9.1 - The objectives of government economic policy

What are the main four macroeconomic objectives?

- Economic growth

- Low unemployment

- Price stability

- Stable balance of payments

What is the government's economic growth aim?

In the UK, the long run trend of economic growth is about 2.5%. Governments aim to have sustainable economic growth for the long run.

In emerging markets and developing economies, governments might aim to increase economic development before economic growth, which will improve living standards, increase life expectancy and improve literacy rates.

What is the governments employment aim?

Governments aim to have as near to full employment as possible. They account for frictional unemployment by aiming for an unemployment rate of around 3%. The labour force should also be employed in productive work.

What is the governments aims for price stability?

In the UK, the government inflation target is 2%, measured with CPI. This aims to provide price stability for firms and consumers, and will help them make decisions for the long run. If the inflation rate falls 1% outside this target, the Governor of the Bank of England has to write a letter to the Chancellor of the Exchequer to explain why this happened and what the Bank intends to do about it.

What is the governments aims for balance of payments?

Governments aim for the current account to be satisfactory, so there is not a large deficit. This is usually near to equilibrium. A balance of payments equilibrium on the current account means the country can sustainably finance the current account, which is important for long term growth.

What are some additional macroeconomic objectives the government may have?

- Balanced government budget

- Greater income equality

What is the trade of between economic growth and inflation?

A growing economy is likely to experience inflationary pressures on the average price level. This is especially true when there is a positive output gap and AD increases faster than AS.

What is the trade off between economic growth and the current account?

During periods of economic growth, consumers have high levels of spending. In the UK, consumers have a high marginal propensity to import, so there is likely to be more spending

on imports. This leads to a worsening of the current account deficit. However, export-led growth, such as that of China and Germany, means a country can run a current account surplus and have high levels of economic growth.

What is the trade off between economic growth and government budget deficit?

Reducing a budget deficit requires less expenditure and more tax revenue. This would lead to a fall in AD, however, and as a result there will be less economic growth.

What is the trade off between economic growth and the environment?

High rates of economic growth are likely to result in high levels of negative externalities, such as pollution and the usage of non-renewable resources. This is because of more manufacturing, which is associated with higher levels of carbon dioxide emissions.

What is the trade off between unemployment and inflation?

In the short run, there is a trade-off between the level of unemployment and the inflation rate. This is illustrated with a Phillips curve.

As economic growth increases, unemployment falls due to more jobs being created. However, this causes wages to increase, which can lead to more consumer spending and an

increase in the average price level.

The extent of this trade off can be limited if supply side policies are used to reduce structural

unemployment, which will not increase average wages.