Goals of Economic Policy

The Goals of Economic Policy

There are four major goals of economic policy: stable markets, economic prosperity, business development and protecting employment.

Learning Objectives

Compare and contrast the policy tools used by governments to achieve economic growth

Key Takeaways

Key Points

  • Sometimes other objectives, like military spending or nationalization are important.
  • To achieve these goals, governments use policy tools which are under the control of the government.
  • Government and central banks are limited in the number of goals they can achieve in the short term.

Key Terms

  • economic prosperity: Economic prosperity is the state of flourishing, thriving, good fortune in regards to wealth.
  • business development: A subset of the fields of Business and commerce, business development comprises a number of tasks and processes generally aiming at developing and implementing growth opportunities.
  • nationalization: Nationalization (British English spelling nationalisation) is the process of taking a private industry or private assets into public ownership by a national government or state.

Economic policy refers to the actions that governments take in the economic field. It covers the systems for setting interest rates and government budget as well as the labor market, national ownership, and many other areas of government interventions into the economy.

Policy is generally directed to achieve four major goals: stabilizing markets, promoting economic prosperity, ensuring business development, and promoting employment. Sometimes other objectives, like military spending or nationalization, are important.

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Economic Growth: One of the major goals of economic policy is to promote economic growth. How growth is measured though is another question. The above image Rate of change of Gross domestic product, world and OECD, since 1961, is one representation of economic growth.

To achieve these goals, governments use policy tools which are under the control of the government. These generally include the interest rate and money supply, tax and government spending, tariffs, exchange rates, labor market regulations, and many other aspects of government.

Selecting Tools and Goals

Government and central banks are limited in the number of goals they can achieve in the short term. For instance, there may be pressure on the government to reduce inflation, reduce unemployment, and reduce interest rates while maintaining currency stability. If all of these are selected as goals for the short term, then policy is likely to be incoherent, because a normal consequence of reducing inflation and maintaining currency stability is increasing unemployment and increasing interest rates.

For much of the 20th century, governments adopted discretionary policies such as demand management that were designed to correct the business cycle. These typically used fiscal and monetary policy to adjust inflation, output and unemployment.

However, following the stagflation of the 1970s, policymakers began to be attracted to policy rules.

A discretionary policy is supported because it allows policymakers to respond quickly to events. However, discretionary policy can be subject to dynamic inconsistency: a government may say it intends to raise interest rates indefinitely to bring inflation under control, but then relax its stance later. This makes policy non-credible and ultimately ineffective.

A rule-based policy can be more credible, because it is more transparent and easier to anticipate. Examples of rule-based policies are fixed exchange rates, interest rate rules, the stability and growth pact and the Golden Rule. Some policy rules can be imposed by external bodies, for instance, the Exchange Rate Mechanism for currency.

A compromise between strict discretionary and strict rule-based policy is to grant discretionary power to an independent body. For instance, the Federal Reserve Bank, European Central Bank, Bank of England and Reserve Bank of Australia all set interest rates without government interference, but do not adopt rules.

Another type of non-discretionary policy is a set of policies which are imposed by an international body. This can occur (for example) as a result of intervention by the International Monetary Fund.

Fours Schools of Economic Thought: Classical, Marxian, Keynesian, and the Chicago School.

Mainstream modern economics can be broken down into four schools of economic thought: classical, Marxian, Keynesian, and the Chicago School.

Learning Objectives

Apply the four main schools of modern economic thought.

Key Takeaways

Key Points

  • Classical economics focuses on the tendency of markets to move towards equilibrium and on objective theories of value.
  • As the original form of mainstream economics of the 18th and 19th centuries, classical economics served as the basis for many other schools of economic thought, including neoclassical economics.
  • Marxism focuses on the labor theory of value and what Marx considered to be the exploitation of labor by capital.
  • Keynesian economics derives from John Maynard Keynes, in particular his book, The General Theory of Employment, Interest and Money (1936), which ushered in contemporary macroeconomics as a distinct field.
  • The Chicago School of economics is best known for its free market advocacy and monetarist ideas.

Key Terms

  • School of thought: A school of thought is a collection or group of people who share common characteristics of opinion or outlook regarding a philosophy, discipline, belief, social movement, cultural movement, or art movement.
  • mainstream economics: Mainstream economics is a term used to refer to widely-accepted economics as it is taught across prominent universities, and in contrast to heterodox economics.

Throughout the history of economic theory, several methods for approaching the topic are noteworthy enough, and different enough from one another, to be distinguished as particular ‘schools of economic thought. ‘ While economists do not always fit into particular schools, especially in modern times, classifying economists into a particular school of thought is common.

Mainstream modern economics can be broken down into four schools of economic thought:

Classical economics, also called classical political economy, was the original form of mainstream economics in the 18th and 19th centuries. Classical economics focuses on both the tendency of markets to move towards equilibrium and on objective theories of value. Neo-classical economics derives from this school, but differs because it is utilitarian in its value theory and because it uses marginal theory as the basis of its models and equations. Anders Chydenius (1729–1803) was the leading classical liberal of Nordic history. A Finnish priest and member of parliament, he published a book called The National Gain in 1765, in which he proposed ideas about the freedom of trade and industry, explored the relationship between the economy and society, and laid out the principles of liberalism. All of this happened eleven years before Adam Smith published a similar and more comprehensive book, The Wealth of Nations. According to Chydenius, democracy, equality and a respect for human rights formed the only path towards progress and happiness for the whole of society.

Marxian economics descends directly from the work of Karl Marx and Friedrich Engels. This school focuses on the labor theory of value and what Marx considers to be the exploitation of labor by capital. Thus, in this school of economic thought, the labor theory of value is a method for measuring the degree to which labor is exploited in a capitalist society, rather than simply a method for calculating price.

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Marxism: The Marxist school of economic thought comes from the work of German economist Karl Marx.

Keynesian economics derives from John Maynard Keynes, and in particular his book, The General Theory of Employment, Interest and Money (1936), which ushered in contemporary macroeconomics as a distinct field. The book analyzed the determinants of national income, in the short run, during a period of time when prices are relatively inflexible. Keynes attempted to explain, in broad theoretical detail, why high labor-market unemployment might not be self-correcting due to low “effective demand,” and why neither price flexibility nor monetary policy could be counted on to remedy the situation. Because of its impact on economic analysis, this book is often called “revolutionary. ”

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Keynesian Economics: John Maynard Keynes (right), was a key theorist in economics.

A final school of economic thought, the Chicago School of economics, is best known for its free market advocacy and monetarist ideas. According to Milton Friedman and monetarists, market economies are inherently stable so long as the money supply does not greatly expand or contract. Ben Bernanke, current Chairman of the Federal Reserve, is among the significant public economists today that generally accepts Friedman’s analysis of the causes of the Great Depression.