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Economic policy is the term used to describe
all aspects of public policy that affect the production of
goods and services. Such decisions have a direct impact on
the daily lives of everyone in a country, as well as many
people outside it. The three main components of economic policy-fiscal
policy, monetary policy and trade policy-are directed at certain
segments of the economy but have implications for macroeconomics
as well. In the free enterprise system it is accepted that
the vast majority of economic activity should be in the hands
of private individuals and companies, under the assumption
that this will reduce the coercive power of governments, increase
efficiency through competition and reduce corruption and cronyism.
Fiscal policy includes the amount and kinds
of taxes citizens pay, as well as the infrastructure or goods
and services that tax revenues are spent on. It also implies
the balance between spending and income, as governments can
borrow to increase current expenditure and pass the burden
on to future generations. The details of fiscal policy dictate
which economic activities receive incentives and which others
may be the subject of disincentives. Everything from research
and development to space stations can be financed with public
money or receive incentives that could attract private money.
It is generally accepted that it is best to let market forces
direct as much of the expenditure in the private economy as
possible and to take these forces into consideration when
allocating public expenditures.
Monetary policy is so sensitive to political
influence and, if mismanaged, can be such a danger to economic
stability that the US Congress has placed it in the hands
of an independent authority: the US Federal Reserve Bank.
Monetary policy encompasses such areas as interest rates,
public debt, bond sales, the printing and issuing of money,
credit availability, exchange rate policy and types of savings
instruments. Clearly, the confidence that citizens have in
their own currency as a means of exchange and as a store of
value of their hard work and enterprise is basic to the proper
and efficient functioning of an economy. The impact of the
effects of changes in monetary policy, unlike fiscal policy,
are felt immediately. For example, when the Federal Reserve
Bank raises interest rates by tightening monetary policy (by
selling off US Treasury Notes and Bonds, it can remove liquidity
from the market), the cost of borrowing-everything from consumer
credit card debt and mortgages to business purchases of capital
equipment-increases instantaneously. Examples of the international
impact of a country's monetary policy are the ability to attract
foreign capital with higher interest rates, or the effect
of exchange rates on exports and imports.
Trade policy deals with the international
sphere. Goods and services are sold to foreign countries (exports)
or are purchased from abroad (imports) and sold/distributed
locally. Parallel to these transactions in real goods is the
payments process. Exports and imports are usually financed
through letters of credit issued by the private banking systems
of the respective countries. Credit may be proffered by the
supplier, and governments too frequently offer guarantees
of export credit. Obviously, exchange rate fluctuations have
a big impact on international trade given their potential
to affect relative prices quickly. Exporters and importers
buy and sell currencies forward to protect against an exchange
rate risk. Devaluation of a country's currency makes exports
cheaper and imports more expensive but contributes to relative
price increases (inflation). Trade policy deals with issues
such as tariffs, quotas, joining or opposing trade blocs,
and supporting rules-based international trade organizations
that promote free trade, such as the World Trade Organization.
A few countries today still use high tariffs to protect local
industries or producers; however, this so-called infant industries
approach leads to production of low-quality goods at high
prices, benefiting producers and harming consumers. An open
trading system is now widely considered as the best avenue
to promote economic growth. Gains have been shown to accrue
to all countries that trade with each other, even if one of
them has a comparative advantage.
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