2.6.4 Conflicts And Trade-offs Between Objectives And Policies

Question 1

Potential conflict between the macroeconomic objectives

Answer 1

• 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

Question 2

Econ growth vs budget deficit

Answer 2

• 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

Question 3

econ growth vs budget deficit evaluation

Answer 3

• 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

Question 4

The Phillips curve (pic)

Answer 4

• shows a tradeoff between inflation and unemployment.
• A demand-side policy to reduce unemployment could conflict with price stability

Question 5

The Phillips curve explanation

Answer 5

• 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

Question 6

Reducing unemployment and increases inflation trade offs (Phillips)

Answer 6

• a shortage of labour might increase wages = trade offs between reductions in unemployment and increase in inflation

Question 7

Unemployment and inflation evaluation

Answer 7

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

Question 8

Economic growth vs balance of payments

Answer 8

• 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

Question 9

Econ growth vs balance of payments evaluation

Answer 9

• 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

Question 10

Economic growth vs environment

Answer 10

• 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

Question 11

Govt spending effects on supply-side

Answer 11

• 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

Question 12

Interest rate effects on supply-side

Answer 12

• 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

Question 13

Policies to improve growth and trade balance

Answer 13

• supply-side policies
• exchange rate depreciation
• sound/ effective macro economic policies

Question 14

How can supply-side policies improve growth and trade balance?

Answer 14

• Reforms to improve labour productivity
• Incentives to boost research & development & innovation
• Measures to increase investment in export sectors

Question 15

How can exchange rate depreciation improve growth and trade balance?

Answer 15

• 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

Question 16

How can Sound/Effective Macro Economic Policies improve growth and trade balance?

Answer 16

• Monetary policy to help keep inflation low relative to the inflation of major trading competitors
• Infrastructural investment to increase export competitiveness

Question 17

Example of conflict between econ growth and inflation

Answer 17

• 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

Question 18

Environment and econ growth chain of reasoning evaluation

Answer 18

• more developed = develop tech to use resources more sustainably & efficiently
• more wealth = afford environmental protection = limit environmental footprint

Question 19

Trade offs of unemployment

Answer 19

• inflation
• worsened current account

Question 20

How can low unemployment lead to inflation?

Answer 20

• 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.

Question 21

Evaluation of low unemployment leading to inflation

Answer 21

• 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.

Question 22

How can low unemployment worsen the current account?

Answer 22

• 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.

Question 23

Evaluation of low unemployment worsening the current account

Answer 23

• 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