• Unwanted fluctuations in any of the above, e.g., if any are felt to be undesirable atthe level they are at, the government may step in and try to alter and improvethem.
How can government try to manage the economy?There are two main ways: fiscal policy and monetary policy.
Fiscal policy= taxation largely, plus some subsidies. This label also includesgovernment spending these days; once it was separated out in text books as “directaction”, “government spending” or a similar phrase.Monetary policy= changing the money supply or the rate of interest to alter the level of aggregate demand. NOTE: Since 1997 this power was removed from government and given to the MonetaryPolicy Committee of the Bank of England. The government is represented on this and canstrongly influence its decisions but not control it.
Both main ways of managing have certain implications attached:
Fiscal policy: tends to have strong resource allocation effects, for example if thegovernment increases the tax on cigarettes, it hits smokers only; if it increase income tax,it ignores those on low incomes who do not pay this tax.Fiscal changes are usually done in an annual budget in April – so a desired change can beslow to implement, as we may have to wait until April to announce it! Some changes tocome might be leaked beforehand. In addition to the budget proper, the country mayhave a mini-budget around October. Once a change is announced in the budget, theeffect is virtually immediate.Monetary policy: the government no longer can do this directly – despite its ability toinfluence the views of the Monetary Policy Committee.The effects of monetary policy may be slow and it can take between 6 months and 18months to get the full impact of interest rate changes.
What does government actually do?
1. It may try to increase aggregate demand: it might do this if it feels thatunemployment is too high, and inflation is reasonably low; or the standard of living could safely be increased; or economic growth could be higher.- To increase demand:
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