Every country in the world has a government that helps determine economic and social policies. Usually, within developed economies, there are 4 main objectives, and these are:

• To ensure sustainable growth
• To control inflation
• To ensure full employment
• Manage the balance of payments

These main objectives can be achieved using 2 kinds of central policy – Fiscal and Monetary.

Fiscal Policy

This is a government-controlled policy on tax, borrowing and spending. It comes in the form of 2 types

Direct taxation – This is the tax on income, profit, and inheritance.
Indirect Taxation – This is a tax on items and services such as VAT.

Monetary Policy

This type of policy is controlled by the Central Bank and is concerned with the supply of money and interest rates within an economy. Often Central Banks operate outside of Government control, but the government can intervene if necessary. They can do this by electing officials they think will work in line with the overall economic aims of the political party in charge.

So how do these policies achieve the government’s aims?

To ensure sustainable growth governments would want to see an increase in national income but as a result, this will see the demand for goods and services increase. Increasing taxes on income for example lowers net pay which ultimately lowers the demand for goods and services. This is also the case when it comes to interest rate setting, higher interest rates mean higher mortgage and loan rates for consumers and businesses which again lowers net pay. It is important the government and central bank work together to ensure national income grows in line with the value of goods and services, if not, this can cause higher inflation.

Controlling Inflation is another key economic aim. It is defined as the decrease in the purchasing power of a currency or the increase in the value of goods and services. Inflation is mainly controlled by monetary policy through interest rates and the supply of money. Changes in price are often determined by economic factors such as supply and demand. A good example of this is how the costs of goods and services have risen because of Brexit and the pandemic stimulus. Most governments aim for an inflation level of about 2%. A healthy economy should see inflation throughout time but too much inflation in the short term can cause issues in wealth, quality of living and supply which can be damaging for the long term. The Consumer Price Index (CPI) is the measure in which investors are concerned when it comes to the markets as this index tracks a general basket of inflationary goods and services.

Case Study:

The UK government injected over £300bn into the UK economy and the Bank of England lowered interest rates too. This meant that access to credit became cheaper and loans became more available throughout the lockdown due to the schemes the government ran. The general public saw an increase in national savings and income which continued to grow throughout the lockdowns. Once restrictions were eased UK consumers had a record amount to spend and therefore spent a lot, as a result, demand for UK holidays, cars and other goods/services increased in value to the point where supply could not match demand and therefore the price of goods available on the market went up in value. A fine example of this is the notable second-hand car market value increase throughout 2021. Cars don’t really go up in value but because of supply issues due to increased demand, the second-hand car market went up in value which was passed down to the consumer. Interest rates are lowered to try and stimulate economic growth through spending, which is what they got but at a rapid rate.

Most countries are going through a crisis like this where prices are rapidly rising. The main way to combat rising prices is to increase our interest rates which lowers national income as consumers pay more for mortgages, credit and other interest-tied products.

This leads to another economic aim which is to achieve full employment. Achieving full employment is done by social policies which affect education and standards of living along with fiscal policy. Taxation on consumers and businesses helps determine public spending, which includes social services like Police, Medical and Fire along with Infrastructure spending like rail, roads, and construction. Demand and supply also play a key role in achieving full employment. If the demand for a product is high then supply needs to match the demand, businesses will employ staff to ensure supply is met but if staff are not available the costs of the goods and services then rise, which puts pressure on other economic aims such as inflation and national income.

Case Study:

In 2021 the UK faced a trucker shortage, this is the direct result of Brexit and coronavirus. Social policies can be put into place to offer training and incentives for more people to take on trucking as a career. For incentives to be offered to the public, the government would have to allocate some of its public spending to that industry. In the short term, the government can offer visas to migrant workers who are qualified – which again is more of a social policy. Until this issue is resolved supply and demand issues will persist as retailers cannot fill the shelves – causing inflationary pressure on the goods sold, which again is passed to the consumer. As a result of this interest rates may go up faster than expected to keep inflationary pressure at the right level.

Managing the balance of payments is the last main objective. This involves analysing one country's payment against another. This is measured using statistics from imports and exports on a macroeconomic level. There are two main accounts that countries use:

• The current account
• Capital and financial account

The current account measures trade from goods and services, income from investment, employee remuneration and current transfers. The current account is generally seen as more important than the capital account as it has a more significant effect on the government’s aims of employment.

The capital account measures the flow of overseas investments, private sector investment abroad, FX borrowing and deposits into UK banks and official reserves.

Exchange rates can really affect the current account and cause quite a lot of headaches for central banks and governments. A deficit in the current account would indicate that the country is not matching overseas expenditure to overseas income. The deficit in principle must be financed from somewhere, usually, if this is the case it can come from the country's capital reserves however these are not infinite and while they can ease short-term deficits, governments cannot rely on reserves for the long-term. Another alternative is to increase overseas borrowing, basically, finance the deficit, but again this would not be in a country's interest and that debt in question would have terms and interest payable which can make the whole situation worse in the long term.

Another way of correcting a deficit involves manipulating the value of the currency of the country in debt. For example, if the government allowed the value of the GBP to fall in value against all other currencies this would make it more expensive for UK buyers which would encourage them to then stay local within their country and not buy from abroad and import. Devaluing GBP also makes the UK more competitive on a global scale as the country’s exports would become cheaper. Both these outcomes help the current help.