Difficulties in Formulating Macroeconomic Policy

Difficulties in Formulating Macroeconomic Policy

Policy makers try to influence the behaviour of broad economic

aggregates in order to improve the performance of the economy. The

main macroeconomic objectives of policy are: a high and relatively

stable level of employment; a stable general price level; a growing

level of real income (economic growth); balance of payments

equilibrium, and certain distributional aims.

This essay will go through what these difficulties are and examine how

these difficulties affect the policy maker when they attempt to

formulate macroeconomic policy.

It is difficult to provide a single decisive factor for policy

evaluation as a change in political and/or economic circumstances may

result in declared objectives being changed or reversed.

Economists can give advice on the feasibility and desirability of

policies designed to attain the ultimate targets, however, the

ultimate responsibility lies with the policy maker.

Policy makers are continually trying to formulate policies that will

help the economy achieve these objectives. However, there are

numerous difficulties which policy makers are faced with.

In a democratic society like the UK, the macroeconomic objectives are

not under the sole control of the Government. For example, the level

of employment depends on the decisions not only of the government

(e.g. for employment in the public sector) but also of private firms

as to how many workers they wish to employ. Also, membership to

international organisations (i.e. WTO or EU etc.) means that the

international regulations and directives must be adhered to and cannot

be altered. Therefore, the freedom of action of the policy maker is

restricted, as the new policy must function along side existing

international policies.

Most policies are designed against the background of a theoretical

model. However, there is no ‘true’ model and so different policy

makers and economists may have different views to certain economic

variables. Therefore, each policy maker will formulate different

policies based on their views in order to achieve the same objective.

For example, Keynesians view that consumption expenditure depends upon

current disposable income. Whereas Milton Friedman argued that

consumption is related to permanent rather than current income. He

was therefore more sceptical about he usefulness of a tax change for

stabilisation purposes than one who believes that consumption depends

on current disposable income.

Policy makers usually use Fiscal policy to alter the level, timing or

composition of government expenditure and/or the level, timing or

structure of tax payments. And they use

Monetary policy to alter the supply of money and/or credit and also to

alter interest rates.

But some policies are not always successful; a good example was the

decision to use monetary policy to solve the liquidity trap. This

policy aimed to reduce interest rates and stimulate investment