income and wealth

- To limit/control inflation or to achieve some measure of price stability

- A satisfactory balance of payments, usually defined as avoiding an external deficit

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Policy objectives in more detail: Full Employment

Two definitions:

1) Beveridge defintion- full employment when unemployment falls to 3% of the labour force.

Partly becuase they regard Beveridge's 3% definition as too arbitrary and lacking any theoretical underpinning, free-market economists favour a second defintion:

2) Free-market economists- full employment occurs in the economys aggregate labour market at the market-clearing real wage rate, where the number of workers willing to work equals the number of workers whom employers wish to hire.

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Policy objectives in more detail: Growth and Livin

There isn't much point in achieving full employment if everybody with a job then experiences low standards of living. 

Thus, a government must try to reduce unemployment as well as achieve an acceptable standard of living and sustainable rate of economic growth

Growth facilitates higher living standards, and usually also creates more jobs.

As policy objectives, lower unemployment and economic growth generally go hand-in-hand, although some free-market ecnomists argue that a certain level of unemployment is needed to create the supply-side conditions in which growth is best favoured

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Policy objectives in more detail: A Fair Distribut

As well as achieveing the first three policy objectives, most governements (especially those where people vote) want to avoid unacceptably unfair/inequitable (unfair, unjust) distributions of wealth and income

However, as soon as equitable considerations are introduced into economics, normative judgements are made about what is a 'socially fair' distribution of income and wealth, and about what ought to happen in the economy. 

A possible conflict also exists between greater equality in the distribution of income and wealth and the policy objective of faster economic growth. Free-market economists argue that people must be incentivised for faster and sustained growth to be achieved. However, this may require a greater income inequality to create the conditions in which people are prepared to take financial risks, knowing that is successful, they, rather than other people, will enjoy the fruits of their efforts. 

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Policy objectives in more detail: Controlling Infl

People sometimes regard controlling inflation as an end in itself, and believe that price stability (zero inflation) or a steady rate of inflation (ideally 2%) is a good thing.

However, sometimes inflation can have benefits. For example, a steady but low rate of inflation may be associated with a climate of consumer and business optimism. The deflationary policies needed to remove inflation from the economic system completely may create economic stagnation and highly depressed economic conditions

Extending this argument further, controlling inflation should be regarded not as an ultimate objective but as an intermediate objective, or a necessary condition that must be achieved in order to create the efficient and competitive markets that are required, in the long run, for the main policy objectives of full employment and sustained growth to be achieved. Even these don't form the true ultimate policy objective, increasing human happiness or economic welfare

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Policy objectives in more detail: Satisfactory Bal

'Satisfactory' can be interpreted in different ways. Some assume that a satisfactory balance of payments occurs only when governments have the biggest possible current account surplus (ie exports exceeding imports). However a country can only enjoy a trading surplus if another country suffers a deficit. It is impossible for all countries to have a surplus. Therefore, most economists take the view that the balance of payments is 'satisfactory' if they are in equilibrium or when there is a small but sustainable deficit

The current account of the balance of payments contains two main items: the monetary value of exports (of goods and services), and the monetry value of imports. If the value of imports exceeds the value of exports, there is a current account deficit; if the value of exports exceeds imports then there is a current account surplus. 

In the mid 1970s, huge current account deficits caused the UK to suffer two massive balance of payments crises. To try to reduce the deficits, the governments had to contract or deflate the economy resulting in higher unemployment and slow growth.

In recent years however, the UKs current account deficit has been much larger but this is no longer regarded as a problem, governments are generally prepared to allow market forces to determine the exchange rate which was not an option in the 1970s.

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Policy indicators

1. Jobs – are more people finding work in the jobs that they are suited to and which pay a living wage? How high is unemployment? Is the economy creating enough new jobs for people entering the labour market each year? 
2. Prices –are price rises under control creating the conditions for price stability? Can the economy avoid a period of price deflation? Price stability refers to low, stable, positive inflation of between 1-3% per year.
3. Trade – is the economy performing well in trading goods and services with other countries?
4. Growth – how successful has the country been in achieving growth in the short term and in laying the foundations for expansion in the future? Can grown be sustained especially in terms of its environmental effects?
5. Efficiency - is the economy managing to increase the efficiency of factor resources e.g. through higher productivity so that more goods and services can be supplied at lower cost?
6. Public services – have the benefits of growth flowed through into greater and improved provision of key government services such as education, health and transport?

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