Understanding Macroeconomics: Government, Economy, and Fiscal Policy

Posted on Mar 12, 2025 in Economy

Macroeconomics: Government, Foreign Sector, and National Economy

How Can the Government Boost the Economy?

  • Fiscal Policy: Increase spending, reduce taxes. This encourages people to spend on products, boosting the economy.
  • Monetary Policy: Lower interest rates to encourage borrowing, leading to increased consumption and investment. Increase the money supply.

Governments use monetary policy to influence economic activity. The financial system is essential for economic development, supporting both businesses and households through credit and deposit services.

The ECB (European Central Bank) regulates banks and provides loans, setting official interest rates.

Monetary policy, involving interest rates and money supply, aims to facilitate economic growth and control inflation.

Government Decisions in a Stable Market:

  1. Lower the interest rate without increasing the money supply.

GDP growth increases business investment and loans to families, boosting consumption and production. Typically, the increase in inflation will be smaller than GDP growth.

External Sector

When there is a deficit, solutions involve increasing exports or capital transfers.

Exchange rates can be fixed or flexible.

(Revenues – Expenses) = Result

(Cash inflows – Cash outflows) = Treasury

Treasury = Net Result + Amortization

Real Treasury: Real cash flow

Financial Treasury is calculated by adding depreciation to the net accounting result.

Investment

Any investment process involves:

  1. A disbursement, operating income, and operating costs.
  2. Duration: Knowing how long the investment will last.
  3. Periodic revenues, expenditures, collections, and payments.

Calculations are based on cash flows, but it is more instructive to calculate results and cash flows.

Static Selection Methods:
  1. Accounting Rate of Return: Comparing the average accounting profit with the average investment.
  2. Pay-Back Period: Calculating the time needed to recover the investment. Shorter times are better.

The Pay-Back Period is widely used due to its ease of computation and understanding.

Challenges of Pay-Back:
  • It does not account for funds generated after the recovery period.
  • It does not consider the time value of money in the recovery period.
  • It favors projects of short duration.
Advantages of Pay-Back:
  • Applies to high-risk investments, favoring quicker returns.
  • Considers liquidity preference.
  1. Cost-Benefit Ratio: Establishing a relationship between investment results (cash flow) and cost. The best investment yields the highest cost-benefit ratio.

The disadvantage is not accounting for the time value of cash flows.

An investment with high risk benefits from a quicker recovery of the initial investment.

In summary, these criteria do not account for the equivalence of money or the present value of money, where €1 in year 1 is worth more than €1 in year 4, disregarding interest rates, inflation, or opportunity cost.