The government and central bank use policy to manage the economy primarily to promote stable economic growth, control inflation, maintain full employment, and stabilize the financial system. They use different but complementary tools: fiscal policy from the government involves adjusting spending and taxation to influence demand and economic activity, while monetary policy from the central bank involves controlling the money supply and interest rates to influence borrowing, spending, and inflation. Key reasons for using these policies include:
- Controlling inflation by adjusting interest rates or taxes to keep prices stable.
- Stimulating economic growth during downturns by lowering interest rates, increasing government spending, or cutting taxes.
- Preventing the economy from overheating and creating bubbles by tightening policies in boom periods.
- Maintaining high employment levels by encouraging investment and spending.
- Responding to economic crises with targeted interventions to stabilize markets and support vulnerable groups.
Central banks specifically use tools like open market operations, discount rates, and reserve requirements to influence liquidity and interest rates in the economy, thereby managing inflation and economic growth. Governments adjust fiscal measures to influence overall demand and redistribute resources to sustain economic prosperity and social welfare.