2.6 macroeconomic objectives

objectives

• low unemployment

• low, stable inflation

• balance of payments

• balanced gov budget

• environmental protection

• Greater Income Equality

low unemployment

Target rate is 4-5%

• there will always be friction al unemployment making it impossible to achieve 100% employment

low and stable rate of inflation

Target rate of 2%

• A low rate of inflation is desirable as it is a symptom of economic growth

Balance of payments

for a country is a record of all the financial transactions that occur between it and the rest of the world

• If exports > imports it will create a current account surplus

• If imports > exports, it will create a current account deficit

The UK traditionally has a current account deficit

Balanced government budget

• If expenditure > revenue, there is a budget deficit

• Any deficit has to be financed through public sector borrowing

• Any borrowing is added to the public sector debt (Government debt)

Greater income equality

• reduction in the differences in peoples income

macroeconomic policies

• demand side

• supply side

• trade offs

Demand side polies

• aim to shift AD

• fiscal and monetary policies

Fiscal policies

Involves the use of government spending and taxation

• direct taxation- paid directly to the gov

• indirect tax- imposed on goods and services

Monetary policies

• interest rates- cost of borrowing and return on saving

• quantitative easing- increasing the money supply

Expansionary demand side policies

• Demand-side policies that aim to increase aggregate demand are called expansionary policies

• Expansionary monetary or fiscal policy will shift aggregate demand to the right

Contractionary demand side policies

• Demand-side policies that aim to decrease aggregate demand are called contractionary policies

• Contractionary monetary or fiscal policy will shift aggregate demand to the left

strengths of monetary polices

• The Bank of England operates independently from the Government (political process)

• Is able to consider the long-term outlook

• Targets inflation and maintains stable prices

• Depreciating the currency can increase exports

weaknesses of monetary policies

• Conflicting goals e.g economic growth puts upward pressure on inflation

• Time lags between policy and the desired impact (up to 2 years)

• Expansionary policy is less effective in negative output gaps than when used with positive output gaps

  • Consumers may not respond to lower interest rates when confidence is low

• Cheaper credit can inflate asset prices in the long term

• The interest rate has limitations on downward adjustment

strengths of fiscal policy

• Spending can be targeted on specific industries

• Short time lag as compared with monetary policy

• Redistributes income through taxation

• Reduces negative externalities through taxation

• Increased consumption of merit/public goods

• Short term government spending can lead to an increase in the long-run aggregate supply

  • E.g. Building a new airport immediately increases government spending and AD, but when it is built, the potential output will have increased

weaknesses of fiscal policy

• Policies can fluctuate significantly as governing parties' change 

  • Long term infrastructure projects may lack follow-through

• Increased government spending can create budget deficits

  • Repaying this debt may lead to austerity on future generations

• Conflicts between objectives

  • E.g. Cutting taxes to increase economic growth may cause inflation

Supply side policies

 aim to shift (LRAS) 

• interventionist- direct gov intervention to increase full employment level

• market based - aim to remove obstructions in the free market that are holding back improvements to the long-run potential

Aims of supply side policies

• Market-Based and Interventionist Strategies to Meet the Aims of Supply-side Policies

Aim of Supply-side Policy	Market-Based Approach	Interventionist Approach
To increase incentives	Reducing income/corporation tax rates Restructuring the unemployment benefits system to incentivise the unemployed to seek work
To promote competition	Privatisation and deregulation Trade liberalisation	Increased government spending on innovation Direct support to firms (subsidies) promotes international competitiveness
To reform the labour market	Decreasing trade union power so wages can be decreased Decreasing minimum wages to lower costs of production	Increased government spending on improving occupational mobility
To improve the skills and quality of the labour force		Increasing government spending on education and retraining Increasing government spending on healthcare so that productivity improves
To improve infrastructure		Increased government spending on infrastructure

strengths of supply side policies

• They increase the rate of growth of an economy

• They reduce average price levels

• They reduce unemployment 

• They often increase the value of net exports

• Improvements in Infrastructure can raise the quality of life for all citizens

weaknesses of supply side policies

• The distribution of income worsens as labour market reforms and wage policies lower worker's wages

• They are expensive to implement

• There are significant time lags between expenditure and seeing the benefits

• Due to the long-term nature, changes in government often result in changes to budgets and scope of projects

  • The end result may be less effective than it could have been

Trade offs between macroeconomic objectives

Trade-off	Explanation
Economic Growth and Inflation	Increasing economic growth causes the economy to move closer to full employment. Prices for remaining resources are bid up leading to inflation which may outpace the target inflation rate of 2%
Economic Growth and Environmental Sustainability	Economic growth often increases pollution, negative externalities and the depletion of non-renewable resources. The higher the growth, the faster the depletion
Economic Growth and Inequality	During periods of high economic growth, the profits the owners of the factors of production receive are disproportionate to any increase in workers' wages leading to greater inequality
Economic Growth and Balanced Budget	Economic growth driven by expansionary fiscal policy often requires a budget deficit
Economic Growth and Balancing the Current Account	Economic growth usually leads to higher incomes which leads to an increase in imports by households thereby worsening the current account balance
Low Unemployment and Low Inflation	The closer an economy moves to full employment the less workers will be available for hire and wage inflation will help increase overall inflation

Short run Phillips curve

Observes that there may be a trade-off between unemployment and inflation

• Rising inflation is accompanied by falling unemployment

• Rising unemployment is accompanied by falling inflation

• This trade-off makes it difficult for the government to achieve both low unemployment and low inflation