Macroeconomic objectives and policies

Possible macroeconomic objectives

Four key objectives

  • low inflation

  • Economic Growth

  • Low unemployment

  • Current account balance

Peripheral objectives

  • balance government budget

  • Protection of environment

  • Greater income equality

Demand side policies

Monetary policy:

interest rate

  • Increase cost of borrowing

  • Fall in demand for assets

  • Confidence decreases

  • Value of pound will rise

Problems with this method

  • Balance of trade deficit

  • Interest rate take up to two years to have their full affect

  • High interest rates over long period of time discourage investment

quantitative easing : buying assets in exchange for money

  • asset price rises

  • Money supply increases

  • Commercial banks may lower their interest rate

Problems :

  • Hyper inflation

  • May become too dependant on quantities easing

  • No guarantee that higher priced assets lead to higher consumption

Fiscal policy

  • Rise in government spending

  • Increase of tax: disposable and corporate

    problems

  • Taxes and spending have impact on inequality

  • By cutting government spending to reduce AD, it also reduces the quality of services

  • High taxes reduce incentives

  • political issues

Evaluation of demand side policies

  • No effect on long run output

  • Depend on where economy is operating

  • Time lags

  • Expansionary policy is inflationary

  • Deflationary policy bring unemployment

Monetary vs fiscal

  • monetary: gov don’t have to spend extra money

  • Fiscal : significant impact on supply side, eg: increasing spending in the education to increase AD will also increase LRAS

Great Depression and global financial crisis

Supply side policies

  • market based policies are policies used to remove anything that prevents the free market from working inefficiently

  • Interventionist policies correct market failure eg the free market under provides education so the government provides it

Policies

  • increase incentives

  • Promote competition

  • Reform labour market

  • Improve skills and quality of labour force

  • Improve infrastructure

Evaluation of supply side policies

  • increase output and decrease prices

  • Improve balance of payment

  • No impact when LRAS is elastic

  • Often government has to spend more money which will lead to budget deficit

  • Take long time

Conflicts and trade off between objectives

  • Economic growth vs protection of environment : as we use resources to produce more goods we produce pollution and destroy habitats

  • Economic growth vs balance of payments: rapid economic growth leads to problem of balance of payments. India produces largely for themselves and increase in wealth has led to increase in imports. China has seen massive growth but has been largely by producing goods for exports

  • Unemployment vs inflation (Phillips curve)

Conflict and trade off between policies

  • Expansionary and deflationary fiscal policy: Expansionary policies will increase output, employment and economic growth but will lead to inflation and may worsen balance of payment. Deflationary will reduce inflation, but reduce employment and economic growth

  • Change in interest rates: Raise value of pound which will decrease exports, bad for investment. Low interest rates could lead to income inequality- as middle and lower class keep savings in bank whilst the richer keep it in stocks

  • Supply side policies: Able to decrease long term inflation but may increase it in the short term if they encourage investment

  • Fiscal deficit: Reducing government spending will cause income inequality, especiallt those who rely on welfare