An economic policy refers to actions that a government may take to alter the economy of a city, state, or nation. It is usually comprised of various measures, through which the government seeks to influence the overall economy. There are three methods through which a government typically seeks to control the economy with its budget, known as the allocative, stabilization, and distributive functions. While all three functions are always used collaboratively, their emphasis may change with each new government, era, and global economy.
The allocative function refers to how much of the government’s budget will be allocated to certain projects. For instance, the government may decide that, as part of their economic policy, it needs to spend more money on developing a standing army and health care. Allocating funds gleaned from taxes also allows the government to create jobs or public venues. A government does not necessarily need to spend money as part of allocation, it can, for example, raise the nation’s minimum wage.
A government may use the stabilization function to stabilize a nation’s economy by controlling interest rates or inflation, and by pushing the employment rate towards full employment. When it's budget enters a deficit, a government needs to stabilize the economy, this is often done through monetary controls. Governments may reduce interest rates in an effort to keep employment rates and wages up, because when interest rates are high and the economy is bad, it is common for unemployment to soar while wages plummet.
The distributive function of a government’s economic policy refers to the different levels of taxation and the economic burden that each economic level must bear. Increasing property and income taxes, for instance, could affect the middle class and the very wealthy more than those on the lower end of the economic strata. A tobacco and alcohol tax, however, might only really affect the lower classes. Governments attempt to ensure that the distribution of taxes is fair for all who are affected by them.
Governments may also attempt to regulate businesses and industry as part of their economic policy. Doing so is important because it is necessary to prevent monopolies. It is crucial to encourage competition in the marketplace because, if a company has a monopoly on an area of the consumer market, it is more likely to exploit customers by raising prices.
As part of economic policy, governments must to be aware of events on the international stage. In the U.S., the U.S. Department of Treasury Office of Economic Policy monitors international economic developments, and evaluates and analyzes them to project what economic conditions might be in the future. Using macroeconomics — a branch of economics that studies the performance and structure of an economy — this department can create a model that helps enable the government to come up with a viable and efficacious economic policy.