Macroeconomic Policy 101

Should government keep its hands off the economy and leave economic players and the markets alone, as conservatives (notably Republicans in the United States) tend to uphold? This traditional laissez-faire philosophy, from that French phrase that means “leave alone,” argues that economies and businesses function best with no government intervention.

At the other extreme are command-and-control economies, like what prevailed, and were later abandoned, in the former Soviet Union and still prevail in North Korea (with disastrous results). Virtually all other economies lie somewhere between laissez-faire and command-and-control, with some closer to the capitalist free market end while others choose to be closer to the socialist extreme. But even free market adherents accept that there are six legitimate roles that government must play in any economy: (1) provide for a stable set of rules and institutions; (2) maintain competition; (3) correct for externalities; (4) provide for public goods and services; (5) correct undesired market outcomes; and (6) ensure economic stability and growth. I’ve written on some of these before; I focus here on the last.

What are the indicators of economic stability and growth? My usual “PiTiK” test focused on presyo (prices, particularly stability thereof), trabaho (jobs, or overall employment), and kita (incomes, or growth thereof) could well be our yardstick. High rates of inflation or rapid increase in prices, high rates of unemployment, and falling incomes are triggers for social unrest and instability. Government’s goal, then, is to keep the first two down, while maximizing growth to support the growing population and uplift their quality of life.

How can government ensure economic stability and growth? Two types of policy tools are at its disposal: fiscal policy and monetary policy. The first refers to the use of government’s taxation powers and public expenditure management to influence economic outcomes. The Departments of Finance (which collects taxes and other government revenues) and Budget and Management (which sets levels of public spending) are primarily in charge here. The National Economic and Development Authority also determines levels of spending by the various government entities via its planning and public investment programming functions. Monetary policy, on the other hand, refers to management of the supply of money circulating in the economy, exclusively exercised by a country’s central bank or monetary authority—the Bangko Sentral ng Pilipinas (BSP) in our case. Central banks use several tools to do this, given their supervisory role over all banks and their sole authority to print and issue money.

Money supply is critical for stability of prices and for influencing economic activity, hence growth in incomes and job generation. But the BSP walks a perennial tightrope: More money in the economy, which goes with lower interest rates, induces more production activities and more jobs, but too much of it pushes up prices when “too much money is chasing too few goods.” If it controls inflation by tightening the supply of money, it could choke economic activity and dampen growth. Monetary policy is thus a constant balancing act. Putting the wrong people in the central bank could spell disaster.

Raising taxes slows the economy as it takes money from people who would otherwise spend it to buy goods and services and hence create demand to stimulate production. On the other hand, hiking government spending, financed from taxes or via loans (say from China), stimulates the economy if spent on domestic goods (say construction materials) and services (say welders)—but not if spent on imported goods (say Russian weapons). Economic instability could result when public spending far outstrips revenues and government debt becomes overly burdensome—and from various other effects like surging imports leading to a rising exchange, in turn leading to rising prices. Fiscal policy, too, is a balancing act best entrusted to competent economists.

If the economy is stable and doing reasonably well these days, we have our economic managers and central bankers to thank for it.

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