10. Government Economic Policy Objectives

4 main macroeconomic objectives

1. strong economic growth
2. low inflation
3. reduced unemployment
4. equilibrium in the balance of payments

Other macroeconomic objectives

* balanced budget
* environmental protection
* greater income equality

Economic growth

an increase in the capacity or productive potential of an economy

Actual growth

the percentage change in real national output as adjusted for the effects of inflation (e.g. real GDP)

Trend rate of growth

the average rate of economic growth over a period of both economic booms and slumps

Determinants: Short-run economic growth

↑AD (e.g. ↓i, ↑G), ↑SRAS (e.g. ↓ATC, ↓W)

Determinants: Long-run economic growth

↑LRAS (e.g. ↑innovation, ↑I, ↑education, ↑population, ↑capacity)

Negative output/ recessionary gap

the difference between the level of actual output and trend output when actual output is below trend output

Features: Negative output/ recessionary gap

* unused or underused resources
* downwards inflationary pressure

Positive output/ inflationary gap

the difference between the level of actual output and trend output when actual output is above trend output

Features: Positive output/ inflationary gap

* fully used or overused resources
* upwards inflationary pressure

Economic instability

**particularly large** and **particularly frequent** ups and downs in the economic cycle

Examples: Demand-side shock

* ↑confidence → ↑P(houses) → ↑C
* a country’s major trading partners go into a recession → ↓Qd(X)

Examples: Supply-side shock

* poor harvest → ↓Qs(food) → ↑P(food) → ↓capacity
* discovery of a new major source of oil → ↑Qs(oil) → ↓P(oil) → ↑capacity

Examples: ‘Animal spirits’

* excessive growth in credit and levels of debt
* destabilising speculation and asset price bubbles

Determinants: Sustainable economic growth

* expand output annually
* find a continuous supply of raw materials
* find growing markets (for the increased output)
* reduce negative externalities

Recent macroeconomic performance: Economic growth

* from 2000 - 2008 the UK experienced continuous GDP growth of just under 3% a year.
* in 2008 the UK went into a long recession followed by a long, slow recovery
* the UK economy experienced short bursts of growth and slow-downs and nearly went back into a recession in 2012
* by 2014, GDP returned to the level it was just before the recession

Recent macroeconomic performance: Inflation

* between 2000 - 2015 inflation, as measured by the CPI, has been between 0.5 - 3%
* at the start of the recession in 2008 and again in 2011 inflation rose to about 5%

Recent macroeconomic performance: Unemployment

* unemployment was low, between about 1.4 - 1.7 million, from 2000 - 2008
* between 2008 - 2011 unemployment rapidly increased to 2.7 million (8%)

Recent macroeconomic performance: Balance of payments

* from 1984 - 2014 the UK has had a current account deficit

Recent economic performance: Economic sectors

* the tertiary sector accounts for roughly 75% of GDP
* the secondary sector accounts for roughly 10% of GDP

Full employment

where everybody of working age, who wants to work, can find employment at the current wage rates

Under-employment

when someone has a job, but it’s not a job that utilises that persons skills, experience or availability to the best effect

Types of unemployment

1. cyclical unemployment
2. structural unemployment
3. seasonal unemployment
4. frictional unemployment

Cyclical unemployment

unemployment caused by a shortage of demand in an economy

Seasonal unemployment

unemployment due to uneven economic activity during a year

Structural unemployment

unemployment caused by the decline of a major industry, which is made worse by labour immobility

Frictional unemployment

unemployment experienced by workers between leaving one job and starting another

Determinants: Frictional unemployment

* number of job vacancies available
* welfare benefits
* quality of information
* labour immobility

Real wage unemployment

real wages are pushed above the equilibrium level of employment (e.g. TUs, NMW)

Cost-push inflation

caused by the rising cost of inputs to production

Demand-pull inflation

caused by excessive growth in aggregate demand compared to supply

Fisher’s Equation of Exchange

money supply x velocity of money = price level x aggregate transactions (MV = PT)

Quantity theory of money

in the short-run V and T remain constant so P is directly caused by M

Equation: Balances for trade

balances for trade = exports - imports

Equation: Balances for investment income and transfers

balances for investment income and transfers = credits - debits

Equation: Current account balance

current account balance = balances for trade + balances for investment income and transfers

Value: Current account deficit

\-ve current account balance

Value: Current account surplus

\+ve current account balance

Cons: Balance of payments deficit

* uncompetitive
* weaker pound → ↑P(M) → ↑inflation
* structural unemployment

Cons: Balance of payments surplus

* stagnation
* overreliance on exports
* undervalued currency → inflationary pressures → rising costs of production → rising prices