Issues in Macroeconomics
8. Economic Policy

Economic actors are a little like Hollywood actors: once they become aware of problems, they demand solutions. Examples of macroeconomic solutions to world problems would be to lower the rates of inflation and unemployment, stabilize the world's economies, foster healthy relations among national economies, and promote economic growth at home and abroad.

The policy options are many. At the extremes are laissez faire and active, real-time government intervention.

Today, almost every government in the world is playing an active role in its nation's economy. The U.S. government regulates business, spends billions of dollars on military projects, education, and highways, levies heavy taxes, and regulates the amount of money circulating in the economy. In carrying out those activities, and many others, it resorts to several types of economic policy:

Institutional policies are policies designed to influence the behavior of economic institutions. Such policies include the setting of rules such as the minimum wage, safety and health standards for the workplace, rules governing foreign trade, and the levying of taxes.

Fiscal policy is policy related to taxation and government spending. Most government spending is for the purchase of public goods, such as national defense, education, and highways. But the government also uses taxes and expenditures to influence the business cycle, perhaps adjusting this or that tax rate to help lift the economy out of a slump or to dampen the inflationary effects of a too-accelerated growth.

Monetary policy is policy that affects interest rates and the amount of money in circulation. It has a direct effect on the banking industry. One of its aims is to avoid inflation, thereby minimizing the ups and downs of the business cycle. Although government policies are designed to solve macroeconomic problems, the government itself sometimes creates a problem. When the government spends more than it receives in taxes, for example, it has to borrow money to make up the difference. (This is what is meant by "deficit spending".) Some people claim that it's a bad thing for the government to run a deficit, others, a good; still others believe that government deficits do not much matter.

Economic policy is a major theme running through this book. In almost every chapter the question arises: What should the government do? Take action? Or trust the markets to put matters right?

Bayla: The biggest problem we have is one the government is not equipped to solve: it's that the government is just too big.

McCloskey: Yes-high five! [They do it.]

Maria: I don't know about that. Think of how important all the welfare programs are . . . .

Bayla: Those programs don't even work. The government should stop meddling with the economy. Let the markets work! Laissez faire, I say!

Maria: That's ridiculous. Without government intervention we'd be at the mercy of capricious market forces. We'd be defenseless against the rich and the powerful. There would be anarchy.

Bayla: I'd love it. I'd be one of the rich.

Maria: How can you be so blind to the problems they've just mentioned? For example, the poor of Jamaica and Bangladesh?

Bayla: Well, maybe the government is one of the blind ones.

Maria: It's easy to say that. In the meantime there are problems of unemployment, inflation, and trade deficits that have to be dealt with by somebody.

Paul: Yeah, and how about measures to protect workers, all kinds of rules and regulations that we need for smoothly working markets?

Klamer: Right on. You refer to the institutional policies. They are important indeed.