The market regulates itself. That is a basic assumption of classical economics. If one takes this statement literally, it would mean that the state is not involved in any way in the economic affairs of a nation. In practice, however, this is not the case. Rather, the state must create the framework conditions that are necessary for a functioning economy.
This is where economic policy comes into play. This deals with the state and its influence on the market and its economic processes. In this article you will find out what the goals of economic policy are, who is doing it and which topics are particularly important in economic policy.
Economic Policy – Definition
The term economic policy is defined as state measures intended to influence the economic processes and structures within a country. A distinction is made between general and specific economic policies.
General economic policy refers to the national economy as a whole, while specific measures are aimed at individual areas.
An example of a special economic policy is the Works Constitution Act, which regulates cooperation between employers and employee representatives.
On the other hand, infrastructure projects such as the expansion of the fiber optic network are part of general economic policy. Because everyone benefits from this – companies as well as private households.
Economic Policy – Actors
What exactly a country’s economic policy looks like depends on the actors involved, their structures and social functions, as well as their cooperation with one another. Essentially, national and supra- or international economic policy actors differentiate.
Figure 1: Actors in economic policy
At the national level, the Bundestag, the federal government, the state parliaments and the state governments are responsible for economic policy. In addition, labor courts, chambers of industry and commerce, chambers of crafts, employers’ associations and trade unions, as well as the Deutsche Bundesbank are among those who shape economic policy.
At the European level, i.e. supranational, the European Commission and the European Central Bank are important economic policy actors.
Various international organizations also influence the economic policies of the individual states, both directly and indirectly. The most important institution with direct influence is the International Monetary Fund (IMF). When granting loans to indebted countries, the IMF can set certain conditions that result in direct implementation as part of economic policy.
Country X is heavily in debt and needs money to make new investments. The IMF ties the approval of a loan to the condition that tax evasion must be actively combated and that government spending must be drastically reduced. Country X then enacts a law that drastically increases penalties for tax fraud. In addition, a budget law is passed, in which a number of savings in the administrative apparatus are planned.
The International Monetary Fund has consequently influenced both fiscal policy and political budgetary decisions with its lending.
Another international institution with direct influence on economic policy is the World Bank. It can set certain guidelines for states in the context of development aid.
In addition to the World Bank and the International Monetary Fund, the UNO (United Nations) and the OECD (Organization for Economic Cooperation and Development) should also be mentioned at the international level. Although they cannot impose conditions or influence economic policy by allocating funds, they can provide advice or create a broad public and thus indirectly influence a country’s policy. It does this by publishing analyses, recommendations and reviews.
The United Nations are calling on the industrialized nations to invest at least 7 percent of their gross domestic product (GDP) in development aid measures. Countries that don’t come close to contributing this value are publicly named by the UN and practically pilloried. In this way, they exert public pressure on the states and indirectly influence their development aid policies.
If you would like to find out more about the international players in economic policy, please have a look at our article World Politics Institutions. You can find this in the topic block Economics as a subtopic on globalization.
Economic Policy – Goals
All economic policy measures serve to achieve economic goals. These are specified in the stability law and are also referred to as «the magic square»:
In addition, the natural environment should be preserved for future generations and a fair distribution of income and wealth should be guaranteed. All of these objectives must be taken into account as equally as possible when making economic policy decisions.
You can find more about the economic policy goals in our article Economic goals in the social market economy.
The main areas of economic policy
In the following we give you a brief overview of the areas of economic policy. A distinction is made here between regulatory policy, process policy and structural policy.
Figure 2: Areas of economic policy Source: iwk-verlag.de
In Figure 1 you can see the many areas in which economic policy influences the market and thus also the entire economy. The following topics are particularly relevant for your learning success at school:
The following sections explain briefly and concisely what the individual areas of economic policy are about.
If you would like more detailed knowledge on a topic, simply click on the relevant term and you will be taken directly to the desired article.
Economic Policy – Fiscal Policy
Fiscal policy, also known as financial policy, is the most important tool that a state has at its disposal for economic stabilization.
Fiscal policy is understood to mean government measures that promote economic growth and smooth out economic fluctuations.
There are different types and measures of fiscal policy, which we will briefly explain to you below.
Types of Fiscal Policy
First of all, one can distinguish between anti-cyclical and pro-cyclical fiscal policy. Anti-cyclical fiscal policy measures are taken against the business cycle. This means that in an economic crisis, the state increases its public spending and decreases government revenues.
This is intended to increase demand within the entire economy and initiate the economic upswing. The state is thus closing a demand gap caused by the economic downturn. That’s why we’re talking about one here demand-oriented economic policy.
The resulting budget deficit is closed by increasing income and reducing expenditure during the economic high phase (boom).
Figure 3: Anti-cyclical fiscal policy Source: bpb.de
In the case of pro-cyclical fiscal policy, on the other hand, government spending runs parallel to the business cycle. So the state increases its spending during a boom in order to reinforce the boom. However, this type of financial policy is pursued by very few countries, since the inflation rate and national debt are very high.
Another way of conducting fiscal policy is classic budgetary policy. It fell somewhat into oblivion with the first economic crises and has become increasingly important again since the 1970s. You have probably heard of so-called neoliberalism. This takes up the ideas of classic budget policy again. Its representatives demand that the state allow the market to regulate itself through a neutral tax policy.
Fiscal policy measures
In order to conduct fiscal policy, the state must take fiscal policy measures. Taxes are probably the most important tool at his disposal. He can go through tax increases increase government revenue or through it tax cuts to reduce.
When the state lowers taxes by way of anti-cyclical fiscal policy during an economic downturn and thereby increases demand, this is referred to as expansionary fiscal policy. The opposite of that is the restrictive or contractive fiscal policy. Here, taxes and thus government revenues are being increased in order to compensate for deficits in the expansive fiscal policy.
You can read more about this topic in our article on fiscal policy.
Economic Policy – State Budget
You have now learned a lot about government revenue and government spending and when what is increased or decreased and for what purpose. Perhaps you have also heard of the black zero. For a long time, it was the declared goal of the Finance Minister at the time, Wolfgang Schäuble. who the black zero demands, wants a balanced national budget.
The state budget is the sum of all income and expenditure within a state.
Not only the finances at the federal level play a role, but also those in the federal states and municipalities. Each district and each municipality has its own financial budget.
In many cases, the expenditures that a state, a state or a municipality can make are stipulated by law. For example, there must always be money for schools and social assistance. The federal and state parliaments decide on the amount of expenditure in the respective areas. This means that every year the government has to present to the elected MPs what money is to be spent on and what revenue is expected.
Once Parliament has approved a budget, those in government can no longer easily change it. If additional expenses are unexpectedly incurred, a so-called supplementary budget must be voted on.
Economic Policy – Monetary Policy of the European Central Bank
Unlike fiscal policy, monetary policy is not run by governments but by central banks. Since January 1, 1999, monetary policy within the European Union has been managed solely by the European Central Bank (ECB). The member states no longer conduct their own monetary policy. The monetary policy of the ECB is therefore of particular importance to you when preparing for the Abitur.
Until December 31, 1998, monetary policy in Germany was in the hands of the Deutsche Bundesbank. The Deutsche Bundesbank still exists today. However, it no longer conducts direct monetary policy. Rather, it is responsible for ensuring that sufficient intact cash is in circulation and that damaged and counterfeit banknotes are withdrawn from circulation. Interest rate policy, on the other hand, is now the responsibility of the ECB.
Monetary policy refers to all measures taken by central banks to control the…