2.6.4 Conflicts And Trade-offs Between Objectives And Policies Flashcards
Potential conflict between the macroeconomic objectives
- reducing unemployment vs price stability
- Economic growth vs balance of payments
- Economic growth vs Environment
- economic growth and inflation
- economic growth & budget deficit
- economic growth and income equality
Econ growth vs budget deficit
- reducing budget deficit = higher taxes and lower spending = tightening of fiscal policy = fall in AD = lower econ growth
- if govt want to boost econ growth = expansionary fiscal policy (tax cuts/increase spending) = increase AD = bigger deficit
econ growth vs budget deficit evaluation
- depends on how you reduce a budget deficit.
- raising retirement age = difficult to get welfare benefits = reduce govt spending = little impact on econ growth (working longer = increased LRAS).
- but effects on equality
The Phillips curve (pic)
- shows a tradeoff between inflation and unemployment.
- A demand-side policy to reduce unemployment could conflict with price stability
The Phillips curve explanation
- As rate of unemployment falls, labour shortages may cause an increase in wage inflation and higher unit labour costs
- When an economy is booming, so does the derived demand for and prices of components and raw materials – leading to higher costs
- Rising demand and falling unemployment can lead to suppliers raising their prices to increase their profit margins
Reducing unemployment and increases inflation trade offs (Phillips)
- a shortage of labour might increase wages = trade offs between reductions in unemployment and increase in inflation
Unemployment and inflation evaluation
It’s possible to reduce both inflation & unemployment with successful supply-side policies
- can reduce structural unemployment without causing wage inflation
- also if growth is sustainable, in the long run, inflation will remain low
Economic growth vs balance of payments
- growing economy (e.g India) = many imports = reduced trade balance = reduced incentive for exporters to export if it can be sold at home
- high consumption
- High econ growth may increase inflation making exports less competitive
Econ growth vs balance of payments evaluation
- but if growth is export-led (e.g China) = current account can improve
depends on a country’s MPM. - eg Germany has seen strong econ growth but it often runs a current account surplus
Economic growth vs environment
- growth may damage the environment if it involves increased manufacturing. But increased incomes from growth/wealthy country = can convert to clean energy or develop tech/protect protection
Govt spending effects on supply-side
- increased govt spending = positive impact on supply-side of economy through improved healthcare and education or through changes in taxes
- but increased spending = problem in supply in short run = increased demand-pull inflationary pressures
Interest rate effects on supply-side
- increased interest rates (monetary) to control inflation = damage to supply-side economy
- higher interest rates reduce investment in the economy = increased cost-push inflationary pressure while reducing demand-pull inflationary pressure
Policies to improve growth and trade balance
- supply-side policies
- exchange rate depreciation
- sound/ effective macro economic policies
How can supply-side policies improve growth and trade balance?
- Reforms to improve labour productivity
- Incentives to boost research & development & innovation
- Measures to increase investment in export sectors
How can exchange rate depreciation improve growth and trade balance?
- A depreciation of the currency (in theory) makes exports more price competitive and imports are more expensive
- But the effects are dependent on price elasticity of demand
How can Sound/Effective Macro Economic Policies improve growth and trade balance?
- Monetary policy to help keep inflation low relative to the inflation of major trading competitors
- Infrastructural investment to increase export competitiveness
Example of conflict between econ growth and inflation
- In the late 1980s during the Lawson boom the UK experienced a high rate of econ growth = inflationary pressures to increase = unsustainable = recession in 1991
- if growth is quick = supply constraints pushing up commodity prices increases
Environment and econ growth chain of reasoning evaluation
- more developed = develop tech to use resources more sustainably & efficiently
- more wealth = afford environmental protection = limit environmental footprint
Trade offs of unemployment
- inflation
- worsened current account
How can low unemployment lead to inflation?
- cause an acceleration in wage inflation in labour market = rise in cost-push & demand-pull inflationary pressures (short-run Phillips Curve)
- Bargaining power of workers rises + skilled labour shortages & increased demand for raw materials = variable costs higher = inward shift of SRAS = higher rate of inflation.
Evaluation of low unemployment leading to inflation
- Not automatic that inflation will rise.
- Improved supply-side flexibility of the labour market = caused a fall in the NAIRU (non-accelerating inflation rate of unemployment) = Unemployment can fall further without threatening rising wage inflation.
- External factors (e.g. lower commodity prices, impact of global competition) = off-setting factors even if wages are rising more quickly.
How can low unemployment worsen the current account?
- leads to rising real wages = increased household incomes = surge in demand for imports of g/s especially if the marginal propensity to import is high
- a rise in M= worsening of the current account of the BoP.
- E.g. unemployment in UK now less than 4%, in 2016 the UK ran a record current account deficit of more than 5% of GDP.
Evaluation of low unemployment worsening the current account
- falling unemployment might be a result of improved supply-side performance e.g increase labour productivity = export industry more competitive
- export sales might have grown due to depreciation (E.g 2016) which (in case of Marshall-Lerner condition) = improve net trade balance whilst also stimulating output & employment in sectors e.g tourism & cars
