Government policies

There are three types of policies: monetary and fiscal
policies which are also known as demand-side policies
and supply-side policy. Government use them to achieve
economic targets such as economic growth, reduce
unemployment, reduce inflation and of course increase trade.
So I would like to talk about each of them more detailed.

In economics, fiscal policy is the use of government spending
and revenue collection to influence the economy.
The two main instruments of fiscal policy are government
spending and taxation. Changes in the level and composition
of taxation and government spending can impact on the
following variables in the economy:

• Aggregate demand and the level of economic activity;
  
• The pattern of resource allocation;
  
• The distribution of income.

So in other word government changes the level of taxation and government expenditure to affect to the economy.

The effectiveness of fiscal policy depends on a number of factors:

• The accuracy of forecasting. Government would obviously like to act as swiftly as possible to prevent a problem of excess or deficient demand. The more reliable are the forecasts of what is likely to happen to aggregate demand, the more able will the government to be intervene quickly.
• The extent to which changes in government expenditure and taxation will affect total injections and withdrawals.
• The extent to which changes in injections and withdrawals affect national income. Will it be possible to predict the size of the multiplier and accelerator effects?
• The timing of the effects. It is no good simply being able to predict how long they will take. If there are long time lags with fiscal policy, it will be far less successful as a means of reducing fluctuations.
• The extent to which changes in aggregate demand will have the desired effects on output, employment, inflation and the balance of payments.

Discretionally fiscal policy deliberates changes in tax rates or the level of government expenditure in order to influence the level of aggregate demand. Government may use it if there is a fundamental disequilibrium in the economy or substantial fluctuations in national income. If government expenditure on goods and services (roads, health care, education) is raised, this will create a full multiplied rise in national income. The reason is that all the money gets spent and thus all of it goes to boosting aggregate demand. Cutting taxes, however, will have a smaller effect on national income. The reason is that cutting taxes increases people's disposable incomes, of which only part will be spent. Part will be withdrawn into extra savings, imports and other taxes. In other word not all the tax cuts will be passed on round the circular flow of income as extra expenditure.

Monetary policy is the process by which the government, central bank, or monetary authority of a country controls the supply of money, availability of money, and cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy. Monetary policy either can be expansionary or contractionary policy. If it is expancionary policy government use it to reduce unemployment in the period of recession by cutting interest rates. If it is contractionary it is used by the government to reduce inflation by raising interest rates.

It is impossible to use monetary policy as a main force of controlling aggregate demand. It is especially weak when when it is pulling against the expectations of firms and consumers and when it is implemented too late. However, if the authorities operate a tight monetary policy firmly enough and long enough, they should eventually be able to reduce lending and aggregate demand. But there will inevitaly be time lags and imprecision in the process. An expansionary monetary policy is even less reliable. If the economy is in the recession, no matter how low interest rates are driven, people cannot be forced to borrow if they do not wish to. Firms will not borrow to invest if they predict continuing recession. Despite these problems, changing interest rates can be quite effective. After all, they can be changed very rapidly. There are not the time lags of implementation on that there are with fiscal policy.

Supply-side policies:

• education
• training
• increase investment
• reduce the power of Trade Unions
• increase the number of small firms
• cutting of the direct taxation
• privatisation