Question

What are the two basic functions of government in the macro-economy?

Answer 1

The two basic functions of the government in the macro-economy
are monetary policy and fiscal policy.
MONETARY POLICY is the management of money supply through indirectly
controlling interest rates. The main objectives of monetary policy are
controlling inflation, consumption, growth, and liquidity.
The monetary policy objectives are achieved by directly modifying the interest rates in some
instances. However, the most popular form of monetary policy is OMO's(Open market operations)
and in that case the government buys and sells government securities in the open market. The open market operations
will have an effect on the interest rates and money supply in the economy.
An additional monetary policy tool is setting the reserve requirements for commercial banks.
The reserve requirement is the percentage of deposits a commercial bank has to keep as reserves
and cannot lend that money as loans. By setting the reserve requirement, the government is able to influence the
money supply.
FISCAL POLICY is the management of government spending and tax rates to influence the economy.
The GDP of a country is given by the following:
Gross domestic product (GDP) = C(Consumption) + G (Government spending) + I (Capital Investment) + X (net exports)
The government can pump money into the economy by decreasing taxes and increasing government spending levels.
On the other hand, the government can increase taxes and decrease government spending levels to control
inflation in the economy.