H: Policy Conflicts

Question 1

What are the macroeconomic objectives?

Answer 1

• Economic growth (positive but stable growth in GDP)
• Price stability (2%)
• minimising unemployment
• stable balance of payments on current account
• balanced budget

others include an equitable distribution of income

Question 2

What is a policy conflict or a trade-off?

Answer 2

When the achievement of one precludes the achievement of another one

Question 3

Explain how a conflict arises between economic growth and the balance of payments

Answer 3

1. When real incomes are rising at a rapid rate, consumers will buy more imported goods and services - leading to a worsening of a country’s trade balance
2. Fast growing countries may suffer from high inflation which then worsens the price competitiveness of domestic industries including exporters causing a rise in imports
3. Businesses will need to import extra raw materials, components and capital equiplment to help expand production.

Question 4

What are the three main measures that could be taken to overcome the trade off between growth and balance of payments?

Answer 4

• Supply side policies
• Exchange rate depreciation
• Sound/effective macroeconomic policies

Question 5

Explain how supply side policies can be used to overcome the trade off between growth and the balance of payments?

Answer 5

1. Export promotion - might involve export subsidies; improving infrastructure for trade; enhancing competitiveness; seeking new markets for domestic goods and services.
2. Import substitution - the govt can encourage domestic firms to produce g+s that are currently imported. This could be done via a grant or subsidy. Protectionist strategies such as tarrifs and quotas could also be used to reduce volume of imported g+s.
3. Structural reforms -improve overall competitiveness and efficiency of the economy. This could involve streamlining regulation that impact on firms, investing in education and skills development, upgrading infrastructure.
4. Fiscal and monetary policies - eg reducing the exchange rate to make exports cheaper and imports more expensive
   5.** Incentives to promote research, development and innovation **

Question 6

How can we evaluate the use of exchange rate depreciation to overcome the trade off between growth and the balance of payments?

Answer 6

The effects on the balance of trade depend on the price elasticity of demand for export and imports

Question 7

Explain the conflict between growth and inflation

Answer 7

As an economy benefits from short run economic growth, it will start to use up its productive caacity leadin to inflationary pressures

Sometimes there may be no conflict - high inflation and slow growth

stagflation

Question 8

How do we resolve the conflict between economic growth and inflation?

Answer 8

1. Monetary policy - increasing bank rates or stopping QE
2. Fiscal policy - tighter fiscal policy (eg reducing government spending/increasing income tax) can be used to slow down demand and stop the economy overheating
3. Supply side policies - improving productivitym efficiency and competitiveness. Productive capacity can grow without increases in AD triggering inflation
4. Exchange rate management - this would depend on the current situation and whether inflation is D-P or C-P. E.g. if it is due to a depreciated currency causing imported raw materials to be too expensive, the exchange rate could be appreciated.
5. Wages policies - govt could work with trade unions and employers to establish wage setting mechanisms that strike a balance between growth and inflation