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Economics Explained: Types Of Economic Policy

Updated: Feb 3, 2022

It’s easy to forget how much economic policy is involved in our every day life.

The amount of interest you pay on your bank loan is driven by economic policy.

The amount of tax you pay on a chocolate bar is driven by economic policy.

New jobs being created within a certain sector, again driven by economic policy.

With this thing called ‘economic policy’ affecting our everyday life. We should know what it is and how it works, right?

Well, there are 3 main types of policy to be aware of.

Firstly, there are demand-side policies. These impact the total (otherwise known as ‘Aggregate’) demand and expenditure in the economy. They can be classified into two groups.

Fiscal policy

These are changes to Government spending or taxation in order to influence the total demand. For example, if the Government is in a bit of a sticky situation, you may see a fall in spending through less money being poured into housing and schooling, complemented by an increase in taxation rates.

Monetary policy

This influences the demand (and supply) for money in the economy by either changing interest rates or the altering how much money is in the economy. This type of policy is usually done by the Central Bank, and can be in a number of ways such as;

  • Cutting interest rates to make borrowing cheaper and boost spending. This is bad for savers though as it means you get less interest as a return on your savings. This can usually be a medium to increase economic growth.

  • Raising interest rates to make borrowing more expensive and reduce spending — this reduces inflationary pressures within the economy.

  • Quantitative easing. This is boosting the supply of money by Central Bank. The aim is to increase the money supply and reduce interest rates.

Then we have the other half to the equation, supply side

Supply side policy

These are attempts to increase the productive capacity of the economy by;

  • Increasing Government spending on education and training.

  • Government investment in new infrastructure

  • Government provision of public goods, such as flood defences (public goods refer to things that the private sector is likely to provide as there is no profit incentive, but that’s a whole other Economics explained lesson)

  • Privatisation of state-owned assets

All of these policies can go in one of either directions.

Expansionary: Used to stimulate growth.

If we look at it fiscally, its through increased government spending or reducing taxes. This increases the aggregate demand within an economy, allowing people to spend more and thus grow the economy.

For monetary policy, this would see an increase in the money supply (by quantitive easing) and decreasing the interest rate which stimulates consumption because the benefits of spending are (low interest on repayments!!!)

Contractionary: Used to slow down growth in the economy.

By actions such as: reducing government spending, increasing taxes, reducing the money supply or increasing the interest rate, we will see a reduced inflationary pressure and/or reduced the budget deficit, leading to lower economic growth.

There are also some other types of policies to be aware of:

Exchange rate policy

The government can try to unofficially influence the exchange rate by changing interest rates or buying/selling currency.

If a government wants to boost export demand and higher economic growth they will devalue the currency.

If a government wants to say, reduce the inflation rate, you may see them try to appreciate their currency.

Trade policy

Trade policy relates to the tariffs a government may place as a form of protectionism (or trading blocks to their economy)

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