Macro Economic Dimensions Of International Finance

It is undoubtedly valuable for these effecting macroeconomic policies, as well as for those affected by them, to know what the policies will do.  In particular, it is important for macroeconomic policy makers as well as for corporate planners to know the potential effectiveness of monetary or fiscal policy.  As we shall show, there are circumstances which favor monetary policy and others which favor fiscal policy, but because of additional considerations or an inadequate understanding, the government might mistakenly take an expansionary policy action that will not subsequently raise sales ot general demand.  It is very important for a business executive to know which circumstances will make certain policies ineffective so that a plant is not expanded and debt is not incurred at the wrong time.  The key factors that determine whether different policies will or will not be effective are the exchange-rate system in effect and possible conflicting forces on the economy.  When exchange rates are fixed -  that is, pegged – devaluation policy can be used as well as monetary and fiscal policy for stimulating the economy.  For example, pegged exchange rates can be reset at a lower level to increase the demand for exports and shift domestic spending away from imports and toward import substitutes.  However, devaluations can be effective in raising output and improving the balance of payments only if there is some slack in the economy.   Otherwise devaluations are inflationary.

Another policy alternative available with any exchange-rate regime involves the imposition of import tariffs and/or the position of export subsidies.  The effectiveness of tariffs and subsidies depends on the type of exchange-rate system and also on the amount of slack in the economy.  By “effectiveness” we mean the extent to which policies can influence aggregate demand and production.  With fixed exchange rates we can consider four different types of macroeconomic policy for stimulating the economy: monetary policy, fiscal policy, devaluation policy, and tariff/subsidy policy.