Understanding Economic Policy: Key Components and Mechanisms

Components of Economic Policy

Tax Policy

Tax policy is an essential tool to facilitate growth, investment, and social balance. It is a key concern for the Government.

Exchange Policy

Exchange policy is the joint action implemented by the monetary authority to establish or manage the exchange rate parity.

Interest Rate

The interest rate is the percentage applied to a sum of money (capital) and is equivalent to the amount to be paid or charged for loaning or borrowing money.

Money Supply

The money supply is the principal variable used. It is the amount of money circulating in the economy to move the commercial and financial transactions of society. It is the package of cash circulating in the economy and serves to cherish and value, deferring future payments.

Reserve Requirement

The reserve requirement is the obligation to keep at the Central Bank (CB) a percentage of the funds raised from the public, whether domestic or foreign. It is an instrument of monetary policy and a liquidity guarantor. If the percentage of banks' reserve requirements increases, they will have to save more money, and so there will be less money in circulation.

Central Bank

The Central Bank is the executing agency of a country's monetary policies.

Features:

• Execution of monetary, currency, and financial policies in agreement with the monetary program approved by the Central Bank.
• It is in charge of removing damaged banknotes and coins that are in circulation and replacing them with others if they are eligible.
• It exclusively manages the issuance of banknotes and coins representing the national currency and determines the amount of banknotes and coins in circulation.

Methods to Determine the Amount of Money in Circulation

It is determined by the sum of the prices of goods divided by the average number of cycles of movement of the currency units of the same sign.

The monetary policy of the country uses money to secure and maintain economic stability. It uses mechanisms such as interest rate fluctuations in order to maintain stability and balance in the circulation of money or value. Two methods are used:

• Expansionary monetary policy: when the goal is to put more money in circulation.
• Restrictive monetary policy: when the object is to remove money from the market.

Balance of Payments

The Balance of Payments (BP) is an accounting document that records the commercial operations, services, and capital movements carried out by residents of a country with the rest of the world during a specified period, usually one year. The balance of payments provides detailed information on all transactions between residents and nonresidents. The balance of payments is divided into four subdivisions:

Current Account

The current account records payments from trade in goods and services and income in the form of profits, interest, and dividends earned from capital invested in another country.

Capital Account

The capital account records capital transfers and the acquisition of intangible non-produced assets.

Financial Account

The financial account adds the change in assets and liabilities. Therefore, it reflects the financial flows between residents of a country and the world.

Errors and Omissions Account

The errors and omissions account covers what is known as the capital unspecified. It is said to be an adjustment for the statistical discrepancy of all other accounts of the balance of payments.

One way to overcome a deficit of BP is through increased exports and decreased imports.

The BP has a deficit if the sum of the current and capital accounts gives a negative balance.