The instruments that governments use to manipulate the activities of a nation are termed as the economic policy tools. These instruments play the essential role in the attainment of macroeconomic goals which include economic growth, price stability, full employment, and favorable balance of payment. Excellent economic policies assist governments to regulate the economy through manipulation of components such as inflation, unemployment, and national income so as to make the economy stable and competitive.
There is a variety of tools available to the policymakers, both at the central bank and government levels. Such instruments affect different parts of the economy such as the investment, consumption and production. This paper discusses the major economic policy instruments which are used to guide policymakers to direct economic performance and how expansion takes place.
Monetary Policy: The Government Controls Money supply and interest rates
The economic policy making has one of the most effective tools known as monetary policy. It is the control of the supply level of money, as well as the level of interest rates of any country provided by the central bank of the country. Monetary policy aims at controlling inflation, stabilization of currency and control of economic growth. Monetary policy can be of two kinds namely expansionary and contractionary.
Expansionary Monetary Policy
The same is employed when the economy is reducing. Central banks stimulate the economy by reducing the interest rates and put more money into circulation which promotes borrowing, investment, and spending as well. As an example, in the period of a recession central banks can lower the interest rates to make the borrowing less expensive and to stimulate the business and consumers to spend more.
Contractionary Monetary Policy
This is applied during a period of high inflation and when an economy is overheated. Central bank would increase the interest rates and decrease the supply of money in the economy to prevent over spending and over borrowing so that the inflation can be controlled.
Quantitative Easing (QE)
QE is an unconventional monetary policy instrument employed in the event when interest rates have already been lowered down to near zero level, and any further reduction fails to produce any positive effects. The central banks buy securities of the government and the private sector to pump money into the economy and this stimulates lending and investment.
Government Spending and Taxation
Fiscal policy is a policy of using government expenditure and tax to control the economy. Governments are able to change the amount of spending as well as the rate of taxation in order to boost economic performance or depress the economy.
Government Spending
This spending can be increased though the governments can enhance the aggregate demand which will lead to job creation and growth of the economy since most of these spending are made in infrastructural development and providing services to people. An example of this would be during recession, governments tend to employ people through construction of roads or bridges and others which will enable them to project money and hire people.
Taxation Policy
The other important fiscal policy tool is taxation. Cutting taxes will help stir up purchasing and investment activities by the businesses and the consumers respectively, boosting the economy. On the contrary, tax increases would contribute to the reduction of inflationary pressure as people have less discretional income and, hence, demand in the economy.
Deficit Spending
Deficit spending entails the expenditure to spur the economy during economic recessions when governments have to spend more than it would be received in taxes in a bid to spur the economy. Although this will raise the level of government debt, it may be used to cushion the impact of a recession and initiate growth.
Trade Policy: International Trade and investment Promotion
Trade policy is the way to control international trade by means of using imports restrictions, trade agreements and export subsidies. The trade policy is used by countries to open their markets, to boost exports as well as to defend their industries.
Free Trade Agreements (FTAs)
These are the trade agreements and set before countries to lower or even wipe out the barriers existing to trade. FTAs promote international trade, increase exports and enable nations to specialise in non-differentiated sectors.
Tariffs and quotas
The governments can introduce tariffs (taxation on imports) or Quota (limiting the quantity of imports) to safeguard the local industry against the foreign competition. Although tariffs could offer temporary respite to the local industries, they have the propensity to increase the prices paid by the consumers and they can also affect the market efficiencies.
Export Subsidies
There are those governments that give subsidies to industries in their country so that they can be in a position to compete in the international trading markets. Governments stimulate exports and hunt down job openings by encouraging industries such as agriculture, manufacturing or technology to be subsidized. Such subsidies though may affect the global markets and result to trade war.
Regulatory Policy: Providing Business and Market Practices
Regulatory policy implicates establishing rules and guidelines which companies cannot contradict. It strives to have businesses run collectively and openly by safeguarding consumers, employees and the environment.
Antitrust Laws
The laws are meant at deterring monopolistic actions and encourage competition. This will be done by regulating mergers and acquisitions as well as banning anti-competitive measures so that governments can ensure the existence of a competitive market, which is healthy in the sense that it reduces the price of goods and fosters innovations.
Labor Laws
Labor laws guide the employment activities such as wage levels, working conditions and the rights of the workers. Governments secure their workers by setting standards of minimum wage and providing workplace safety and inspire social stability.
Environmental Regulations
The governments are implementing environmental rules that aim at safeguarding natural resources and the health of humanity. Such standards may comprise factory emissions standard, wastes management, and energy savings standards. Although these regulations can create costs to businesses, they can make their sustainability in the long run and can contribute to the process of green technologies formation.
Exchange Rate Politics: The Case of Currency Value
Another significant instrument in the economic policy making is the exchange rate policy, and this applies mostly to countries that are involved in international trade. Governments have been controlling the exchange rates and by that, they can affect the level of trade balances, inflation of the economy and general competiveness.
Fixed vs. Floating Exchange Rates
There are countries that stick to a fixed exchange rate where the currency is pegged with another currency i.e. the U.S. dollar. This brings certain stability in international trade but restricts the usage of monetary policy by a country in line with regard to economic conditions. A floating exchange rate is formed among other countries and it is decided by market forces whether the currency is going to be strong or weak. This repairs governments an additional leeway although it can cause the volatility of forex rates.
Currency Devaluation
A government can decide to devalue its currency so that its exports can be cheap and affordable in the world market. Devaluation may too push up imported goods and cause inflation.
Economic Efficiency Policies
Supply side policies are based on the idea to expand productive ability of the economy by enhancing the efficiency and flexibility of the labour force and capital markets. These policies concentrate on less government interference, enhancement in encourage work and investment, and elimination of obstructions to competition.
Subsidies to make Investments
Governments can also introduce tax reductions or tax allowances to business ventures undertaking an investment in research and development (R&D), in new technologies, or in infrastructure. Such incentives assist in boosting productivity, as well as in long-term growth.
Labor Market Reforms
Labor market reforms usually fall under the supply-side policy that eases the employment and retention of workers by the business organisations. This may consist of tightening of employment protection regulations, declining the power of unions, or the enhancement of vocational training so that the labor force may be proficient and open-minded.
Deregulation
Governments can reduce the instances of regulation which can make life easier to businesses to operate and innovate. Deregulation allows the development of competitive forces, it helps in cost reduction and entrepreneurship thus enhancing productivity and growth in the economy.
Life skills and Investment in education and human capital
Investment in education and human capital is one of the most significant long-term economic policy. Economic growth is supported by a quality educated and skilled population as this enhances productivity, innovation and leads to the emergence of emerging industries.
Education Policies
Governments, which invest in education, have formed a highly skilled cadre of the workforce, which is in a better position to adjust the everchanging technology and global competition. The sustainable economic growth requires education strategies aimed at enhancing access to qualitative education including that of vocational and technical training.
Research and Development (R&D)
The use of Research and Development (R&D) as an investment leads to innovation and technological advancement that is one of the greatest contributors of economic growth. Governments may encourage new industries (renewable energy, biotechnology, and digital technologies etc.) by facilitating R&D activities.
Conclusion: Interaction between the Instruments of Economic Policy and Growth
Tools of economic policies are crucial to achieving growth and maintenance of economic stability. Governments have various tools to control the direction of the economy throughout the implementation of monetary and fiscal policies, trade regulations and investing in education. All the tools are unique in supporting the macroeconomic issues and ensuring long-term developments. The success of such tools is subject to their level of implementation and coordination, and adherence to technological changes and transformations across the globe.
Economies are changing and hence the policies governing them have to change. Governments have to keep on improving its economic policies and figure out ways to embrace the changes to create more growth and sustainability in their economies while adopting to the new challenges. Using the appropriate combination of policy tools, governments can establish a scenario that would encourage innovation, competition, and inclusive innovation-based economic development.