Economic theories have been very critical in influencing policy making decisions that affect both the local and international economies. These theories are used by the policymakers to shape and execute efficient economy growth, stability and development policies. The theories give the guidelines by which the governments examine as well as address all the economic issues including economic inequalities, inflation, and unemployment. The relationship between the economic theory and policy making is very critical to any individual who is interested in how economic decisions are arrived at as well as their impact to the society.
The Implication of Economic Theories and Policies
Policies that governments embrace rely on economic theories. With this knowledge on how far supply, demand and market forces are connected, a policymaker is able to formulate tactics that are likely to affect these forces in such a manner that they favour the overall good of the economy. The theories also give a guide on how to respond to the crisis of the economy, how to stimulate the economy and to decrease inequality.
Examples of the most popular economic theories are:
- Keynesian Economics
- Monetarism
- Supply-Side Economics
- Behavioral Economics
- Neoclassical Economics
All these theories have a different interpretation of economic behavior, and consequently each has its implications on policy formulation.
Keynesian Economics: Government Interventions in Stabilization of the Economy
Keynesian economics was formulated by the famous John Maynard Keynes during the great depression and has been the theory which suggests that the government should play an active role on the economy. Keynes felt that in periods when the economy is not doing well, demand of the economy was usually insufficient in the private sector and this resulted in unemployment and stagnated economy. In response to this, Keynes introduced the concept that the state intervention in form of fiscal policies i.e. raising government spending and reducing taxation must occur so as to spur demand and move the economy.
Keynesian economics holds the view that the economy is unstable in nature and needs the government to stabilize the economy. Policymakers taking up the Keynesian prescriptions usually give paramount preference on pumping up the government expenditure particularly during recession to keep the aggregate demand stable and to obviate the adverse impacts of economic slowdowns.
Policy Applications:
- Stimulus Spending: The government can engage in government spending by boosting infrastructure, education and healthcare which will boost the demand and generate jobs.
- Tax Cuts: In an additional stimulus of demand, tax cuts may stimulate household consumption spending and stimulate business investment.
- Monetary Easing: Central banks can ease up the interest rates by reducing them in order to allow borrowing to be cheap to influence both the businesses and the consumer to spend more.
Keynesian economics has been very helpful in determining how to handle significant economic crises. A typical example can be cited in the 2008 world financial crisis when most governments adopted Keynesian stimulus package as the strategy of revamping their economies.
Monetarism: Money Supply as a Way of Checking Inflation
The other theory which disputes the Takeykeenism economics is the theory of monetarism which is attributed to Milton Friedman. According to monetarists, the rate of flow of money is the major trigger of inflation and hence it is very essential that there be a control on money flow as a means of controlling inflation and ensuring stability in the economy. This theory indicates that inflation is not a resultant of increased demand on goods, but due to too much money being supplied into circulation.
The philosophy of monetarist is that a government should not interfere much and rather the monetary policy should be concerned with the control of inflation by the central bank. They also propose moderate and consistent increase in money supply, this will enable the economy to expand at a steady and sustainable rate that is not inflationary in nature.
Policy Applications:
- Regulation of Money Supply: Central banks can control money supply by applying such measures as changing the interest rates and implementing open market operations that can put inflation in check.
- Low Inflation Targeting: Authorities specifically urban planners, central banks establish specific goals of inflation and it is regarded as a means of keeping the prices stable and hence fostering economic growth.
- Limited Fiscal Policy: Monetarists hold to the position that government intervention in fiscal policy or using the state to stimulate spending e.g. raising expenditure or lowering taxes will fail and prove counterproductive by causing inflation.
Monetarism has had its share since most of the central banks requested its insights, especially during the 1980s, when inflation rates were very high.
Supply-Side Economics: Tax Cut so as to Promote Investment
Supply-side economics focuses on the ideology that by lowering the taxes and regulatory controls of businesses and the higher-paid individuals, investments will be stimulated and jobs be created and the economy will grow. The advocates of the supply-side economics state that governments reduce the burden on business by decreasing taxation rates, which allows businesses to invest in their innovational, production, and growth.
The other argument given by the supply-side economist is that when individuals, especially in the high income bracket are overtaxed, they save much on the tax and put more of it in investment which serves as an extra booster of the economy. The main theme of this theory is based on its practice to ensure that business friendly environment is created to encourage the entrepreneur to take risks, grow and build wealth.
Policy Applications:
- Tax Cuts: This is reducing the taxes imposed on corporations and that charged to earners with high income as it is said to promote investing, which in turn boosts the economy.
- Deregulation: Lessening the government regulation, which limits business activity may facilitate the expanding of businesses and the creation of employment.
- Entrepreneurs Rewards: Policies which encourage entrepreneurship including the reduction of tax on small businesses can lead to the creation of a more aggressive economy.
Behavioral Economics: The Human Decision-Making
Behavioral economics combines psychology and classical economics to improve knowledge on how human beings make choices. Behavioral economics differs with classical economics in the perspective that persons are celebrated to be rational, and that they make choices that maximize their utility numbers, making it obvious that people are made to be informed by cognitive shortcuts, emotions, and social influences.
Behavioral economics has been used to formulate policies in such a way that it manipulates individuals into making better decisions without limiting the freedom of choice of the similar individuals.
Policy Applications:
- Nudging: Governments can encourage people to make healthier, more solvent choices without requiring them to do so by so-called nudging.
- Behavioral economics in policymaking: Policymaking to enhance public health, behavioral economics has contributed to policy reforms to get people to quit smoking or the advantage of being vaccinated.
- Enhancing Financial Decisions: Policies aimed at getting people to save towards their retirements or to enrol them in the social security can be formulated with the application of behavioral economic knowledge.
Neoclassical Economics: The Optimality of Free Markets
The neoclassical school of economics presupposes that markets are mostly efficient and that people make rational choices. According to this theory, with freedom of markets, markets will automatically be in equilibrium, and the result is that supply will equal demand, and the resources will also be optimally allocated.
Neoclassical economics embraces the concept of low regulation, free trade and competition. The reasoning in the theory is that everyone will act on the basis of his or her self-interest, thereby making the decisions which result in the most effective and wise use of resources.
Policy Applications:
- Free Trade Agreements: Neoclassical economics demands the reduction of trade restriction so that the economy functions more effectively and the commodities and services enter the markets freely, across borders.
- Deregulation: The fact that governments are going to stop imposing the restrictions on businesses will also mean that the market is going to run smoother as businesses are going to compete to produce better products and services.
- Tax Policies: Neoclassical economists tend to support low tax rates and government expansion since they feel that would stimulate the economy further by enabling consumers and businesses to spend more.
Conclusion
In conclusion, I would say that economic theories have a dynamic role in policy making. The economic theories are important in making policy decisions that touch all aspects of the society. Economic theories guide the government in whether by means of Keynesian demand-stimulating policies, monetarist inflation restraint, or supply-side growth attempts, economic theories can influence government behaviors during prosperity and crisis. With the existing economic transformations in the world, the economic theories should change to meet some emerging issues like technological changes, the environment, as well as the changes in society. Policymakers have to be adaptable and responsive, and the knowledge provided by these economic theories will help create policies that will stabilize the growth, decrease inequality, and stimulate stable and prosperous economies.