2.1.3 Relationships between objectives and policies

Unemployment on inflation

• Low unemployment tends to lead to higher inflation. This is because as more people have jobs, disposable income increases and the economy grows. This leads to more demand-pull inflation. 

• If inflation is high, interest rates may increase. This contractionary monetary policy is likely to increase unemployment as spending slows.

Economic growth on inflation

• When the economy grows, disposable incomes generally rise which results in higher demand-pull inflation. 

• If interest rates are increased to combat high inflation, economic growth will fall. 

Economic growth on environmental protection

• High economic growth results in a damage to the environment. This is because higher economic activity leads to firms expanding, which results in damage to the environment. E.g. pollution. 

• However, as the economy grows and firms profits increase, firms may spend more on using green technology and invest in production techniques which are good for the environment.

Inflation and the current account on the balance of payments

• Higher inflation worsens the current account. This is because higher inflation means export competitiveness decreases (as exports become more expensive). This means the demand for exports falls, worsening the current account. 

• Also, inflation increases the demand for imports as consumers demand foreign goods which are relatively cheaper (assuming inflation abroad is not as high as in the domestic country). This results in a worsening of the current balance.