3.3.8 Prudent Economic Management: Macroeconomic Policies
Prudent economic management requires appropriate macroeconomic policies to control government debt and inflation whilst allowing growth
Samuelson and Nordhaus, in chapter 21 of Economics, explain both the scope and importance of macroeconomics:
“Thanks to Keynes and his modern successors, we know that in its choice of macroeconomic policies – those affecting the money supply, taxes, and government spending – a nation can speed or slow its economic growth, trim the excesses of price inflation or unemployment from business cycles, or curb large trade surpluses or deficits.” [p. 381]
Macroeconomics is a contested and complex subject. It is not possible to precisely calculate the impact of policy decisions: there are doubts about the accuracy of both current and historical data, there are disagreements about their interpretation, and the world is continually changing – which makes forecasting difficult.
Sustained prosperity requires prudent economic management, maintaining stability, as described in the following sub-sections:
● A government needs to manage its borrowing – so that any fiscal deficit, the gap between its income from taxation and its spending, is temporary (3.3.8.1). Otherwise, its debt would continually grow and be difficult to repay.
● If an economy starts to shrink, a government can intervene by applying a stimulus to economic growth (3.3.8.2), by temporarily increasing its spending or by cutting taxes. This gives consumers more money to spend.
● Inflation is a reduction in the purchasing power of money (3.3.8.3). It is defined by rising prices, which amounts to a fall in the purchasing power of money. Central banks use monetary policy to keep inflation under control in most countries, usually by adjusting interest rates to dampen economic demand.
● The balance of trade (3.3.8.4), the difference between the value of exports and the value of imports, is affected by currency exchange rates. Currency traders assess the relative strength of a country’s economy when exchanging one currency for another, and that has a direct impact on inflation in the importing country.
● Macroeconomic policies can affect the balance of power between the major economic actors (3.3.8.5): businesses, their employees, and the State.
These aspects of macroeconomic policy can affect each other, as was vividly illustrated by the consequences of Kwasi Kwarteng’s ‘mini-budget’ in September 2022. Prime Minister Liz Truss and Britain’s new Chancellor had tried to stimulate economic growth, ahead of an anticipated recession, by making dramatic tax cuts. This was the opposite of prudent economic management. It was arrogant and incompetent, and it created financial chaos:
● The perceived recklessness of their policies caused the pound to lose value, “plummeting to all-time lows against the dollar”, so that imports would become more expensive and would later fuel inflation (which was already high).
● The measures would have increased the fiscal deficit. And they hadn’t published an independent forecast from the Office of Budget Responsibility (OBR) to describe how the increased government debt would be repaid. This caused consternation in financial markets and led to “a surge in UK government borrowing costs”.
● Their proposed tax cuts would have increased the amount of money in the economy, leading directly to inflation.
● It is hard to see how the stimulus could have worked. There was insufficient capacity for the economy to grow at that time, with labour shortages widely reported. And the tax cuts would have benefited the rich, not the poor, in the middle of a cost-of-living crisis. The rich don’t have to spend their money immediately, so it is debatable how effective the stimulus would have been.
● The Bank of England signalled that it would have no choice but to increase interest rates, to reduce inflation.
The IMF criticised the timing: “given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy”.
This page is intended to form part of Edition 4 of the Patterns of Power series of books. An archived copy of it is held at https://www.patternsofpower.org/edition04/338c.htm.