11.4 Possible Conflicts Between Macroeconomic Policy Objectives

Why does a positive output gap lead to inflation

Excess demand over capacity causes firms to raise prices

Why does a negative output gap reduce inflation

Unused resources mean low demand pressures, keeping prices stable or falling

How do output gaps affect unemployment

Negative output gaps increase unemployment; positive gaps reduce it

Draw the short-run and long-run Philips curve

What happens when demand-side policies reduce unemployment in the short run according to Bill Phillips

Inflation rises due to increased consumer spending and wage pressure

Why is the long-run Phillips curve vertical

Because in the long run, unemployment returns to its natural rate, regardless of inflation

Why are demand-side policies ineffective at reducing unemployment in the long run

Because any gains in employment are offset by rising inflation, with unemployment returning to its natural rate

What kind of policies are recommended to reduce long-term unemployment

Supply-side policies like education,training, and labour market reforms to improve workforce skills and flexibility

What is the ‘natural rate of unemployment’

The level of unemployment that persists in the long-run when the economy is at full capacity

Why can economic growth conflict with inflation control

Rapid growth raises aggregate demand, which can lead to demand-pull inflation if the economy is near full capacity

How does economic growth potentially worsen a country’s current account

Increased incomes raise demand for imports, leading to a larger current account deficit, especially in countries like the UK with high import propensities

In what way can economic growth harm the environment

It often leads to higher emissions, pollution, and the depletion of non-renewable resources due to increased industrial actitivity

How does cutting a budget deficit potentially reduce economic growth

It involves reducing government spending or raising taxes, which lowers aggregate demand and slows growth