POLICY CONFLICTS MACRO

How does Expansionary Fiscal Policy (+G, -T) promote economic growth and reduce unemployment?

• Govt spending: Direct investment in healthcare/infrastructure increases aggregate demand while improving labor productivity and firm efficiency (investment in healthcare; workers less sick so +efficiency, and infrastructure spending reduces geographic immobility; +labour so +quantity and +quality of FOP so LRAS shifts right)

• Tax cuts: Increases disposable income, raising consumer spending +C; eval: depends on MPC

• Impact: Higher AD causes firms to hire more labour to meet demand, driving Real GDP growth and reducing cyclical unemployment

How does Expansionary Fiscal Policy conflict with Fiscal Stability (budget deficit and national debt)

• Higher spending combined with lower tax revenue widens the annual budget deficit.

• To finance this deficit, the government must issue government bonds (borrowing), which increases the total national debt and future debt-servicing costs.

Why might Expansionary Fiscal Policy cause inflation when the economy nears full capacity?

If AD shifts right while the economy is near full capacity supply cannot expand to match demand due to limited resources as economy is near full capacity (using almost all available resources efficiently to achieve maximum sustainable output).

causes severe demand pull inflation and minimal or no economic growth

Key Implications of Nearing Full Capacity (LRAS)

When an economy nears full capacity at itsLong-Run Aggregate Supply (LRAS), it means it is producing close to its maximum sustainable output using all available resources efficiently

Low Unemployment: Cyclical unemployment drops to near zero. The economy operates at the natural rate of unemployment, meaning jobs are widely available and most willing workers are employed

Competition for scarce workers allows employees to demand higher wages. Businesses pass these rising labor and production costs on to consumers through higher prices, triggering demand-pull or cost-push inflation.

How does Contractionary Monetary Policy (raising base interest rates) lower inflation?

Higher interest rates increase borrowing costs and the reward for saving

leading to lower consumption (-C) and investment (-I).

AD shifts left, dampening demand-pull inflation and reducing general price levels

How does using Contractionary Monetary Policy to reduce inflation conflict with Economic Growth?

Higher rates suppress consumption and private investment

This causes AD to fall or grow more slowly, leading to lower Real GDP growth or a potential recession, while increasing cyclical unemployment, fall in incomes spend even more less, multiplier effect

How does high interest rate policy conflict with Reducing Inequality (wealth distribution)?

• Net savers and asset owners benefit from higher returns on deposits and interest yields.

• Increases mortgage/borrowing costs, reducing disposable income for lower-income households; these costs take up a higher proportion of wages from low income households.

• Widens income/wealth inequality between asset owners/savers and low-income borrowers

How do Market-Based Supply-Side Policies (deregulation and benefit cuts) aim to increase long-run economic growth? Examples? Evals?

government actions designed to increase an economy's productive capacity and improve market efficiency, shifting the long-run aggregate supply curve to the right.

• goal: strong and sustainable economic growth, lower unemployment and increased productivity.

• eval: time lags, increase inequality, high costs

EXAMPLES

FREE MARKET (NO GOVT INTERVENTION)

• deregulation (low barriers to entry, +competition)

• tax cuts

• labour market reforms: reduce power of trade unions, lowering or abolishing minimum wages or cutting unemployment benefits to encourage job seeking

• trade liberalization: removing tariffs, quotas and trade barriers to foster international competition

INTERVENTIONIST:

• education and training

• infrastructure investment ie transport

• healthcare spending eg NHS

• R&D subsidies.

what are supply side policies?

Supply-side policies are government strategies designed to increase the productive capacity and long-run economic growth of an economy. They are generally divided into two main categories: free market policies and interventionist policies.

• goal: strong and sustainable economic growth, lower unemployment and increased productivity.

• eval: time lags, increase inequality, high costs

FREE MARKET (NO GOVT INTERVENTION)

• deregulation (low barriers to entry, +competition)

• tax cuts

• labour market reforms: reduce power of trade unions, lowering or abolishing minimum wages or cutting unemployment benefits to encourage job seeking

• trade liberalization: removing tariffs, quotas and trade barriers to foster international competition

INTERVENTIONIST:

• education and training

• infrastructure investment ie transport

• healthcare spending eg NHS

• R&D subsidies.

How do market-based supply-side policies conflict with Income Equality and Environmental Sustainability?

Inequality Conflict: Cutting benefits harms low-income households reliant on welfare, widening the income gap and increasing poverty.

Environmental Conflict: Aggressive deregulation (e.g., relaxing planning laws) can lead to land degradation, loss of greenbelt areas, deforestation, and high negative externalities.

How does simultaneous Expansionary Fiscal Policy (tax cuts) and Contractionary Monetary Policy (rate hikes) lead to a policy-mix conflict?

Opposing Effects: Fiscal tax cuts aim to boost AD through higher consumption, but Central Bank rate hikes raise borrowing costs and encourage saving, directly offsetting/cancelling out the fiscal stimulus.

Debt Servicing Conflict: Higher base rates raise government bond yields, significantly increasing interest payments on the national debt created by the fiscal stimulus.

What is financial 'Crowding Out', and how does massive government borrowing cause it?

• Large-scale government borrowing boosts the demand for bonds so govt floods market w/ +bonds, causing prices to drop

• This pushes up bond yields to incentivise bond purchase, hence increasing interest rates as bond yields act as the benchmark floor for every other interest rate in the economy due to its risk free nature; they are risk free so firms/individuals who aren’t as risk free have to put interest rates higher to remain competitve.

• Consequently, private sector borrowing and investment (-I) are "crowded out" as borrowing becomes too expensive for private firms (-priv sector investment)

How does implementing strict Austerity (cutting public spending) conflict with Interventionist Supply-Side goals?

Austerity: fiscal policies implemented by governments to reduce budget deficits and public debt through spending cuts, tax increases, or a combination of both.

Austerity cuts government spending which starves funding for critical public goods like education, vocational training, and infrastructure

This weakens the long-term goal of building a high-skilled, highly productive knowledge economy.

What is economic 'Hysteresis', and how can short-term fiscal cuts permanently lower LRAS?

Definition: Hysteresis occurs when a short-term economic shock causes permanent long-term structural damage.

Mechanism: Short-term budget cuts lead to prolonged unemployment. Workers lose skills and motivation (de-skilling), while businesses cut capital investment.

Result: Causes a permanent drop in the economy's productive capacity, shifting LRAS to the left

How can environmental regulations have both positive and negative impacts on economic growth?

Negative (Short Run): Increases production costs for firms, reducing profits, capital investment, and short-run growth.

Positive (Long Run): Encourages green innovation, creates new industries, improves resource efficiency, and prevents costly long-term climate damage, boosting LRAS.

How can policy conflicts between macroeconomic objectives be resolved?

Policy Combinations: Use Demand-Side policies (e.g., Expansionary Fiscal Policy) alongside Supply-Side policies (e.g., workforce training).

Effect: Expansionary fiscal policy boosts growth/employment, while supply-side policies expand capacity (LRAS), controlling inflation and improving export competitiveness.

Limitation: Hard to coordinate, expensive, and supply-side policies have long time lags.

Which two main macroeconomic objectives conflict when aggregate demand falls

Inflation vs Unemployment / Economic Growth:

Falling AD reduces demand-pull inflation (a positive outcome).

However, it worsens economic growth (causing negative growth or recession) and increases unemployment (as firms lay off workers due to surplus capacity).

Why does short-run economic growth driven by AD worsen the Current Account on the Balance of Payments?

Higher AD increases national income and consumer disposable income. Due to the UK's high Marginal Propensity to Import (MPM), consumers spend more on foreign luxury goods and services.; MPM=Proportion of additional income spent on foreign goods; CHANGE IN IMPORTS/CHANGE IN INCOME

Import expenditure exceeds export earnings. worsening the current account deficit.

How can supply-side labor market reforms conflict with reducing income inequality?

Measures like reducing removing minimum wage strips low-skilled workers of their wage floor, directly reducing their earnings and bargaining power. High-skilled workers are unaffected because market demand already keeps their pay well above the minimum wage, widening the overall income gap.

How can policy conflicts between macroeconomic objectives be resolved? Give example

Policy Combinations: Use Demand-Side policies (e.g., Expansionary Fiscal Policy) alongside Supply-Side policies (e.g., workforce training).

Effect: Expansionary fiscal policy boosts growth/employment, while supply-side policies expand capacity (LRAS), controlling inflation and improving export competitiveness.

Limitation: Hard to coordinate, expensive, and supply-side policies have long time lags.