An Economic Policy is an economic policy that a country implements in order to promote economic growth by controlling the costs associated with the changes in the level of activity in the economy. The overall economic policy of most governments covers the monetary systems, national budgets, tax allocation, interest rates and other such areas of government intervention into the domestic economy. All these policies have an impact on the short and medium term economic performance of a country. The intention of these policies is to maintain the current economic structure while allowing some room for adjustment if the need arises.
An economic policy, therefore, aims to make domestic economic policies more effective. It also attempts to ensure the long-term sustainability of the domestic monetary system. Basically, this policy is an attempt to avoid deflation, which results from a fall in aggregate demand in response to a fall in aggregate supply in the domestic economy. This policy aims to prevent the downward shift of prices that can result from a fall in aggregate demand due to fiscal stimulus programs. And, as part of the overall effort to promote economic stability, it is also used to control the risk that the fiscal policy will become ineffective, leading to a shift in the interest rates and the real exchange rate.
In addition, this policy is also implemented when there is a need to maintain a certain level of foreign currency liquidity for certain countries. For example, during the time of the Asian economic crisis, a very large amount of money was withdrawn from the United States dollar and placed in various Asian currencies. This policy, sometimes called monetarily easing or monetizing the dollar, allowed the dollar to be retained as the reserve currency in the eyes of many investors. The Asian crisis eventually ended when this foreign currency liquidity was restored.
The basic reason for monetizing the dollar is to avoid direct costs of trade that are related to the changes in the balance of payments. To illustrate, if the United States government decides to sell dollars and buy Chinese dollars, a trade deficit would arise. Because of the policy adopted by the U.S. government, the Chinese government could now raise its value against the dollar, which eliminated the trade deficit. In this way, monetization is seen as an important part of a country’s economic recovery strategy.
When a country has a persistent current account deficit, that country will have a lower economic growth rate. A similar situation could occur in the case of Greece, the euro area, Italy, or Japan. Because of these circumstances, a policy called deflation may be applied. In order to combat deflation, the European Central Bank can change the central interest rate to offset any excess demand from the local economy. In order to provide additional support for the national currency, a common practice is to allow the central bank to intervene actively in the market. This form of fiscal policy is often used after a shock to the economy, such as a collapse of a financial institution or the sudden loss of confidence due to market unpredictability.
On a broader scale, the use of fiscal policy is also seen in the Forex market. In general, the Forex policy is employed as a method to counter trade imbalances caused by currency depreciation. The Bank of England is the Bank of Europe’s central bank. In addition to this, the EIB [European Central Bank] or the European Monetary Fund can also become involved in the policy. While these bodies do not actually intervene in the domestic exchange market directly, they are used to provide support for exporters of specific goods and to ensure that import surpluses are reduced.
In the case of the UK, imports and exports are closely tied to changes in the supply of certain products. Because of this, the Bank of England uses two policy tools: the base rate tool and the base interest rate. Changes in the base rate can affect the competitiveness of the UK economy and the extent to which trade flows are balanced. Similarly, the base interest rate can impact the amount paid by firms for borrowing money and affect the level of investment made by consumers.
The use of these policy tools is essential to ensure the economic stability of the country. However, it should be noted that these instruments only become operative once a country has experienced a substantial run of growth. For instance, the Bank of England base rate Tool has been frequently used since the onset of the global credit crunch in order to offset recent increases in exports. While a significant rise in exports can boost overall competitiveness and lift the economy out of its recent slump, an increase in imports will prevent the economy from growing at the same pace as it would otherwise. This is why it is particularly important to pay attention to official economic indicators like the Purchasing Managers Index (PMI), the Retail Purchasing Managers Index (RPMI) and Producer Price Index (PPI).