Macroeconomic aims of the government
● The public sector in every economy plays a major role as a producer and an employer. Governments
work locally, nationally and internationally
● There are major macroeconomic objectives of the government, they are-
● Economic growth
○ Economic growth refers to an increase in the gross domestic product (GDP), the amount of
goods and services produced in the economy, over a period of time. More output means
economic growth. But if output falls over time, it can cause
■ Fall in employment, incomes and living standards of the people
■ Fall in the tax revenue the government collects from goods and services and incomes,
which inturn will lead to a cut in government spending
■ Fall in the revenues and profits of firms
■ Low investments, people won’t invest in production as economic conditions are poor and
they will yield low profits
● Price stability
○ Inflation is the continuous rise in the average price levels in an economy during a time period.
○ Governments usually target an inflation rate it should maintain in a year. If prices rise too quickly
it can negatively affect the economy because it
■ Reduced people purchasing powers as people will be able to buy less with the money
they have now than before
■ Causes hardships for the poor
■ Increase business costs especially as workers will demand higher wages to support their
livelihood
■ Makes products more expensive than the products of other countries with low inflation.
This will make exports less competitive in the international market.
● Full employment
○ If there is a high level of unemployment in a country, the following may happen
■ The total national output will fall
■ Government will have to give out unemployment payment to the unemployed, increasing
public expenditure while income taxes fall - causing a budget deficit
■ Large unemployment causes public unrest and anger towards the government
● Balance of payments stability
○ Economies export many of their products to overseas residents, and receive income and
investment from abroad; they also import goods and services from other economies, and make
investments in other countries. These are recorded in a country’s Balance of payments
○ Exports > imports = surplus in balance of payments
○ Exports < imports = deficit in balance of payments
○ All economies try to balance this inflow and outflow of international trade and payments and try
to avoid any deficits because
■ If it exports too little and imports too much, the economy may run out of foreign currency
to buy further imports
■ A deficit in balance of payments causes the value of its currency to fall against other
foreign currencies and make imports more expensive to buy
■ A surplus in balance of payments causes its currency to rise against other foreign
currencies and makes its exports more expensive in the international market.
● Income redistribution
○ To reduce the inequality of income among its citizens, the government will redistribute incomes
from the rich to the poor by imposing taxes on the rich and using it to finance welfare schemes
for the poor. All the governments struggle with income inequality and try to solve it because
■ Widening inequality means higher levels of poverty
■ Poverty and hardships restrict the economy from reaching its maximum productive
capacity.
Fiscal Policy
● Fiscal policy
○ It is a government policy which adjusts government spending and taxation to influence the
economy
○ Government aims for a balance budget and tries to achieve it using fiscal policy
○ It helps the government achieve its aim of economic growth by being able to influence the
demand and spending in the economy. It also indirectly helps maintain price stability, via the
effects of tax and spending
● When there is a budget surplus, the government employs an expansionary fiscal policy where
government spending is increased and tax rates are cut
○ It helps stimulate growth, employment and help increase prices
● When there is a budget deficit, the government employs contractionary fiscal policy where
government spending is cut and tax rates are increased
○ It helps control inflation resulting from too much growth
● The main areas of government spending includes defence and arms, road and transport, electricity,
water, education, health, food, stocks, government salaries, pensions, subsidies, grants etc.
● Reasons for government to spend
○ To supply goods and services
○ To achieve supply-side improvements in the economy
○ To spend on policies to reduce negative externalities such as pollution control
○ To subsidize industries which may need financial support
○ To help redistribute income and improve income inequality.
○ To inject spending into the economy to aid economic growth
● Effects of government spending
○ Increased government spending will lead to higher demand in the economy and thus aid
economic growth, but it can also lead to inflation if the increasing demand causes prices to rise
faster than output
○ Increased government spending on public goods and merit goods, especially in infrastructure,
can lead to increased productivity and growth in the long run.
○ Increased government spending on welfare schemes and benefits will increase living standards
and help reduce inequality
○ Too much government spending can also cause ‘crowding out’ of private sector investments.
Private investment will reduce if the increase in government spending is financed by increased
taxes and borrowing(large government borrowing will drive up interest rates and discourage
private investment)
● Taxes
○ Government earns revenue through interests on government bonds and loans, incomes from
fines, penalties, escheats, grants in aid, income from public property, dividends and profits on
government establishments, printing of currency etc. but its major source of revenue comes
from taxation
● Taxes are compulsory payments made to the government by all people in an economy. There are many
reasons for levying taxes from the economy.
○ It is a source of government revenue
○ To redistribute income
○ To reduce consumption and production of demerit goods
○ To protect home industries
● Classification of taxes
○ Taxes can be classified into direct, indirect, progressive, regressive or proportional tax
● Direct taxes
○ Taxes on income. The burden of tax payment falls directly on the person or individual
responsible for paying it
● Types of direct taxes
○ Income tax
○ Corporate taxes
■ Tax paid on a company’s profits.
○ Capital gains tax
■ Taxes on any profits or gains that arise from the sale of assets held for more than a year
○ Inheritance tax
■ Tax levied on inherited wealth
○ Property tax
■ Tax levied on property/land
● Advantages of direct tax
○ High revenue,
○ Can reduce inequalities in income and wealth as they are progressive in nature
● Disadvantages of direct tax
○ Reduced work incentives
○ Reduces enterprise incentives
○ Tax evasion
● Indirect taxes
○ They are taxes on goods and services sold. It is added to the prices of goods and services and
it is paid while purchasing the goods or service. It is called indirect because it indirectly takes
money as tax from consumer expenditure
● Example of indirect tax
○ GST/VAT
■ These are included in the price of goods and services. Increasing these indirect taxes
will increase the prices of goods and services and reduce demand and in turn profits.
Reducing these taxes will increase demand.
○ Custom duty
■ Includes import and export tariffs on goods and services flowing between countries.
Increasing tariffs will reduce demand for product
○ Excise duty
■ Tax on demerit goods like alcohol and tobacco to reduce its demand
● Advantages of indirect tax
○ Cost effective
○ Expanded tax base
○ Can achieve specific aims
○ Flexible
● Disadvantages of indirect taxes
○ Inflationary
○ Regressive
○ Tax evasion
● Qualities of a good tax system
○ Equity
■ The tax rate should be justifiable rate based on the ability of the taxpayer
○ Certainty
■ Information about the amount of tax to be paid, when to pay it, and how to pay it should
all be informed to the taxpayer
○ Economy
■ The cost of collecting taxes must be kept to a minimum and shouldnt exceed the tax
revenue itself
○ Convenience
■ The tax must be levied at t convenient time for example after a person receives his
salary
○ Elasticity
■ The tax imposition and collection system must be flexible so that tax rates can be easily
changed as the person's income changes
○ Simplicity
■ The tax system must be simple so that both the collectors and payers understand it well
Monetary Policy
● The money supply is the total value of money available in an economy at a point of time.
● The government can control money supply through variety of tools including open market operations
(buying and selling government bonds) and changing reserve requirements of banks
● The interest rate is the cost of borrowing money. When a person borrows money from a bank, he has to
pay an interest calculated on the amount he borrowed. Interest can also be earned on the money
deposited by individuals in a bank
● The interest on borrowing is higher than the interest on deposits therefore helping banks make a profit
● Higher interest rates will discourage borrowing and therefore investments, it will also encourage
people to save rather than consume (fall in consumption also discourage firms from investing and
producing more.)
● Lower interest rates will encourage borrowing and investments and encourage people to consume
rather than save (rise in consumption also encourage firms to invest and produce more)
● The monetary authority of the country cannot directly change the general interest rate in the economy.
Instead, it changes the interest rates of borrowing between the central bank and commercial banks as
well as the interest on its bonds and securities
● These will then influence the interest rates provided by commercial banks on loans and deposits to
individuals and businesses
● Monetary policy is a government policy controlling money supply (availability and cost of money) in an
economy in order to attain growth and stability
● It usually is conducted by the country’s central bank and usually used to maintain price stability, low
unemployment and economic growth
● Expansionary monetary policy
○ It is where the government increases money supply by cutting interest rates.
○ Low interest rates will mean more people will resort to spending rather than saving, and
businesses will invest more as they will have to pay lower interest on their borrowings.
○ Thus, the higher money supply means more money being circulated among the government,
producers and consumers, increasing economic activity.
○ Economic growth and an improvement in the balance of payments will be experienced and
employment will rise
● Contractionary monetary policy
○ It is where the government decreases money supply by increasing interest rates.
○ Higher interest rates will mean more people will resort to saving rather than spending, and
businesses will be reluctant to invest as they have to pay high interest on their borrowings.
○ Thus, the lower money supply will mean less money being circulated among the government,
producers and consumers, reducing economic activity.
○ This helps slow down economic growth and reduce inflation, but at the cost of possible
unemployment resulting from the fall in output.
Supply-side Policy
● Supply side policies are microeconomic policies aimed at increasing supply and productivity in the
economy, to enable long-term economic growth. Some of these policies include
○ Public sector investments
○ Improving education and vocational training
○ Spending on health
○ Investment on housing
○ Privatization
○ Income tax cuts
○ Subsidies
○ Deregulation
■ Removing or easing the laws and regulations required to start and run businesses so
they can operate and produce more output with reduced costs and hassle encouraging
investments
● Supply side policies have the direct effect of increasing economic growth as the productive capacity of
the economy is realised. In doing so, it can create more job opportunities and help reduce
unemployment. Trade reforms will also enable its to improve its balance of payments
● However the reliance on public expenditure and tax cuts mean that the government may run large
budget deficits. Deregulation and privatisation will also reduce government intervention in the economy
which may prompt market failure
