Conflicts between economic objectives =

Governments make trade offs between their objectives

Most governments have the same four macroeconomic objectives- strong economic growth, reducing unemployment, keeping inflation low and maintain an equilibrium in the BOP

Also have other objectives- more equal distribution of income and wealth, maintaining economic stability, protecting the environment and improving productivity and international competitiveness

Trying to achieve one of these objectives may make it more difficult to achieve another

In the short run, governments decide which objectives they think are most important and accept that these decisions may have an adverse effect on their other objectives

Governments may have to use short term policies to correct sudden problems such as major unemployment caused by a severe recession

Changes in AD are likely to cause conflict between objectives

Short run economic growth is caused by the AD curve shifting right- could be due to an increase in any of the components of AD

Example; if AD curve shifts to the right then there will be an increase in the output and as a result there will be a decrease in unemployment

However a shift to the right of the AD curve will also result in an increase in the price level- higher prices may also lead to a lack of competitiveness internationally meaning a decrease in exports, rise in imports and therefore a worsening in the current account of the BOP

However a shift in LRAS curve will enable the government to achieve all four of the main macroeconomic objectives at the same time

If the LRAS curve shifts to the right then this will lead to an increase in output and reduce unemployment

Price level will also fall and this will improve the country’s competitiveness- improving the BOP

Suggest that if the government only used demand side policies to achieve it’s macroeconomic objectives then this will lead to conflict between the objectives

However, supply side policies are more likely to help a government achieve their four main economic macroeconomic objectives in the long run

Inflation and unemployment

When unemployment is reduced and the economy begins to approach full capacity there are fewer spare workers, so demand for workers increase- especially for skilled workers. This will lead to an increase in wages and the extra cost of this will be passed on by producers to consumers in the form of higher prices- causing cost push inflation

Low unemployment may cause consumers to spend more because they feel more confident in their long term job prospects- this may cause prices to rise due to demand pull inflation

So reducing unemployment makes it more difficult to keep inflation at the preferred low rate

Economic growth and environmental protection

Economic growth can put a strain on the government for example :

New factories and increases in production can raise levels of air and water pollution

Economic growth will tend to increase the use of natural resources- can be a problem if these resources are non renewable

Ecosystems might be damaged or even destroyed by the construction of new factories, housing etc.

Economic growth and inflation

A rapidly growing economy can cause large increases in prices, due to an increase in demand- this will cause a higher than desirable level of inflation

Attempts to keep inflation low can restrict growth - e.g. if interest rates are kept high to reduce inflation by discouraging spending this can restrict economic growth

Inflation and equilibrium in the BOP

If inflation is low this implies that prices are rising slowly, If prices rise more slowly than those in other countries, then exports to other countries will increase and imports will decrease. This would increase a surplus on the BOP, but reduce a BOP deficit

However, low inflation is often maintained by high interest rates. High interest rates encourage foreign investment which increases demand for the domestic currency- increasing its value.

This will make exports more expensive and imports cheaper, so exports will decrease and imports will increase- this would reduce a surplus on the balance of payments, but make a deficit worse

Economic growth and a reduction in wealth inequality

Economic growth can increase inequality as not everyone benefits equally from a growing economy

As an economy grows, highly skilled workers may become more in demand while the demand for low skilled workers may fall

Governments can choose to use increased tax revenue from economic growth to decrease this inequality by:

• Increasing welfare payments

• Using progressive taxes (i.e. taxes where the rich pay a higher rate than the poor)

• Increasing the minimum wage in line with increases in the average wage

However, increasing taxes or welfare payments may damage future economic growth for example:

• High taxes may be a discentive for individuals and businesses to earn and grow

• Extra welfare payments may not encourage people to work

Supply side policies that help people back to work and reduce geographical and occupational labour immobility would encourage growth, while reducing the welfare budget and unemployment