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Introduction
Macroeconomic Policy means the monetary and fiscal policy it refers to the instruments by which a government tries to regulate or modify the economic affairs of the country in keeping with certain objectives; In other words, it tries to assess the behaviour of the economy as a whole and to seek ways in which its aggregate performance might be improved. These are achieved through certain instruments and objectives of macroeconomic policy. Its two main instruments are monetary and fiscal policy, and its four major objectives are full employment, price stability, economic growth, and balance of payments equilibrium. The policy targets are the specific values which a government attaches to its various objectives of macroeconomic policies. For instance, the government may have policy objectives like to achieve full employment, to achieve price stability and to attain the targeted growth rate for the economy. Thus, the policy targets of the government are to reduce unemployment rate, control inflation rate and to increase growth rate per year. On 'the other hand, policy instruments are those exogenous variables that can be directly influenced by the government. The government can influence macroeconomic policies by such instruments of monetary policy as bank rate, changes in reserve ratios, open market
operations, selective credit controls, etc. Similarly, it can use such fiscal policy instruments as tax rates, budgetary policy, compensatory fiscal policy, etc.
Objectives of Macroeconomic Policy
The following are the objectives of macroeconomic policy.
(1) Full Employment
Full employment has been ranked among the foremost objectives of economic policy. But there is no unanimity of views on the meaning of full employment. The classical economists always believed in the existence of full employment in the economy. To them unemployment was a normal situation and any deviation from this was regarded as something abnormal. Full employment existed when everybody at the running rate of wages wishes to be employed. Those who are not prepared to work at the existing wage rate are not unemployed because they are voluntarily unemployed.
There is, however, no possibility of involuntary unemployment in the sense that people are prepared to work but they do not find work. However, this classical view on full employment is consistent with some amount of frictional, voluntary, seasonal or structural unemployment.
(2) Price Stability
One of the policy objectives of monetary and fiscal policy is to stabilise the price level. Both economists and laymen favour this policy because fluctuations in prices bring uncertainty and instability to the economy. Rising and falling prices are both bad because they bring unnecessary loss to some and undue advantage to others. Again, they are associated with business cycles. The policy of price stability keeps the value of money stable, eliminates cyclical fluctuations, brings economic stability, helps in reducing inequalities of income and wealth, secures social justice and promotes economic welfare.
(3) Economic Growth
One of the most important objectives of macroeconomic policy in recent years
has been the rapid economic growth of an economy. Economic growth is measured by
the increase in the amount of goods and services produced in a country. A growing economy produces more goods and services in each successive time period. Thus, growth occurs when an economy's productive capacity increases which, in turn, is used to produce more goods and services. In its wider aspect, economic growth implies raising the standard of living of the people and reducing inequalities of income distribution. All agree that economic growth is a desirable goal for a country.
(4) Balance of Payments
Another objective of macroeconomic policy is to maintain equilibrium in the balance of payments. The achievement of this goal has been necessitated by the phenomenal growth in the world trade as against the growth of international liquidity. It is also recognised that deficit in the balance of payments will retard the attainment
of other objectives. This is because a deficit in the balance of payments leads to a sizeable outflow of gold. But it is not clear what constitutes a satisfactory balance of payments positions. Clearly a country with a net debt must be at a surplus to repay the debt over a reasonably short period of time. Once any debt has been repaid and an adequate reserve attained, a zero balance maintained over time would meet the policy objective. But how is this satisfactory balance to be achieved on the trading account or on the capital account? The capital account must be looked upon as fulfilling merely a short-term emergency role in times of crisis.
Conflicts or Trade-off in Policy Objectives
The four policy objectives discussed above are not complementary to each other. Rather they are conflicting with one another. If a government tries to fulfill one objective, some other objective moves away. It has to sacrifice one objective in order to attain the other. It is, therefore, not possible to fulfill all these policy objectives simultaneously. We discuss below conflicts between different policy objectives.
Full Employment and Economic Growth
The majority of economists hold the view that there is no inherent conflict between full employment and economic growth. Full employment is consistent with 4 per cent unemployment in the economy. So the relationship between full employment and economic growth boils down to a trade-off between unemployment and growth. Periods of high growth are associated with low level of unemployment and periods of
low growth with rising unemployment.
In 1961 Aurther Okun established a relationship between real GNP and changes in the unemployment rate. This relationship has come to be known as Okun's Law. This law states that for every three percentage points growth in real GNP,
unemployment rate declines by one percentage point every year. This is illustrated in Figure 5.1 where the curve U represents unemployment and curve G the real growth of an economy for a few years.
To begin with, the economy is growing at 3 per cent with an unemployment rate of 4 per cent. During the year 1970, when the real GNP increases by 4.5 per cent (from 3 per cent to 7.5 per cent), the unemployment rate feel by 1.5 per cent (from 4 per cent to 2.5 per cent). In the next year 1971, the growth rate of the economy falls to zero arid the unemployment rate rises to 5 per cent. In the subsequent year 1972, the real growth rate increases to 3 per cent and the unemployment rate declines to 4 per cent.
Economic Growth and Price Stability
There is conflict between the goals of economic growth and price stability. The rise in prices is inherent in the growth process. The demand for goods and services rises as a result of stepping up of investments on a large scale and consequent increase in incomes. This leads to inflationary rise in prices, especially when the level of full employment is reached. In the long-term, when new resources are developed and growth leads to the production of more commodities, the inflationary rise in prices will be checked. But the rise in prices will be there with the growth of the economy and it will be moderate and gradual.
Full Employment and Price Stability
One of the objectives of macroeconomic policy is to have full employment with price stability. But the studies of Philips, Samuelson-Solow and others in the 1960s established a conflict between the two objectives.
These findings are explained in terms of the Philips curve. They suggest that full employment can be attained by having more inflation and that price stability can be achieved by having unemployment to the extent of 5 to 6 per cent. Economists do not find any conflict between unemployment and price stability. They hold that so long as there are unemployed resources, there will be price stability. Prices start rising only when there is full employment of resources. This is illustrated in Figure 5.2 where the percentage of resources unutilized (or unemployed) are taken on the horizontal axis and the percentage change in price level is taken on the vertical axis. Thus, each point indicates the percentage of resources unemployed along with the price level. According
to this theory, so long resources U1, U2 and U3 are unemployed the price level remains constant at P0. It is only when the economy reaches the full employment level F, prices 'rise from P0 to P1 to P2 to P3 with successive increases in demand. Thus,there is no conflict between unemployment and stable prices as shown by the shaded
area of the figure.
However, the macro policy implications of such a relationship are that there can be no conflict between full employment and price stability so long as the economy is in the shaded area. This is because when there is full employment, resources are not in excess supply and if the government controls the excess demand through appropriate monetary and fiscal policy, there will be stability of the price level. But if the economy happens to be at point P, which may be taken to be a point on the Phillips curve, there will be conflict between the objectives of full employment and price stability.
Full Employment and Balance of Payments
There is a major policy conflict between full employment and balance of payments. Full employment is always related to balance of payments deficit. In fact, the problem is one of maintaining either internal balance or external balance, if there is a balance of payments deficit, then a policy of reducing expenditure will reduce imports but it will lead to increase in unemployment in the country. If the government raises aggregate expenditure in order to increase employment, it will increase the demand for imports thereby creating disequilibrium in the balance of payments. It is only when the government adopts expenditure-switching policies such as devaluation that this conflict can be avoided, but that too temporarily.
Price Stability and Balance of Payments
There appears to be no conflict between the objectives of price stability and balance of payments in a country. Fiscal and monetary policies aim at controlling inflation to discourage imports and encourage exports and, thus, they help in attaining balance of payments equilibrium. However, if the government tries to remove
unemployment and allows some inflation within the economy, there appears a conflict between these two objectives. For a rise in the price level will discourage exports and encourage imports, thereby leading to disequilibrium in the balance of payments. But this may not happen if prices also rise by the same rate in other countries of the world.
Problem of Coordination of Macroeconomic Policy Objectives
We have seen above that there are four policy goals which are often in conflict with each other. The problem is one of achieving them simultaneously. Full employment, economic growth and price stability are the major objectives of economic policy. They are essential for the internal balance of the economy. But balance of payments equilibrium is also an essential policy objective because a disturbance in the balance of payments has serious effects on growth, employment and prices. This objective, therefore, requires external balance. The theory of economic policy has centred around two problems. First, the relation between the number of policy objectives and the number of policy instruments; and second, the assignment of policy instruments to the realisation of the objectives. In order to achieve given objectives with the same number of policy instruments, the second problem of the assignment of instruments to targets arises. The formulation of the assignment problem will eventually lead to equilibrium values of the objectives, despite lack of coordination between them.
Conclusion
Full employment, economic growth, balance of payments and price stability are the major objectives of economic policy. The four policy objectives discussed above are not complementary to each other. Rather they are in conflict with one another. If a government tries to fulfill one objective, some other objective moves away. It has to sacrifice one objective in order to attain the other. It is, therefore, not possible to fulfill all these policy objectives simultaneously. There can be possibility of internal and external imbalance. To achieve both objectives of internal and external balance simultaneously a judicious combination of expenditure-reducing and expenditure-switching instruments is needed.
Macroeconomic Policy means the monetary and fiscal policy it refers to the instruments by which a government tries to regulate or modify the economic affairs of the country in keeping with certain objectives; In other words, it tries to assess the behaviour of the economy as a whole and to seek ways in which its aggregate performance might be improved. These are achieved through certain instruments and objectives of macroeconomic policy. Its two main instruments are monetary and fiscal policy, and its four major objectives are full employment, price stability, economic growth, and balance of payments equilibrium. The policy targets are the specific values which a government attaches to its various objectives of macroeconomic policies. For instance, the government may have policy objectives like to achieve full employment, to achieve price stability and to attain the targeted growth rate for the economy. Thus, the policy targets of the government are to reduce unemployment rate, control inflation rate and to increase growth rate per year. On 'the other hand, policy instruments are those exogenous variables that can be directly influenced by the government. The government can influence macroeconomic policies by such instruments of monetary policy as bank rate, changes in reserve ratios, open market
operations, selective credit controls, etc. Similarly, it can use such fiscal policy instruments as tax rates, budgetary policy, compensatory fiscal policy, etc.
Objectives of Macroeconomic Policy
The following are the objectives of macroeconomic policy.
(1) Full Employment
Full employment has been ranked among the foremost objectives of economic policy. But there is no unanimity of views on the meaning of full employment. The classical economists always believed in the existence of full employment in the economy. To them unemployment was a normal situation and any deviation from this was regarded as something abnormal. Full employment existed when everybody at the running rate of wages wishes to be employed. Those who are not prepared to work at the existing wage rate are not unemployed because they are voluntarily unemployed.
There is, however, no possibility of involuntary unemployment in the sense that people are prepared to work but they do not find work. However, this classical view on full employment is consistent with some amount of frictional, voluntary, seasonal or structural unemployment.
(2) Price Stability
One of the policy objectives of monetary and fiscal policy is to stabilise the price level. Both economists and laymen favour this policy because fluctuations in prices bring uncertainty and instability to the economy. Rising and falling prices are both bad because they bring unnecessary loss to some and undue advantage to others. Again, they are associated with business cycles. The policy of price stability keeps the value of money stable, eliminates cyclical fluctuations, brings economic stability, helps in reducing inequalities of income and wealth, secures social justice and promotes economic welfare.
(3) Economic Growth
One of the most important objectives of macroeconomic policy in recent years
has been the rapid economic growth of an economy. Economic growth is measured by
the increase in the amount of goods and services produced in a country. A growing economy produces more goods and services in each successive time period. Thus, growth occurs when an economy's productive capacity increases which, in turn, is used to produce more goods and services. In its wider aspect, economic growth implies raising the standard of living of the people and reducing inequalities of income distribution. All agree that economic growth is a desirable goal for a country.
(4) Balance of Payments
Another objective of macroeconomic policy is to maintain equilibrium in the balance of payments. The achievement of this goal has been necessitated by the phenomenal growth in the world trade as against the growth of international liquidity. It is also recognised that deficit in the balance of payments will retard the attainment
of other objectives. This is because a deficit in the balance of payments leads to a sizeable outflow of gold. But it is not clear what constitutes a satisfactory balance of payments positions. Clearly a country with a net debt must be at a surplus to repay the debt over a reasonably short period of time. Once any debt has been repaid and an adequate reserve attained, a zero balance maintained over time would meet the policy objective. But how is this satisfactory balance to be achieved on the trading account or on the capital account? The capital account must be looked upon as fulfilling merely a short-term emergency role in times of crisis.
Conflicts or Trade-off in Policy Objectives
The four policy objectives discussed above are not complementary to each other. Rather they are conflicting with one another. If a government tries to fulfill one objective, some other objective moves away. It has to sacrifice one objective in order to attain the other. It is, therefore, not possible to fulfill all these policy objectives simultaneously. We discuss below conflicts between different policy objectives.
Full Employment and Economic Growth
The majority of economists hold the view that there is no inherent conflict between full employment and economic growth. Full employment is consistent with 4 per cent unemployment in the economy. So the relationship between full employment and economic growth boils down to a trade-off between unemployment and growth. Periods of high growth are associated with low level of unemployment and periods of
low growth with rising unemployment.
In 1961 Aurther Okun established a relationship between real GNP and changes in the unemployment rate. This relationship has come to be known as Okun's Law. This law states that for every three percentage points growth in real GNP,
unemployment rate declines by one percentage point every year. This is illustrated in Figure 5.1 where the curve U represents unemployment and curve G the real growth of an economy for a few years.
Economic Growth and Price Stability
There is conflict between the goals of economic growth and price stability. The rise in prices is inherent in the growth process. The demand for goods and services rises as a result of stepping up of investments on a large scale and consequent increase in incomes. This leads to inflationary rise in prices, especially when the level of full employment is reached. In the long-term, when new resources are developed and growth leads to the production of more commodities, the inflationary rise in prices will be checked. But the rise in prices will be there with the growth of the economy and it will be moderate and gradual.
Full Employment and Price Stability
One of the objectives of macroeconomic policy is to have full employment with price stability. But the studies of Philips, Samuelson-Solow and others in the 1960s established a conflict between the two objectives.
These findings are explained in terms of the Philips curve. They suggest that full employment can be attained by having more inflation and that price stability can be achieved by having unemployment to the extent of 5 to 6 per cent. Economists do not find any conflict between unemployment and price stability. They hold that so long as there are unemployed resources, there will be price stability. Prices start rising only when there is full employment of resources. This is illustrated in Figure 5.2 where the percentage of resources unutilized (or unemployed) are taken on the horizontal axis and the percentage change in price level is taken on the vertical axis. Thus, each point indicates the percentage of resources unemployed along with the price level. According
to this theory, so long resources U1, U2 and U3 are unemployed the price level remains constant at P0. It is only when the economy reaches the full employment level F, prices 'rise from P0 to P1 to P2 to P3 with successive increases in demand. Thus,there is no conflict between unemployment and stable prices as shown by the shaded
area of the figure.
However, the macro policy implications of such a relationship are that there can be no conflict between full employment and price stability so long as the economy is in the shaded area. This is because when there is full employment, resources are not in excess supply and if the government controls the excess demand through appropriate monetary and fiscal policy, there will be stability of the price level. But if the economy happens to be at point P, which may be taken to be a point on the Phillips curve, there will be conflict between the objectives of full employment and price stability.
Full Employment and Balance of Payments
There is a major policy conflict between full employment and balance of payments. Full employment is always related to balance of payments deficit. In fact, the problem is one of maintaining either internal balance or external balance, if there is a balance of payments deficit, then a policy of reducing expenditure will reduce imports but it will lead to increase in unemployment in the country. If the government raises aggregate expenditure in order to increase employment, it will increase the demand for imports thereby creating disequilibrium in the balance of payments. It is only when the government adopts expenditure-switching policies such as devaluation that this conflict can be avoided, but that too temporarily.
Price Stability and Balance of Payments
There appears to be no conflict between the objectives of price stability and balance of payments in a country. Fiscal and monetary policies aim at controlling inflation to discourage imports and encourage exports and, thus, they help in attaining balance of payments equilibrium. However, if the government tries to remove
unemployment and allows some inflation within the economy, there appears a conflict between these two objectives. For a rise in the price level will discourage exports and encourage imports, thereby leading to disequilibrium in the balance of payments. But this may not happen if prices also rise by the same rate in other countries of the world.
Problem of Coordination of Macroeconomic Policy Objectives
We have seen above that there are four policy goals which are often in conflict with each other. The problem is one of achieving them simultaneously. Full employment, economic growth and price stability are the major objectives of economic policy. They are essential for the internal balance of the economy. But balance of payments equilibrium is also an essential policy objective because a disturbance in the balance of payments has serious effects on growth, employment and prices. This objective, therefore, requires external balance. The theory of economic policy has centred around two problems. First, the relation between the number of policy objectives and the number of policy instruments; and second, the assignment of policy instruments to the realisation of the objectives. In order to achieve given objectives with the same number of policy instruments, the second problem of the assignment of instruments to targets arises. The formulation of the assignment problem will eventually lead to equilibrium values of the objectives, despite lack of coordination between them.
Conclusion
Full employment, economic growth, balance of payments and price stability are the major objectives of economic policy. The four policy objectives discussed above are not complementary to each other. Rather they are in conflict with one another. If a government tries to fulfill one objective, some other objective moves away. It has to sacrifice one objective in order to attain the other. It is, therefore, not possible to fulfill all these policy objectives simultaneously. There can be possibility of internal and external imbalance. To achieve both objectives of internal and external balance simultaneously a judicious combination of expenditure-reducing and expenditure-switching instruments is needed.
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