MACRO - LS14 - Conflicts & Trade-Offs

Question 1

Macroeconomic objectives

Answer 1

• high & sustainable economic growth
• low unemployment
• low inflation
• sustainable current account equilibrium on balance of payments
• sustainable fiscal policy
• environmental objectives e.g reduce pollution/emissions
• objectives relating to income & wealth equality

Question 2

Conflicts between objectives (1)

Answer 2

• inflation too high - can reduce by decreasing AD (e.g. fall in gov/consumer spending) - but can lead to cyclical unemployment or recession - negative economic growth
• growth is too low - in short term can increase AD, lowers unemployment but increases inflation and demand for imports - deteriorates current account. Another way is to increase LRAS - leads to fall in wage rates so increase in inequality, also may mean looser environmental controls
• unemployment too high - can increase AD - may increase inflation & imports (ÇA deficit). Or can be through supply-side, but more jobs can increase inequality if most created jobs are low paying, can harm environment
• large CA deficit - may be difficulties for a country financing deficit, cutting imports reduces consumption and investment - increases unemployment, as fall in AD also affects domestic goods

Question 3

Conflicts between objectives (2)

Answer 3

• fiscal deficit too high - may try to correct by increasing taxes & cutting spending, can increase unemployment and lower economic growth rate, possibly recession, increase inequality
• too large income/wealth inequality - may need direct gov intervention - redistribute through taxes and gov spending, if increase benefits may cause disincentive to work - increasing LT unemployment and LT growth falls
• environmental situation deteriorates - can invest in clean technologies - may lead to lower growth as investment may not increase economic growth, tightening regulation may discourage investment, leading to fall in growth and higher unemployment

Question 4

Short-run Phillips curve

Answer 4

• shortage of labour in specific fields can cause wage pressures to build up, so higher wages, people spend more, production costs increase and inflation rises
• low unemployment/reduced spade capacity leads to higher inflation
• if a government spends to try and reduce unemployment, most likely will cause an increase in wages to absorb the extra spending I.e. inflation - as it goes up they realise wages eroded and firms get less profit so employment increase isn’t likely to be long term

Question 5

Conflicts and trade-offs between economic policies (1)

Answer 5

• expansionary/contractionary fiscal & monetary policy - expansionary increases AD, short term economic growth & reduce unemployment, will also increase inflation and CA deficit, reverse is true for contractionary fiscal policy
• interest rates - use as part of monetary policy to influence AD, inflation & unemployment but if too high then can damage investment and therefore LT growth, also raise value of currency, decreasing exports. Also affects income distribution - low rates benefit borrowers including mortgages - young people more likely to have them, high rates benefit savers/lenders - such as pensioners
  Quantitative easing reduces interest rates encourages better off to borrow money to buy things such as houses, rises asset prices, can increase wealth inequality

Question 6

Conflicts and trade-offs between economic policies (2)

Answer 6

• supply-side policies - should increase productive potential of an economy, should reduce inflationary pressures in long run, if policies encourage investment it will lead to higher AD in short term, can increase inflation. Policies which reduce trade union power, make wages flexible increase inequality
• fiscal deficit - if too high, then may cut spending & increase taxes, can increase unemployment & short term growth fall, can also increase inequality
• environmental policies - can lower LRAS and then growth as can increase production costs and reduce investment but can also force inefficient firms to become efficient e.g. increase recycling, can also increase LRAS as it costs less then the fallout of the costs of environmental market failure