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CHAPTER 2 The Environment of Business 53

Stable Exchange Rates. The exchange rate is nothing but a price. It is the
price of one currency compared with another currency and is generally determined
by the demand and supply for the currencies in the foreign exchange market. Coun-
tries try to maintain a stable currency, a currency with a value that does not fluc- stable currency A currency with a value
tuate wildly, while maintaining an unrestricted trading system by exporting and that does not fluctuate wildly
importing goods and services from other countries. Unless a country has a stable
currency, foreign businesses may not be willing to deal with or invest in that coun-
try, since the business risk associated with unstable currencies is great. Currency
stability is extremely important in international business transactions.
Achieving all four goals of economic management is a daunting task, and very
few countries are able to meet these goals in a consistent manner. Countries that
are rich or are progressing well are the ones that (over time) have been able to meet
most of these economic policy objectives in a relatively successful manner. Well-
managed countries continually try to grow rapidly while maintaining low inflation
by utilizing various economic policy tools.
reality Visit your local car dealership and ask the manager if she or he prefers
CH ECK a stable dollar or a strong dollar and why.

Policy Tools to Manage the Economy

LEARNING OBJECTIVE 2
Summarize the key policy tools available to manage an economy.
Now that we understand the major goals of economic management, our next step
is to identify ways of achieving those goals. Fortunately, governments have some
important direct and indirect policy tools or instruments at their disposal to help
them meet those objectives. These include fiscal policy, monetary policy, incomes
policy, and trade and exchange rate policies. To use an analogy, your goal may be
to get to Sydney, Australia. The tools or instruments may be a jet aircraft (or ship),
the speed of travel, and the route you take. So depending on the policy tool you
chose, you may or may not achieve your goal within the time frame under
consideration.

Fiscal Policy. The two major elements of fiscal policy are government expendi- fiscal policy A government policy of
tures and taxation. Government expenditure is the purchase of goods and services using expenditures and taxation to
guide the economy to meet economic
by government to serve the needs of the general public. The federal government
goals (related to output, employment,
spends a significant amount of money on defense and national security by pur- inflation, and the exchange rate)
chasing big-ticket items like fighter airplanes, battleships, and missiles, by financ- government expenditure The purchase
ing important services like Medicare and social security, and by building highways, of goods and services by government to
serve the needs of the general public
dams, and harbors. Federal, state, and local governments spend money by provid-
ing citizens services through agencies like the police, the FBI, the CIA, and the IRS.
In most economies (especially the advanced countries), public services are made
available by governments with the help of private companies. However, in some
countries, governments also actively run commercial enterprises, for example, the oil
industry, the power sector, mining, and manufacturing. In the United States, the
government is very rarely involved in commercial operations. On the basis of the
composition of GDP (see Exhibit 1.7 in Chapter 1), it is clear that as the size of fed-
eral expenditure increases, the relative size of private consumption or investment
must decrease.
Taxes play an important role in an economy. As we have just seen, without the
help of taxes, governments will not be able to spend money on social programs and
defense. Public services like police and fire protection can only be provided by

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