Government and The

Macroeconomy
The Role of Government
 Local Role: Fund local services (Garbage Collection, Street Lighting, Schools,

Hospitals and more)

 National Role: Achieve macroeconomic goals (Economic Growth, Low Inflation, Stable

Prices and more)

 International Role: Trading of goods and services

The Macroeconomic Aims of the Government

o Governments aim for economic growth because producing more goods and services

raises living standards, improves health and housing, and supports other economic

goals. Growth increases employment and provides more tax revenue to help the poor.

In the long term, it can also stabilise prices by matching demand and improve trade

through exports.

 Low Unemployment

o Unemployment represents a waste of resources. The unemployed may face various

challenges, including reduced income, while the government may need to allocate tax

revenue to support them.

 Low Inflation/Stable Prices

o Governments aim for price stability to ensure economic certainty and maintain

international competitiveness. It allows firms, households, and workers to plan

increases.

 Balance of Payment Stability

o If a country’s spending on imports consistently exceeds its income from exports, it will

be living beyond its means and accumulating debt. Conversely, if export revenue

surpasses import spending, the country's residents may not be enjoying as many goods

as they could.

 Redistribution of Income

o Income and wealth inequality can lead to poverty. Governments aim to reduce poverty

due to its hardships, but inequality can worsen without intervention. The wealthy often

marry within their class, access better education, and have more savings opportunities.

A large gap between the rich and poor can also lead to social unrest as the

disadvantaged may feel socially unjust.

Conflicts between the Macroeconomic Aims

 Full Employment vs Stable Prices

o Achieving full employment can lead to increased consumer spending, which may drive

up demand and result in inflation. Higher inflation can compromise price stability, as

rising prices erode purchasing power.

 Economic Growth vs Balance of Payment Stability

o Rapid economic growth can lead to increased imports as consumers and businesses

demand more goods and services. This can worsen a country’s balance of payments,

creating deficits if exports do not keep pace with imports.

 Full Employment vs Balance of Payment Stability

This may strain the balance of payments if the increase in imports outpaces export

growth, potentially resulting in trade deficits.

 Economic Growth vs Stable Prices

o Economic growth often involves increased production and consumption, which can lead

to higher demand for goods and services. If this demand outstrips supply, it can result in

inflation, compromising price stability.

Fiscal Policy
 Budget: Financial planning of revenues and expenditures of the government

Reasons for Government Spending

 To supply goods and services that are not supplied by the private sector, such as

defence; merit goods, such as education

 To achieve improvements in the supply side of the macro-economy, like providing

subsidies

Reasons to Tax

 To finance public expenditure, building schools and infrastructure

 To discourage certain activities, e.g. taxes on cigarette

 To discourage the import of goods, tariffs are import taxes and can be levied as a % of

the value of imports or a set tax on each item

 To redistribute income from the rich to the poor

 To achieve other macro-economic objectives

Types of Taxation Description Examp

Progressive Tax Tax rate rises with income; higher income = higher tax Income tax
 Types of Taxation Description Examp

Regressive Tax Tax rate falls with income; higher income = lower tax VAT

Proportional Tax Everyone pays same effective tax rate Corporate inc

Direct Tax Levied on individuals Capital gains

Indirect Tax Added to the price of commodities Tariffs

 Equitable

 Economic

 Transparent

 Convenient

Fiscal Policy

 It is the use of taxation and government spending to influence aggregate demand

Policy About

Expansionary Fiscal Reducing taxes and increasing government spending to boost demand, so
Policy employment and output rise. It may be used to reduce recession.

Contractionary Fiscal Increasing taxes and reducing government spending to reduce demand. It m
Policy used to reduce price inflation.
Effects of fiscal policy on govt. macroeconomic aims

 Expansionary fiscal policy can reduce unemployment

 Expansionary fiscal policy can increase economic growth

 Contractionary fiscal policy can reduce high inflation

Monetary Policy
 It is the use of interest rates, direct control of the money supply and the exchange rate

to influence aggregate demand

Contractionary It may be used to reduce price inflation by increasing interest rates charged
Monetary Policy central bank. This means commercial banks will also raise interest to encour
savings.

Expansionary May be used during a recession & to increase employment by cutting intere
Monetary Policy
Effects of monetary policy on government macroeconomic aims

 Expansionary monetary policy can reduce unemployment

 Expansionary monetary policy can increase economic growth

 Contractionary monetary policy can reduce high inflation