🫘Intro to Public Policy Unit 10 – Economic Policy: Fiscal, Monetary, and Trade

Key Concepts and Definitions

• Economic policy encompasses the actions and decisions made by governments to influence economic activity and achieve specific objectives
• Fiscal policy involves the use of government spending and taxation to impact the economy
  • Expansionary fiscal policy increases government spending or reduces taxes to stimulate economic growth
  • Contractionary fiscal policy decreases government spending or raises taxes to slow down economic growth
• Monetary policy refers to the actions taken by central banks to control the money supply and interest rates
• International trade policy deals with the rules, regulations, and agreements that govern trade between countries
• Gross Domestic Product (GDP) measures the total value of goods and services produced within a country's borders over a specific period
• Inflation refers to the sustained increase in the general price level of goods and services in an economy over time
• Unemployment rate represents the percentage of the labor force that is actively seeking employment but unable to find work

Economic Policy Fundamentals

• Economic policy aims to achieve macroeconomic goals such as stable prices, low unemployment, sustainable economic growth, and balanced trade
• Governments use a mix of fiscal, monetary, and trade policies to influence economic outcomes
• The business cycle consists of periods of expansion and contraction in economic activity
  • Economic policies are often designed to smooth out the business cycle and minimize the impact of recessions
• Market forces of supply and demand play a crucial role in determining prices, production, and resource allocation
• Government intervention in the economy can address market failures, provide public goods, and redistribute income
• The Phillips Curve suggests an inverse relationship between unemployment and inflation in the short run
• The Laffer Curve illustrates the relationship between tax rates and government revenue, suggesting that there is an optimal tax rate that maximizes revenue

Fiscal Policy Overview

• Fiscal policy involves the use of government spending and taxation to influence economic activity
• Governments can use expansionary fiscal policy during recessions to stimulate aggregate demand and boost economic growth
  • Expansionary measures include increasing government spending on infrastructure, education, or social programs
  • Tax cuts can also be used to increase disposable income and encourage consumer spending
• Contractionary fiscal policy is used to combat inflation by reducing aggregate demand
  • Governments can decrease spending or raise taxes to slow down economic activity and curb inflationary pressures
• Automatic stabilizers, such as progressive taxation and unemployment benefits, help to moderate the business cycle without explicit government action
• Fiscal multipliers measure the impact of changes in government spending or taxes on overall economic output
• Budget deficits occur when government spending exceeds revenue, while budget surpluses arise when revenue exceeds spending
• Government debt is the accumulation of budget deficits over time and can have implications for long-term economic stability

Monetary Policy Basics

• Monetary policy is conducted by central banks to control the money supply and interest rates
• The primary objectives of monetary policy include price stability, full employment, and economic growth
• Central banks use tools such as open market operations, reserve requirements, and discount rates to influence the money supply and interest rates
  • Open market operations involve the buying and selling of government securities to control the money supply
  • Reserve requirements determine the amount of funds banks must hold in reserve, affecting their lending capacity
  • Discount rates are the interest rates at which central banks lend to commercial banks, influencing the cost of borrowing
• Expansionary monetary policy involves increasing the money supply or lowering interest rates to stimulate economic activity
• Contractionary monetary policy involves decreasing the money supply or raising interest rates to combat inflation
• The transmission mechanism of monetary policy describes how changes in interest rates and the money supply affect economic variables such as investment, consumption, and output
• Central bank independence is crucial for maintaining credibility and effectiveness in conducting monetary policy

International Trade Policy

• International trade policy governs the exchange of goods and services between countries
• Free trade agreements (FTAs) reduce barriers to trade, such as tariffs and quotas, among participating countries (NAFTA, EU)
• Protectionist measures, such as tariffs and subsidies, are used to shield domestic industries from foreign competition
  • Tariffs are taxes imposed on imported goods, making them more expensive and less competitive
  • Subsidies are financial support provided by governments to domestic industries, giving them an advantage over foreign competitors
• The World Trade Organization (WTO) is an international body that oversees global trade rules and resolves trade disputes
• Comparative advantage is the ability of a country to produce a good or service at a lower opportunity cost than another country, forming the basis for specialization and trade
• Exchange rates, which determine the value of one currency relative to another, play a crucial role in international trade
• Trade balances reflect the difference between a country's exports and imports
  • Trade surpluses occur when exports exceed imports, while trade deficits arise when imports exceed exports

Policy Tools and Instruments

• Governments and central banks use a variety of tools and instruments to implement economic policies
• Fiscal policy tools include government spending, taxation, and budget management
  • Progressive taxation, where higher-income earners pay a larger share of their income in taxes, can help redistribute wealth
  • Infrastructure spending can create jobs, stimulate economic activity, and improve long-term productivity
• Monetary policy tools include open market operations, reserve requirements, and interest rate adjustments
  • Quantitative easing (QE) involves central banks purchasing financial assets to increase the money supply and lower long-term interest rates
  • Forward guidance is a tool used by central banks to communicate their future policy intentions, influencing market expectations
• Trade policy instruments include tariffs, quotas, subsidies, and trade agreements
  • Non-tariff barriers, such as regulations and standards, can also be used to restrict trade
• Macroprudential policies aim to promote financial stability by addressing systemic risks in the financial system
  • Capital requirements for banks ensure that they have sufficient buffers to absorb losses during economic downturns
  • Loan-to-value (LTV) ratios limit the amount of credit that can be extended relative to the value of an asset, mitigating risk in the housing market

Real-World Applications and Case Studies

• The Great Depression of the 1930s led to the development of Keynesian economics, which advocated for government intervention to stimulate aggregate demand
  • The New Deal in the United States included expansionary fiscal policies, such as public works projects and social programs
• The 2008 Global Financial Crisis prompted central banks to implement unconventional monetary policies, such as quantitative easing, to stabilize financial markets and support economic recovery
• The European Union (EU) is an example of a regional economic integration that promotes free trade and harmonizes economic policies among member countries
  • The European Central Bank (ECB) conducts monetary policy for the Eurozone, which consists of EU member states that have adopted the euro as their currency
• The US-China trade war, which began in 2018, involved the imposition of tariffs and other trade barriers between the two countries, highlighting the complexities of international trade relations
• The COVID-19 pandemic has led governments to implement expansionary fiscal and monetary policies to support businesses and households during the economic downturn
  • Many countries have provided direct cash transfers, increased unemployment benefits, and offered loans and grants to businesses affected by the pandemic

Challenges and Debates in Economic Policy

• The effectiveness of fiscal policy can be limited by factors such as the crowding-out effect, where government borrowing reduces private investment, and the time lags involved in implementing policies
• Monetary policy faces challenges such as the zero lower bound, where nominal interest rates cannot be reduced below zero, limiting the central bank's ability to stimulate the economy
• The trade-off between inflation and unemployment, as described by the Phillips Curve, can create dilemmas for policymakers in balancing these two objectives
• Globalization and the increasing interconnectedness of economies can make it more difficult for individual countries to pursue independent economic policies
• Income inequality has become a pressing concern, with debates over the role of economic policies in addressing the widening gap between the rich and the poor
• The sustainability of government debt levels has come under scrutiny, particularly in the wake of the COVID-19 pandemic, raising questions about the long-term fiscal health of countries
• Climate change and the transition to a low-carbon economy present both challenges and opportunities for economic policymakers, requiring a balance between environmental sustainability and economic growth