Conflicts & Trade-offs between objectives and Policies

Question 1

Conflicts between 4 Main Objectives

Answer 1

Reducing inflation - Lowers AD, yet this can cause higher unemployment and less growth Increasing growth

• Often done by government spending to boost AD, yet this worsens balance of payments (High Marginal propensity to import means more imports when spending increases) and inflation Reducing Unemployment
• Cyclical unemployment can be reduced by increasing AD, yet this increases inflation. Other forms of unemployment can be reduced through supply-side policies yet these can widen inequality Improving government finances
• Cutting spending and raising taxes to reduce debt and budget deficit reduce AD, which slows growth Improving current account of balance of payments - Reducing AD to reduce imports can slow growth Protecting the environment
• Environmental protection policies can slow growth in short and medium term. e.g. carbon taxes raise costs of production. However, it can stimulate growth in companies involved in clean technology e.g. solar panels Reducing inequality
• Methods such as increased benefits and raising tax for higher earners to ease inequality slows growth or causes budget deficit
• Low unemployment can cause inflation (DRAW PHILLIPS-CURVE) -> more in work -> Higher consumption + firms must give higher wages to attract workers out of current jobs -> Higher AD

Question 2

Short Run Phillips Curve U

Answer 2

U Shows a trade-off between employment and money wages for 2 reasons. Because if unemployment is extremely low, to attract skilled workers firms will have to offer higher wages to get them out of their current job. Also because reducing unemployment is often done by increasing AD, which causes inflation Increasing money wages = increasing inflation as people have more disposable income

Question 3

Conflict between Policies 4

Answer 3

FISCAL Contractionary fiscal policy (reduction of gov. spending and increase in taxes) can cause increasing unemployment and inequality. PIGS countries (Portugal, Ireland, Greece, Spain made to undergo large reductions in spending as a pre-condition of loans form the EU and IMF after the financial crisis 2008. This led to big falls in output and greater unemployment and inequality.

Expansionary fiscal policy can reduce unemployment, yet it leads to inflation and worsening budget deficit MONETARY Expansionary monetary policy (reducing interest rates) will increase AD, thus increasing short term growth and reducing unemployment, yet it can lead to inflation and worsening balance of payments. Vice versa for contractionary

SUPPLY-SIDE Raise the potential output of the economy and increase long term growth rate, but can widen inequality (cuts in benefits and tax rates for high earners)

ENVIRONMENTAL Trade off with short to medium term growth. e.g. carbon taxes increase production costs. However, can stimulate growth of firms in clean technology industry e.g. solar panels