Course_Economic Policy

Educational and Qualification degree: Bachellor of Economy

Substance of the economic policy

Prof. Dr. Rumen Gechev

Chief Assist. Dr. Ivan Bozhikin
Ph.D. Neda Muzho
Contents:
• Definition
1

• Objectives
2

• Models
3

• Mechanisms and interactions between government, parliament,

4 central bank, trade unions and non governmental organizations

• Results
5
Economic policy_definition

 The economic policy of governments covers the systems for setting

levels of taxation, government budgets, the money supply
and interest rates as well as the labour market, national ownership,
and many other areas of government interventions into the
economy.
 Most factors of economic policy can be divided into either fiscal
policy, which deals with government actions regarding taxation
and spending, or monetary policy, which deals with central banking
actions regarding the money supply and interest rates.
 Such policies are often influenced by international institutions like
the International Monetary Fund or World Bank as well
as political beliefs and the consequent policies of parties
Economic policy_goals

 There are four major goals of economic policy: stable markets,

economic prosperity, business development and protecting
employment.
 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. 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.
Economic policy_models

 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.
Economic policy_models

 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.
Economic policy_models

 Mainstream modern economics can be broken down into Four

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

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.
Mechanisms and interactions
 Economic policies are typically implemented and administered by the government.
Examples of economic policies include decisions made about government spending
and taxation, about the redistribution of income from rich to poor, and about the
supply of money. The effectiveness of economic policies can be assessed in one of
two ways, known as positive and normativeeconomics.
 Positive and normative economics. Positive economics attempts to describe how the
economy and economic policies work without resorting to value judgments about
which results are best. The distinguishing feature of positive economic hypotheses is
that they can be tested and either confirmed or rejected. For example, the
hypothesis that “an increase in the supply of money leads to an increase in prices”
belongs to the realm of positive economics because it can be tested by examining
the data on the supply of money and the level of prices.
 Normative economics involves the use of value judgments to assess the performance
of the economy and economic policies. Consequently, normative economic
hypotheses cannot be tested. For example, the hypothesis that “the inflation rate is
too high” belongs to the realm of normative economics because it is based on a
value judgment and therefore cannot be tested, confirmed, or refuted. Not
surprisingly, most of the disagreements among economists concern normative
economic hypotheses.
Mechanisms and interactions
 The government may decide to regulate some aspects of economic
activity in order to engineer economic growth or prevent negative
economic conditions in the future. In general, a government's active
role in responding to and influencing the economic circumstances of a
country is for the purpose of preserving and furthering the economic
interests of the general public.
 For those in political power, having a track record of economic growth
is often an important consideration (especially if they are in a position of
seeking re-election). For example, In the U.S., many studies have shown
that the economy is a major factor that affects how people vote
(specifically in the U.S. presidential election).1 Strong economic growth
typically translates to high job creation, stronger wage growth,
better financial market performance, and higher corporate profits.
 To ensure strong economic growth, there are two main ways that the
federal government may respond to economic activity: fiscal
policy and monetary policy