Most factors ofeconomic policy can be divided into eitherfiscal policy, which deals with government actions regarding taxation andspending, ormonetary policy, which deals withcentral banking actions regarding the money supply and interest rates.
Almost every aspect of government has an important economic component. A few examples of the kinds of economic policies that exist include:[1]
Macroeconomic stabilization policy, which attempts to keep themoney supply growing at a rate that does not result in excessive inflation, and attempts to smooth out thebusiness cycle.
Monetary policy controls the value of currency by lowering the supply of money to control inflation and raising it to stimulate economic growth. It is concerned with the amount ofmoney in circulation and, consequently,interest rates andinflation.
These are referred to as thepolicy goals: the outcomes which the economic policy aims to achieve.
To achieve these goals, governments usepolicy tools which are under the control of the government. These generally include theinterest rate andmoney supply,tax and government spending, tariffs,exchange rates,labor market regulations, and many other aspects of government.
Government and central banks are limited in the number of goals they can achieve in the short term. For instance, there may be pressure on the government to reduce inflation, reduce unemployment, and reduce interest rates while maintaining currency stability. If all of these are selected as goals for the short term, then policy is likely to be incoherent, because a normal consequence of reducing inflation and maintaining currency stability is increasing unemployment and increasing interest rates.
This dilemma can in part be resolved by using microeconomicsupply-side policy to help adjust markets. For instance, unemployment could potentially be reduced by altering laws relating totrade unions orunemployment insurance, as well as by macroeconomic (demand-side) factors like interest rates.
For much of the 20th century, governments adopteddiscretionary policies likedemand management designed to correct thebusiness cycle. These typically used fiscal and monetary policy to adjust inflation, output and unemployment.
A discretionary policy is supported because it allows policymakers to respond quickly to events. However, discretionary policy can be subject todynamic inconsistency: a government may say it intends to raise interest rates indefinitely to bring inflation under control, but then relax its stance later. This makes policy non-credible and ultimately ineffective.
Another type of non-discretionary policy is a set of policies that are imposed by an international body. This can occur (for example) as a result of intervention by theInternational Monetary Fund.
The first economic problem was how to gain theresources it needed to be able to perform the functions of an early government: themilitary,roads and other projects like building thePyramids.
Early governments generally relied ontax in kind andforced labor for their economic resources. However, with the development ofmoney came the first policy choice. A government could raise money through taxing its citizens. However, it could now alsodebase the coinage and so increase themoney supply.
Early civilizations also made decisions about whether to permit and how to taxtrade. Some early civilizations, such asPtolemaic Egypt adopted aclosed currency policy whereby foreign merchants had to exchange their coin for local money. This effectively levied a very hightariff on foreign trade.
By the early modern age, more policy choices had been developed. There was considerable debate aboutmercantilism and other restrictive trade practices like theNavigation Acts, as trade policy became associated with both national wealth and with foreign and colonial policy.
Throughout the 19th century,monetary standards became an important issue.Gold andsilver were in supply in different proportions. Which metal was adopted influenced the wealth of different groups in society.
Thebusiness cycle became a predominant issue in the 19th century, as it became clear that industrial output, employment, and profit behaved in acyclical manner. One of the first proposed policy solutions to the problem came with the work ofKeynes, who proposed that fiscal policy could be used actively to ward off depressions, recessions and slumps. TheAustrian School of economics argues that central banks create the business cycle. After the dominance ofmonetarism[2] andneoclassical thought that advised limiting the role of government in the economy in the second half of the twentieth century, the interventionist view has once more dominated the economic policy debate in response to the2008 financial crisis,[3]
A recent trend originating from medicine is to justify economic policy decisions with best available evidence.[4] While the previous approaches have been focused on macroeconomic policymaking aimed at sustaining promoting economic development and counteracting recessions,EBP is oriented towards all types of decisions concerned not only with anti-cyclical development but primarily with the growth-promoting policies. To gather evidence for such decisions, economists conduct randomized field experiments. The work of Banerjee, Duflo, and Kremer, the 2019 Nobel Prize laureates[5] exemplifies the gold type of evidence. However, the emphasis put on experimental evidence by the movement of evidence-based policy (andevidence-based medicine) results from the narrowly construed notion of intervention, which encompasses only policy decisions concerned with policymaking aimed at modifying causes to influence effects. In contrast to this idealized view of evidence-based policy movement, economic policymaking is a broader term that includes also institutional reforms and actions that do not require causal claims to be neutral under interventions. Such policy decisions can be grounded in, respectively, mechanistic evidence and correlational (econometric) studies.[6]
^Plosila, Walter (May 2004). "State Science- and Technology-Based Economic Development Policy: History, Trends and Developments, and Future Directions".Economic Development Quarterly.18 (2):113–126.
