Macroeconomic policy instruments
Encyclopedia
Macroeconomic policy instruments refer to macroeconomic quantities that can be directly controlled by an economic policy maker. Instruments can be divided into two subsets: a) Monetary policy
instruments and b) Fiscal policy
instruments. Monetary policy is conducted by the Federal Reserve or the central bank
of a country or supranational region (Euro zone). Fiscal policy is conducted by the Executive and Legislative Branches of the Government and deals with managing a nation’s Budget
.
in the U.S.), and changing reserve requirement
s for commercial banks. Monetary policy can be either expansive for the economy (short-term rates low relative to inflation rate) or restrictive for the economy (short-term rates high relative to inflation rate
). Historically, the major objective of monetary policy had been to manage or curb domestic inflation
. More recently, central bankers have often focused on a second objective: managing economic growth as both inflation and economic growth
are highly interrelated.
and its financing so as to influence economic activity. This entails the expansion or contraction of government expenditures related to specific government programs such as building roads or infrastructure, military expenditures and social welfare programs. It also includes the raising of taxes to finance government expenditures and the raising of debt
(Treasuries in the U.S.) to bridge the gap (Budget deficit) between revenues (tax receipts) and expenditures related to the implementation of government programs. Raising taxes and reducing the Budget Deficit is deemed to be a restrictive fiscal policy as it would reduce aggregate demand and slow down GDP growth. Lowering taxes and increasing the Budget Deficit is considered an expansive fiscal policy that would increase aggregate demand and stimulate the economy
.
, who used these concepts in his books On the Theory of Economic Policy (1952) and Economic Policy: Principles and Design (1955).
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
instruments and b) Fiscal policy
Fiscal policy
In economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....
instruments. Monetary policy is conducted by the Federal Reserve or the central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
of a country or supranational region (Euro zone). Fiscal policy is conducted by the Executive and Legislative Branches of the Government and deals with managing a nation’s Budget
Budget
A budget is a financial plan and a list of all planned expenses and revenues. It is a plan for saving, borrowing and spending. A budget is an important concept in microeconomics, which uses a budget line to illustrate the trade-offs between two or more goods...
.
Monetary policy
Monetary policy instruments consists in managing short-term rates (Fed Funds and Discount ratesDiscount window
The discount window is an instrument of monetary policy that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions...
in the U.S.), and changing reserve requirement
Reserve requirement
The reserve requirement is a central bank regulation that sets the minimum reserves each commercial bank must hold of customer deposits and notes...
s for commercial banks. Monetary policy can be either expansive for the economy (short-term rates low relative to inflation rate) or restrictive for the economy (short-term rates high relative to inflation rate
Inflation rate
In economics, the inflation rate is a measure of inflation, the rate of increase of a price index . It is the percentage rate of change in price level over time. The rate of decrease in the purchasing power of money is approximately equal.The inflation rate is used to calculate the real interest...
). Historically, the major objective of monetary policy had been to manage or curb domestic inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
. More recently, central bankers have often focused on a second objective: managing economic growth as both inflation and economic growth
Economic growth
In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...
are highly interrelated.
Fiscal policy
Fiscal policy consists in managing the national BudgetBudget
A budget is a financial plan and a list of all planned expenses and revenues. It is a plan for saving, borrowing and spending. A budget is an important concept in microeconomics, which uses a budget line to illustrate the trade-offs between two or more goods...
and its financing so as to influence economic activity. This entails the expansion or contraction of government expenditures related to specific government programs such as building roads or infrastructure, military expenditures and social welfare programs. It also includes the raising of taxes to finance government expenditures and the raising of debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
(Treasuries in the U.S.) to bridge the gap (Budget deficit) between revenues (tax receipts) and expenditures related to the implementation of government programs. Raising taxes and reducing the Budget Deficit is deemed to be a restrictive fiscal policy as it would reduce aggregate demand and slow down GDP growth. Lowering taxes and increasing the Budget Deficit is considered an expansive fiscal policy that would increase aggregate demand and stimulate the economy
Economy
An economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...
.
History
The classification of some macroeconomic variables as instruments and some others as targets or objectives is originally due to Jan TinbergenJan Tinbergen
Jan Tinbergen , was a Dutch economist. He was awarded the first Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel in 1969, which he shared with Ragnar Frisch for having developed and applied dynamic models for the analysis of economic processes...
, who used these concepts in his books On the Theory of Economic Policy (1952) and Economic Policy: Principles and Design (1955).