2.1 Economic Policy

All businesses operate within the economic environment, which affect financial managers making decisions in various ways. For examples, labor costs will be affected by changes in employer's social insurance contribution, firm will have less money to invest if tax rises, export firm benefits from weakness of domestic currency attributed to the decrease of interest rate, and so on.

These actions taken by government in the economic field are refereed as economic policy. It covers the systems for setting levels of taxation, government budgets, the money supply and interest rates as well as the labor market, national ownership, and many other areas of government interventions into the economy, in an attempt to pursue goals like：

·economic growth；

·low inflation；

·full employment；

·balance of payments stability.

To achieve the goals, governments use multiple policy tools which are under the control of the government. These generally include the interest rate and money supply, tax and government spending, tariffs, exchange rates, labor market regulations, and many other aspects of government instruments. However, these goals cannot necessarily all be sustained together for a long period of time.

For instance, there may be pressure on the government to reduce inflation, reduce unemployment, and reduce interest rates while maintaining currency stability. If all of these are selected as goals for the short term, then policy is likely to be incoherent, because a normal consequence of reducing inflation and maintaining currency stability is increasing unemployment and increasing interest rates.

Many macroeconomic policies can be divided into either monetary policy or fiscal policy.

2.1.1 Monetary Policy

货币政策指中央银行为实现经济目标运用各种工具调节货币供应量和利率，进而影响宏观经济的方针和措施的总和。

Monetary policy deals with central banking actions regarding the money supply and interest rate.

Targets of monetary policy relate to the volume of national income and expenditure.

·Growth in the size of the money supply.

·The level of interest rates.

·The volume of credit or growth in the volume of credit.

·The volume of expenditure in the economy.

Interest rate targets are a vital tool of monetary policy and are taken into account when dealing with variables like investment, inflation, and unemployment.

One target of monetary policy is interest rates themselves because there is a direct relationship between interest rates and other variables like investment, inflation, and unemployment.

Interest rate changes as one target of monetary policy, could have great impact on economy as a whole. If interest rate increases, customers are encouraged to save money rather than spend it, corporate is reluctant to borrow and expand. It will reduce the money supply in the economy and thereby to reduce the level of effective demand which will, in turn, decrease inflation and improve the balance of payments, vice versa.

The interest rate has been set either by national government or the central bank, which generally tend to reduce interest rates when they wish to increase investment and consumption in the country's economy. However, a low interest rate as a macro-economic policy can be risky and may lead to the creation of an economic bubble, in which large amounts of investments are poured into the real-estate market and stock market.

Finance in News

US interest rate rise-Impact on China？

The Fed's main interest rate has been practically zero since the dark days of the financial crisis. It has been unchanged since December 2008, a few weeks after the collapse of the investment bank Lehman Brothers. Since June 2009, the recovery from the recession brought growth to the economy at an average annual rate of 2. 2%. Federal Reserve chairwoman Janet Yellen put the financial markets on notice months ago that an interest rate rise could come soon since the early 2016.

In 15/Dec/2016, the US Federal Reserve has moved to finally increase interest rates. This increase is more significant than usual because it marks an end to the unique circumstance of ultra-low interest rates. The Federal Reserve has also indicated they expect to raise interest rates three times throughout 2017. The rise in US interest rates could increase the flow of Chinese financial assets out of China, causing a further weakening of the Yuan. Some analysts are concerned the Chinese economy is vulnerable to a boom and bust situation, with rising debt levels-this makes US a relative safe haven and attractive place for deposits. On the other hand, the appreciation in the dollar will make Chinese exports even more competitive, boosting export demand and growth. It is not certain whether the Chinese economy would benefit from the stimulus of a depreciation or whether the inflationary effects would be harmful.-Dec,2016

For example, the Federal Reserve federal funds rate in the United States has varied between about 0.25% to 19% from 1954 to 2016, while the Bank of England base rate varied between 0.5% and 15% from 1989 to 2016, and China experienced rates close to 11% in the 1990s down to 1.75% in 2016. During an attempt to tackle spiraling hyperinflation in 2007, the Central Bank of Zimbabwe increased interest rates for borrowing to 800%.

Exchange rates which are determined primarily by supply and demand of the currency would be intervened by government by adjusting interest rates.

Interest rate, exchange rate and inflation, all are interrelated and interact on each other. It is difficult for a company to make decision due to the volatility. We will discuss more details about how company tackling such issues in Chapter 16 and 17.

2.1.2 Fiscal Policy

财政政策是指国家通过财政支出与税收政策的变动来影响和调节总需求。

Fiscal policy involves using government spending and taxation in order to influence aggregate demand in the economy.

Fiscal policy affects business enterprises in various ways.

·Government spending increase is an“injection”into economy, adding to aggregate demand for goods and services, thus affect the environment of business.

·Tax changes definitely have impact on business operations, both corporation tax and personal tax which associated with labor costs.

In addition, the government also influences markets through other regulations. By regulating market demand, supply, price, profit, quantity, quality, entry, exit, information or technology, governments expect individual company or industry to conduct business for overall economic efficiency and social justice. In practice, an acquiring company may get involved in Law of Anti-Monopolies if the target is in the same industry, a steel manufactory may be more concerned about Carbon-Trade policy than others.