According to Economic Times (2017), Macroeconomics is the branch of economics that studies the behaviour and performance of an economy as a whole. It concerns for inflation, national income and income distribution, unemployment etc. As Economic Times (2017) further states, the set of government rules and regulations to control or stimulate the aggregate indicators of an economy frames the macroeconomic policy. These policies involve shaping national income, money supply, inflation, unemployment rate, growth rate, interest rate and many more. In other words, macroeconomic policies are formulated to achieve the macroeconomic goals of the economy.
Basically there are two major macroeconomic policies as fiscal policy and the monetary policy where fiscal policy consists of the concerns for the government expenditure and monetary policy concerns for the money supply in the economy. In other words, the government uses the fiscal policy to decide how the government would affect the macroeconomic factors to achieve the macroeconomic objectives through the changes made to the economic expenditure of the government. Monetary policy is used to alter the money supply of the economy and thereby to control the behaviour of microeconomic factors to ensure that the economy achieves its macroeconomic objectives. According to World Bank (2014), the primary goal of effective macroeconomic policies is to reduce uncertainty and risk in economic decision-making. A stable macroeconomic environment enhances prospects for growth and improved living standards as it refers to contract laws, income distribution, debt management etc.
According to Mayer (2002), monetary policy is generally implemented by independent central banks instead of the political institutions that control fiscal policy. Independent central banks are less likely to make decisions based on political motives. In addition, the exchange rate policy also happens to play a vital role in the achievement of macroeconomic objectives.
Macroeconomic policies vary from country to country based on the resources they have, the expectations of the governments, the rules and regulatory commitments of countries to international institutions such as International Monetary Fund (IMF), World Bank, United Nations etc. But rather than blindly and stand alone trying to achieve the macroeconomic objectives, it is always advisable and fruitful for the developing countries to learn lessons from the developed countries on how they came the long journey to achieve their macroeconomic objectives which ultimately helped them to achieve the ‘developed’ status. There can be seen some countries in the world context that have moved from low income level to high income level status due to their effective management of macroeconomic policies. One such example is Paraguay.
Cooper (1976) has identified several respects of the macroeconomic policies in small open economies with special reference to the effectiveness of monetary and fiscal policies under alternative exchange rate regimes. Frenkel and Mussa (1981) evaluated the effectiveness of optimal monetary policy in open economies by proposing a unified analytical framework which was later used by a considerable number of developed countries.
According to a study carried out by Kubendran (2016) with respect to United States, India, Qatar and United Arab Emirates, in United States, when expansionary monetary policy has been implemented, the decreased interest rate leads to increase in output. Decreased interest rate is also led to capital outflow from the economy and further it led to increase in imports. With respect to India, it shows a positive relationship between money supply and output, which implies expansionary monetary policies in managed float economies will increase output. Also, in a managed float regime in USA fiscal policy were effective to attain external as well as internal equilibrium. Monetary policy in the case of a developed nation under floating exchange rate regime also founds that the monetary policy is effective in attaining internal as well as external balance (Germany). In the context of Qatar where a fixed exchange rate system can be seen, monetary policy has sufficed to attain the general equilibrium. This has been proven correct in the context of United Arab Emirates as well, suggesting the importance of a fixed exchange rate in order to achieve internal and external balance.
All in all, as per the above discussion, fiscal policy seems to be helpful in managing the internal and external equilibrium in developed countries where exchange rate is floated. In the fixed exchange rate maintaining countries, monetary policy happens to be more effective.
So as a developing country which maintains a floating exchange rate system, Sri Lanka can gain better results if it opts for effective management of the fiscal policy where government income (taxes), debt and expenditure are used to impact the economy. This comes in line with John Menad Keneys’s suggestions as well with respect to government expenditures in the times of recession. When the government feels that the actual output of the economy is falling behind the expected and potential output of the economy, government can intervene and increase its expenditure to bring the economy to a balance. For instance, if the government decides to fund a capital project such as construction, that adds value to economic output as well as the income of the employees in that project will rise, resulting in lessened poverty.
However in economics, there comes a concept called crowding out effect which discusses about the private sector lacking resources when the government tends for excessive expenditure. This can also come in the form of a rise in interest rates as a result of government expenditure, which would hinder the investments of the economy. However, an acute monitoring of the policy can help Sri Lanka achieve its macroeconomic objectives rather than opting for the increases in money supply for the which can in turn result in inflation.
Taking these lessons from the developed countries can help Sri Lanka in achieving its objectives in a more fruitful and faster way.
Cooper, R.N., 1976. Monetary Theory and Policy in an Open Economy. The Scandinavian Journal of Economics. 78(2), pp. 146-163.
Frenkel J.A. and Mussa M.L., 1981. Monetary and Fiscal Policies in an Open Economy. The American Economic Review. 71(2), pp. 253-258.
Kubendran, N., 2016. Effectiveness of macroeconomic policies in the context of closed and open economies. Journal of Economics and Management. 25(3).
Mayer, T., 2002. Monetary policy: role of. An Encyclopedia of Macroeconomics. Edward Elgar Publishing: Northampton, Massachusetts. pp. 495–499.
The economic times 2017. Definition of ‘Macroeconomics’. Available at http://economictimes.indiatimes.com
World Bank., 2014. Macroeconomic Policy. Available at http://www.worldbank.org