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Economic Policy, measures taken by government intended to influence the behaviour of the economy. Some measures, such as the budget, operate over the whole economy and constitute policy in the sphere of macroeconomics; others operate on some specific and limited part of the economy, such as agriculture, and are policy elements in the realm of microeconomics. The two kinds of policy impinge on one another since measures affecting the whole economy necessarily affect the parts, and what affects any part or aspect of the economy registers in the performance of the whole.

Microeconomic policies are so multifarious that it is impossible to cover them briefly. They may relate to someone industry or product, or apply more widely. For example, they may involve nationalization or privatization of the railway system, prohibit the export of calves, or ban the opening of shops on Sundays. They may prescribe conditions to be fulfilled in the employment of labour (such as equal pay for men and women), the production and sale of certain products (for example, drugs), and financial operations of various kinds (for example, licensing deposit-taking by banks). Some kinds of policy are regulatory; others seek to encourage particular activities. There are close links with social policies, especially those aiming at improving education or public health with a view to producing a healthier, better educated, and more productive labour force. In general, microeconomic policy sets the legal framework within which market forces operate and without which competition might no longer be fair or socially advantageous.

The scope for macroeconomic policy depends upon the economic system in operation and the framework of laws and institutions governing it. The system may be capitalist or communist, free market economy or command economy, pre-industrial or post-industrial. There are also wide differences between economists over the extent to which government intervention should be welcomed. Some may take a laissez-faire view and put their trust in market forces or dwell on the inadequacies of the government machine. Others may look to the government to remedy the deficiencies of existing arrangements. In their view, economic policy should be designed to eliminate fluctutations in economic activity, reduce unemployment, promote faster economic growth, create greater economic quality, reduce the monopoly powers of large corporations, and prevent deterioration of the environment. The more apparent it is that market forces yield undesirable as well as desirable results, the greater is the pressure on the state to devise and implement economic policies to cope with the defects.

Economic policy may, however, do more harm than good if it is based on a mistaken diagnosis of the economic forces at work, or if those who seek to improve upon market forces lack the necessary understanding and skill. Employment policy, for example, has to rest on a view of the causes of unemployment and took shape only after it was attributed by John Maynard Keynes to a deficiency of demand. The prescription based on this was demand management in the form of a timely injection of additional purchasing power or, when unemployment falls below certain levels, its withdrawal. Similarly, a policy to control inflation must be based on a view of its causes, whether the view is that of Milton Friedman that inflation results from letting the stock of money grow too fast—that is, the doctrine of monetarism—or whether it lays the blame on excess demand or rising labour and raw materials costs. A great deal of economic theory is directed first to demonstrating the virtues of the “invisible hand” behind market forces, and then to analysing the inadequacies of those forces and the need for economic policy to redirect them.

The most important class of macroeconomic policy is demand management, which seeks to regulate the pressure on the community’s resources by operating on the level of spending power and so of demand. This generally takes the form of measures that constitute monetary policy and fiscal policy. On the monetary side, bank interest rates may be driven down or up, the banks may be obliged to restrict credit or lend more freely, and a target may be set for the growth in the stock of money. In some circumstances, these actions could be supplemented by the imposition of restrictions on hire purchase requiring larger down payments or shorter pay-back periods. On the fiscal side, the government may vary the level of taxation or change the tax system in ways intended to encourage or discourage consumer spending or capital investment. Or it may itself spend more or cut expenditure, again with a view to affecting the level of demand. In all such measures, the government operates through the market, giving market forces a new direction but not attempting to supervise them. The government may also intervene directly to regulate the level of demand via rationing or licensing, or fixing limits to consumption; it may also regulate production by legislation of various kinds—requiring employers to follow certain practices in relation to their workers, operating conditions, final product, agreements with other firms, and so on. Such intervention may be economy-wide, as when a limit is set to hours of labour, but it frequently concerns one industry or activity only, so that it is essentially part of microeconomic policy rather than macroeconomic policy.

In wartime, or in a communist or command economy, economic policy is more peremptory and government intervention to control the allocation of resources between different uses is carried much further. The Economic policy becomes a matter of planning from the centre rather than leaving it to individual producers and consumers to express their preferences through the market in response to price signals.

While most of the aims of economic policy fall to the government to pursue, some may be the concern of other bodies. Preserving stability of the value of money, for example, may be regarded by the central bank as its operational responsibility. Moreover, the success of government policy is not something that the government itself can guarantee: it may be highly dependent on the reactions of the public, and on attitudes and capabilities over which the government is likely to have little influence, at least in the short term. The impact of economic policy also depends on the skill and knowledge of those who implement it: since many departments and agencies are usually involved, the task of coordinating them and the various measures making up the policy can be crucial.

The problem of coordination particularly affects the international aspects of economic policy. Dealings with other countries raise a wide range of issues in connection with international trade and investment, the exchange rate, the balance of payments, tariffs, double taxation, copyright law, and so on. Changes in any of these have repercussions on the domestic economy that may be of the highest importance so that the international and domestic aspects of policy have to be closely coordinated. As the world economy becomes more closely integrated (and the European Union and other international or regional trade associations even more so), and global capital and investment becomes more mobile, the restraints imposed on domestic policy by external circumstances are intensified. Simultaneously, domestic policy in any one country impinges also on its neighbours. There is a need, therefore, for coordination between national economic policies and for frequent meetings between those responsible for policy-making at both official and ministerial levels. Such meetings, which were rare before World War II, do now occur regularly, whether at international bodies such as the European Union, the Organization for Economic Cooperation and Development, the International Monetary Fund, the World Bank, and the World Trade Organization, or at summits bringing together the leaders or finance ministers of the leading industrial countries. Economic policy may even be fixed by such bodies or summits, with various sanctions imposed on those participating countries who fail to adapt their policies accordingly. The prospect of European Monetary Union and a European Central Bank, for example, raises the likelihood of monetary policy being decided centrally for the entire European Union.

It is a matter of controversy how far economic policy should be governed by rule or discretion. There are those who would require the budget to be balanced or would set strict limits to budget deficits. Some also propose that central banks should set a fixed limit to the rate of increase of the money stock. Others suggest that unemployment should be held at some fixed proportion of the labour force. Such recommendations not only indicate distrust of the policy-makers but attribute to them at the same time power to adhere in all circumstances to some pre-arranged target.

Since the mid-1970s, macroeconomic policy has altered radically. There is greater reluctance to entrust the state with wide powers, particularly spending powers; there is more scepticism about the state’s ability to manage the economy, and much less faith is put in demand management as a means of stabilizing employment. More emphasis is put on the action of a different kind: ensuring greater competition, providing incentives to innovation and enterprise, making the domestic economy more attractive to foreign investment, and above all, making efforts to improve the education and capabilities of the workforce. The unifying creed of demand management has thus given way to a series of measures, more in keeping with pre-war ideas, on the side of supply.

Contributed By:
Sir Alec Cairncross

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