Governments use economic policy to influence the economy through allocative, stabilizing, and distributive functions. This includes regulating business, controlling interest rates, and creating fair taxation. International events are also monitored to create effective economic policy.
An economic policy refers to the actions a government can take to alter the economy of a city, state, or nation. It usually consists of various measures, through which the government tries to influence the economy as a whole. There are three methods by which a government typically tries to control the economy with its budget, known as allocative, stabilizing and distributive functions. While all three functions are always used collaboratively, their emphasis can change with every new government, era, and global economy.
The allocative function refers to how much of the government budget will be allocated to certain projects. For example, the government may decide that, as part of its economic policy, it must spend more money developing a standing army and health care. The allocation of funds collected from taxes also allows the government to create jobs or public places. A government doesn’t necessarily need to spend money as part of the allocation, it can, for example, raise the nation’s minimum wage.
A government can use the stabilization function to stabilize a nation’s economy by controlling interest rates or inflation and pushing the employment rate towards full employment. When its budget runs into deficit, a government needs to stabilize the economy, this is often done through monetary controls. Governments can lower interest rates in an effort to keep employment rates and wages high, because when interest rates are high and the economy is bad, unemployment is expected to rise while wages fall.
The distributive function of a government’s economic policy refers to the different levels of taxation and the economic burden that each economic level has to bear. Rising property and income taxes, for example, could hit the middle class and the very wealthy more than those at the bottom of the economy. A tax on tobacco and alcohol, however, could only really hit the lower classes. Governments try to ensure that the distribution of taxes is fair for all who are affected.
Governments may also attempt to regulate business and industry as part of their economic policy. Doing so is important because monopolies must be prevented. It is crucial to encourage competition in the market because if a company has a monopoly on one area of the consumer market, it is more likely to exploit customers by raising prices.
In the area of economic policy, governments need to be aware of events on the international scene. In the United States, the US Treasury Department’s Office of Economic Policy monitors international economic developments, evaluates them, and analyzes them to project what economic conditions might look like in the future. Using macroeconomics, a branch of economics that studies the performance and structure of an economy, this department can create a model that helps government craft viable and effective economic policy.
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