Conflicts and trade-offs between objectives and policies

A) Potential conflicts and trade-offs between the macroeconomic objectives

Economic growth and the current account of the balance of payments

In periods of high economic growth, incomes usually rise as National output = National expenditure = National income. As consumer’s disposable income rises, the demand for goods/services is also likely to rise as consumers increase their spending. However, some of the goods/services that domestic consumers demand are from overseas. Therefore, if the demand for goods/services increases, the demand for imports is also likely to increase. As a result of this, the expenditure on imports will increase, leading to an increase in the deficit in the current account of the balance of payments.


Economic growth and the environment

Some countries may experience high rates of economic growth driven by industries that are dependent on unsustainable resources, or those that produce high levels of pollution. This can result in the depletion of scarce resources. Furthermore, with increased output firms are likely to emit increased amounts of pollution. As a result of this, there will be an increase in pollution levels which cause negative externalities.


Economic growth and inequality

During times of high rates of economic growth, income inequality can often increase. This is because only workers within the industries that are producing this economic growth may experience the benefits of this. On the other hand, those in industries which aren’t contributing as much to the high economic growth rate are likely to miss out on the benefits accrued. Therefore, income inequality will increase.


Economic growth and inflation

An increase in economic growth moves the economy closer towards the full capacity level of output. This causes an increase in the pressure on existing factors of production, pushing up the price level of goods/services within the economy. The increase in the price level could cause high levels of inflation (e.g. 8%), which goes against the macroeconomic objective of low and stable inflation.


Economic growth and budget deficit

In order to achieve economic growth, some governments may implement an expansionary fiscal policy. This would require a reduction in taxation and an increase in government spending. However, in order to do this it may mean sacrificing the macroeconomic objective of achieving a budget surplus/reducing the budget deficit. This is because expansionary fiscal policy is likely to result in a decrease in government revenue from taxation and an increase in government expenditure.


B) Short-run Phillips curve

The Phillips curve shows the trade-off between inflation and employment. As unemployment decreases, inflation increases and as unemployment increases, inflation decreases. Therefore, it may be difficult for governments to achieve both the macroeconomic objectives of low and stable inflation as well as low unemployment.

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The economy shown in the diagram is currently operating at an inflation rate of 4% and an unemployment rate of 5%. This unemployment rate is usually the rate at which full employment occurs. Although there is full employment, it does not mean that there is 0% unemployment. This is because some unemployment is necessary. For example, some frictional unemployment is needed to make sure that those who are currently unemployed can spend time looking for a job that suits them and that they’re likely to stay in for a long time. Although the Philips curve is focused on wages inflation, the X axis has been adapted to the inflation rate. This is because around the time that the Phillips curve was made firms were labour intensive. Therefore, it is rational to assume that when wage inflation increases, the inflation rate as a whole will increase at a similar rate.

An increase in aggregate demand (AD1 to AD2) causes real GDP to go past the full employment level of output. As the demand for labour is derived from the demand for goods/services, an increase in AD causes an increase in the demand for labour. This causes a reduction in the unemployment rate (5% to 4%). As a result of this, labour is now scarcer, thus increasing the bargaining power labour have over firms. In order to retain and attract new workers, firms must now increase the wage rate that they’re paying workers and offering to new workers. The increase in wage inflation causes the inflation rate to increase from 5% to 6%.

A decrease in aggregate demand (AD1 to AD3) causes a reduction in the demand for labour.

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