CH40 Conflicts and trade-offs Flashcards
what are some government macroeconomic objectives?
-high and sustainable economic growth
-low unemployment
-low inflation
-a sustainable current account equilibrium on the balance of payments
-a sustainable fiscal policy
-objectives relating to income and wealth equality
-environmental objectives, such as reducing pollution
what can happen with macroeconoic objectives?
they can conflict, particularly when the economy is in disequilibrium
explain the conflict when inflation is too high?
-assume the rate of inflation is too high. One way to reduce the rate of inflation is to reduce aggregate demand for example by cutting consumer spending or government spending.
-however, reducing aggregate demand is likely to lead to a recession and cyclical unemployment. A recession means that the rate of economic growth will become negative
explain the conflict when growth is too low?
-assume that the rate of economic growth is too low. One way to increase it in the short term is to raise aggregate demand. This will lower unemployment but it will increase inflation.
-it is also likely to lead to a rise in imports because increased incomes will lead to extra demand for imported good. A rise in imports will lead to a deterioration in the current account position on the balance of payments.
-another way to raise economic growth is to raise the growth of LRAS. However, many of the methods advocated to raise long-run aggregate supply will lead to a fall in wage rates for many workers. E.g reducing trade union power, making wages more flexible and making it easier for firms to sack workers are all likely to put downward pressure on wages. So inequalities in income could grow. This is a problem is a gov wishes to reduce inequalities.
-equally, supply-side reforms might mean looser environmental controls on firms. This could conflict with environmental objectives
explain the conflict when unemployment is too high?
-if unemployment is too high, one way of reducing it is to raise AD.
-however, this might then conflict with the objectives about inflation and the current account.
-another way of reducing unemployment might be through supply-side reforms. However, more jobs might mean greater inequality if most of the jobs created are very low paid.
-equally, more jobs might come at the expense of environmental objectives. A factory built on agricultural land might harm the environment for example.
explain the conflict when the current account on the balance of payments is deeply in the red?
-if imports are far greater than exports, there might be difficulties for a country in financing this deficit.
-cutting imports by reducing domestic consumption and investment will lead to higher unemployment. This is because a fall in AD will also hit demand for domestically produced goods.
explain the conflict when the fiscal deficit is too high?
-if the gov is borrowing too much as a percentage of GDP, then it may attempt to correct this through cutting its spending and raising taxes.
-however, these austerity measures will raise unemployment and, certainly in the short term, lower the rate of economic growth.
-if the fiscal austerity measures are great enough, the economy will fall into deep recession, as the recent examples of Greece, Portugal and Spain have shown
explain the conflict when inequalities in income and wealth are too great?
-correcting inequalities may involve direct gov intervention by redistributing income through taxes and gov spending.
-direct provision of better educational outcomes for low-achieving students should lead, in the long term, to them being able to earn higher wages.
-correcting inequalities may also involve intervening in markets, e.g. by setting minimum wages or giving trade unions more power.
-economists disagree about the outcomes of these measures. However, reducing inequality, for example, by large rises in benefits for the unemployed is likely to have some disincentive effect to work and this then raises long-term unemployment and reduces long-term growth.
-equally, a failure to correct inequalities in education between children from rich and poor households is likely to reduce long-term economic growth
explain the conflict when the environmental situation is deteriorating?
-if environmental indicators are deteriorating, the gov can introduce policies to reverse these trends.
-as with inequalities, economists disagree about the impact of policies designed to correct environmental failures.
-however, investing in cleaner tech might lead to lower economic growth because investment resources are being diverted into resources that dont contribute to economic growth.
-tightening environmental regulation might discourage investment, leading to lower growth and high unemployment. On the other hand, investing in, say, wind farms or pollution-reducing equipment might lead to an increase in investment and therefore AD. This might raise growth and reduce unemployment
What does the Phillip curve show?
it shows the trade-off between unemployment and inflation.
explain the relationship between unemployment and inflation explained in the Phillip curve?
-the lower the rate of unemployment, the higher the inflation rate.
-this is because when money wages paid to workers go up faster than the increase in output per worker then costs increase for firms. They respond by putting up prices. The rate of increase in money wages is, therefore, a good proxy variable for the rate of increase in the price level i.e. the rate of inflation.
explain the conflicts of expansionary and contractionary fiscal and monetary policy?
-expansionary fiscal and monetary policy will lead to an increase in aggregate demand. This should increase the short-term rate of economic growth and reduce unemployment. However, it is likely to lead to higher inflation and a deterioration on the current account of the balance of payments. This is because an increase in demand for goods and services will be partly met by an increase in imports.
-The reverse is also true. Contractionary fiscal and monetary policy is likely to reduce inflation and improve the current account position but lead to lower economic growth and higher unemployment
explain the conflicts of changes in interest rates?
-the gov might use interest rates as part of monetary policy to influence AD and hence inflation and unemployment in the short term
-however, persistently high interest rates could damage long-term investment and hence reduce long-term economic growth
-equally, persistently high interest rates are likely to raise the value of the currency against other foreign currencies. For the UK, a high value of the pound could damage its international competitiveness and weaken its ability to export, whilst making imports more competitive.
-interest rates also influence the distribution of income and wealth. Low interest rates benefit borrowers including those with mortgages. Younger people are more likely to have mortgages than older people. So low interest rates benefit younger people. High interest rates benefit savers and lenders. Older people, including pensioners, are more likely to have savings and so they are more likely to benefit from higher interest rates.
-interest rates can also influence the distribution of wealth. Quantitative easing, which reduces interest rates to very low levels, encourages the better-off to borrow money to buy assets such as houses for rent. It also leads to rises in the price of assets such as shares and houses, because of higher demand financed by cheap borrowing. So quantitative easing arguably increases wealth inequalities
what are the conflicts of supply-side policies?
-supply-side policies should increase the productive potential of the economy, pushing the LRAS curve to the right. In the long run they should reduce inflationary pressures.
-however, supply-side policies that encourage investment in physical capital will lead to higher AD in the short term if investment does increase. This increases inflationary pressures in the short term.
-supply-side policies designed to reduce trade union power, make wages more flexible or reduce minimum wages are likely to increase income inequalities because wages at the bottom of the income distribution are likely to fall.
-cutting unemployment benefits to encourage people to work is also likely to increase income inequalities at least in the short term.
explain the conflicts of fiscal deficits?
-countries with fiscal deficits which are too high may attempt to reduce this by cutting gov spending and raising taxes.
-this, then, will almost certainly lead to higher unemployment and lower growth in the short term.
-the higher the fall in output as a result of austerity measures and the higher the fall in tax revenues as a result, the more ineffective the policy will be.
-austerity budgets that cut gov spending and raise taxes are likely to widen inequalities in income and wealth. Those who lose their jobs or young people unable to get their first job will be particularly affected
