Question

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(1) What are the major objectives of U.S. government economic policy? (2) What policy tools does the government use to achieve these objectives? (3) Use examples to illustrate how policies are used to achieve these objectives

Answer 1

1.The federal government pursues policies that strive to create a healthy economy that benefits all Americans — not an easy task. An economic policy that benefits one segment of society may be damaging to another. Keeping inflation under control by raising interest rates makes it difficult for businesses to get capital to expand and hire additional workers; the unemployment rate may go up. Low interest rates, on the other hand, can lead to inflation as spending increases; many workers find their pay raises meaningless because prices go up.

Because of the complexity of economic policy, elected officials find that the only way they can come to an agreement on any aspect of it is to work out compromises

To maintain a strong economy, the federal government seeks to accomplish three policy goals: stable prices, full employment, and economic growth. In addition to these three policy goals, the federal government has other objectives to maintain sound economic policy. These include low or stable interest rates, a balanced budget (or at least a budget with a reduced deficit from the previous budget), and a trade balance with other countries.

Stable prices

When prices for goods and services increase sharply, the value of money is reduced, and it costs more to buy the same things. This condition is called inflation. When inflation is kept low, prices remain at the same level. Circumstances beyond the government's control can affect prices. A prolonged drought in the corn belt or an early freeze that hits the orange crop in Florida creates shortages that lead to higher prices. Higher prices for certain critical goods, such as oil, can create inflationary prices throughout the economy.

Full employment

Absolute full employment is impossible to achieve; at any given time, people are quitting their jobs or are unable to work for a variety of reasons. An unemployment rate, the percentage of the labor force that is out of work, of 4 percent or less is considered full employment. The unemployment rate varies from region to region and from state to state. For example, California's rate was higher than the national average in the early 1990s because of cutbacks in the aerospace industry and companies moving out of the state.

Economic growth

Economic growth is measured by the gross domestic product (GDP),the dollar value of the total output of goods and services in the United States. A thriving economy may have a GDP growth rate of 4 percent a year; a stagnant economy may grow at less than 1 percent a year. In a stagnant economy, unemployment is high, productivity is low, and jobs are hard to find.

2. 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.

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.

3. Macroeconomic policies include taxes, government spending and borrowing, exchange rate determinants, and monetary and credit rules. The primary goal of effective macroeconomic policies is to reduce uncertainty and risk in economic decision-making. A stable macroeconomic environment enhances prospects for growth and improved living standards. But stability is not the only concern: these policies also have an important impact on how income is distributed across economic classes and across generations. The World Bank Group’s primary goals are to reduce poverty and ensure shared prosperity, and its macroeconomists are no exception. They work to help policymakers better understand and manage macroeconomic policy so that it works to reduce the number of people living in poverty and to increase the number of people who can share in the benefits of rising incomes.

While governments’ choices on macroeconomic and fiscal policies are already complicated, they gain a significant layer of complexity in countries facing fragility and conflict. Over the past decade the world has witnessed a resurgence of conflict across a variety of countries, including both low-income and middle-income countries. In some contexts, macroeconomics can be considered a driver or enabler of conflict. This is the case in societies where the distribution of natural resource rents is contested and at the root of conflict. In some cases, macroeconomic policymakers are working to achieve the goals of growth, poverty reduction and shared prosperity in an environment constrained by fragility and conflict. The efficacy of certain approaches will depend on the challenges facing a country at the different stages of conflict: in contexts of fragility, during conflict, and in a post-conflict environment (stabilization, reconstruction, kick-starting growth, building resilience).These macroeconomic policy choices will also vary based on countries’ income levels, endowments of human and physical capital as well as natural resources, not to mention the state’s institutional capabilities.