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Examine the difficulties which confront policy makers when they attempt to formulate macroeconomic policy

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Introduction

Module Title: Macroeconomic Policy Essay Question: Examine the difficulties which confront policy makers when they attempt to formulate macroeconomic policy. Word Count: 1956 words 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. ...read more.

Middle

Every government is concerned with the distribution of income and wealth both between individuals and regions within an economy. Their general aim is to ensure a more equitable distribution. Most policies have distributional effects that must be taken into consideration. For example, the introduction of more complicated tax systems are likely to bear more heavily on small than large firms who already possess sophisticated financial accounting systems. Distribution aims are the subject of a considerable degree of controversy but at the very least; policy makers must take into consideration the distributional effects of macroeconomic policies adopted. There may be potential conflicts between aims of macroeconomic policy. It is very difficult for a policy maker to achieve all aims simultaneously by using one policy instrument. For example, a policy decision might be made to maintain a fixed exchange rate and attempt to correct a balance of payments deficit by reducing imports by domestic deflation. If this is the case, there is a potential conflict between full employment and balance of payments equilibrium for a country with a fixed exchange rate. Because of these potential conflicts the policy maker must allocate priorities to the various objectives before making a decision. All policy changes operates with a lag i.e. a period of time before it is effective. There is the inside lag, which is the time taken for an authority to initiate a policy change. Also, there is the outside lag, which is the time taken for that policy change to influence the target variables. ...read more.

Conclusion

But policy makers and economists have no way of predicting sudden shocks to the economy. In conclusion, policy makers are faced with many constraints when they attempt to formulate macroeconomic policy. One of the most significant constraints is the fact that policy makers do not have perfect information of the current economy. There are gaps in the information and there is no way of gathering present information of the economy as the data takes time to collect. When formulating macroeconomic policy, different policy makers will base their new policy on theoretical models. The problem here is that there are numerous models with different views and assumptions as there is no 'true' model. Also, it is difficult to predict accurately what the desirable rate of inflation and employment is. Subsequently, not all policies will succeed. When a policy is established, time lags exist, which means that it may take some time before a problem is noticed and for a policy to be developed (inside lag) and then there is the outside lag, which is the time it will take before the results of the policy can be seen. Time lags are not constant and as a result it is possible for stabilisation policy to be destabilising. During these time lags, exogenous shocks may occur which may mean that the policy is not effective anymore. Lastly, policy makers have to be very careful when formulating new policies, as they will want to maintain their credibility and Governments their electoral appeal. This will mean that their policies must be successful and the results must be visible to the general public in order for them to support the introduction of this policy and the Government. ...read more.

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