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How can Economics Impact Government Policy?

Government decisions to adopt new policies are frequently affected by economic situations. Government policy has historically had a significant impact on growth in the economy, the emergence of new company entities, and the efficacy of financial markets, particularly in the United States.

A nation’s economic activity, in the most general way, reflects what its citizens, companies, and governments wish to buy and sell.

Theoretically, the decisions made by customers and producers are what essentially shape the economy as the U.S. has a capitalist system that is based on the ideas of a free market.

Key Points:

  • Government decisions to adopt new policies are frequently influenced by economic situations.
  • Policy made by the government has always had a significant impact on economic growth and the emergence of new company entities in the United States.
  • Having a history of economic growth is frequently taken into account by individuals in positions of power (such as when they are in the position to run for re-election).
  • Fiscal policy and monetary policy are the two major methods that the federal government may react to economic activity in order to ensure robust economic growth.
  • The Federal Reserve Board in the United States oversees the nation’s monetary policy.

Why Do Governments Get Involved?

The government may decide to limit some aspects of economic activity in order to promote economic growth or prevent unfavorable economic conditions in the future.

The general public’s financial objectives are protected and advanced when the government actively participates in dealing with and influencing a country’s economic situations.

People in positions of power usually consider the history of economic growth.  The economy has a big impact on how people vote, especially in presidential elections, according to a number of US research. 

The Economy’s Impact on Supporting American State Department. Strong economic growth frequently leads to higher pay growth, more employment being created, better investing results, and more company profits.

How Do Governments React to the Economy?

Fiscal policy and monetary policy are the two principal tools available to the federal government for responding to economic activity and ensuring vigorous economic growth.

Monetary Policy

Changing the cost of financing is one of the most popular ways for governments to try to influence a nation’s economic operations.

The most common technique is to employ the federal funds rate, which is an objective rate of interest that influences short-term debt interest rates such as retail debit cards and loan rates. It can be raised or lowered.

Depending on the scenario, the Federal Reserve modifies the rate of return for federal funds to encourage or inhibit economic growth.

The Federal Reserve’s purchase and sale of government assets is another aspect of monetary policy.

When the Federal Reserve purchases a holding from a bank, it increases the quantity of money in circulation. It may be traded assets to get rid of cash and reduce the amount in circulation.

Fiscal Policy

Additionally, the US government may enact legislation to alter spending, change tax rates, or create tax benefits. In terms of budgeting, the government determines that it wants to spend more than it anticipates collecting.

Evaluating public spending has as its goal either fostering economic success or cooling an overheated economy.

Instead of focusing on how the federal government spends money, normal fiscal policy is more concerned with how it raises revenue.

Tax incentives, bigger tax credits, and lower tax rates all help citizens get by financially while promoting economic growth. When advantageous tax regulations are eliminated or taxes are increased, economic activity is impeded.

Monetary and fiscal policy both seek to either slow or speed up economic growth. The employment rate and price level of the country may then be impacted by this.

There are a few little differences between these two types of government engagement, though.

Difference between Government Policies

Monetary Policy

  • Changes in the monetary supply or the accessibility of credit.
  • Alteration in the federal funds rate or the money supply.
  • Central Bank-set.
  • Significant independence from the political process.
  • Impacts debt-related industries, such as the housing market.

Fiscal Policy

  • Modification of the current monetary system’s use.
  • Modifications to tax and expenditure rates.
  • Federal Government-set.
  • Significantly incorporated into the political process.
  • Impacts net deficits and government budgets.

Should the government step into the economy?

The question of whether and how government agencies should intervene in economic activity has philosophical basis. Some people believe that the government owes it to its citizens to protect them from financial hardship.

Others hold the opinion that free markets and commerce will function organically and regulate themselves as they should.

Why Would the Government Involve the Economy?

The government has an inherent interest in protecting the wellbeing of its citizens. In reaction to international circumstances, the government may opt to enact particular legislation to safeguard its standards of living for its population.

The authorities can also pass laws to support economic equity and the welfare of various social classes.

How Does the Government Intrude Into the Economy?

The government interacts with the economy primarily in two ways. Through monetary policy, the government controls market interest rates, which has an impact on how simple or challenging it is to obtain loans.

Through fiscal policy, the government controls resource distribution and spending levels.


The Keynesian school of thought holds that governments are responsible for defending their citizens from economic downturns. Governments achieve this by putting monetary and fiscal policies into place.

The US is able to change its economic approach in an effort to take action when necessary because it has a central bank.

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