Trade Offs between Macro Objectives
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The document discusses various macroeconomic policy objectives and potential trade-offs between them. It notes that achieving all objectives simultaneously is difficult due to conflicts that can arise. Examples of trade-offs include: reducing unemployment can cause higher inflation due to capacity constraints; rapid economic growth can lead to worsening inflation and hurt trade balances if incomes rise quickly. Supply-side policies and exchange rate tools can help address some trade-offs. Value judgments are involved in deciding which objectives to prioritize.
Trade Offs between Macro Objectives
- 2. What are the key objectives of macroeconomic policy? Price Stability (CPI Inflation of 2%) Growth of Real GDP (National Output) Falling Unemployment / Raising Employment Higher Average Living Standards (national income per capita) External Balance on the Current Account A more Equitable Distribution of Income and Wealth
- 3. Additional objectives of macroeconomic policy Balancing the budget and reducing the national debt Improving economic well-being Better regional balance in the UK economy Improved access to public services Improved competitiveness Environmental sustainability
- 4. A crucial part of AS analysis and evaluation is to consider the causes of possible conflicts between key macro objectives Possible Conflicts between Macro Policy Objectives • It is rare for a country to achieve all of its main macroeconomic aims at the same time • Frequently conflicts can appear between the different aims • As a result, difficult choices might have to be made about which objectives are to be given greatest priority • The extent of these trade-offs between objectives will vary from one country to another since the needs of different nations will differ according to their stage of economic development • Supply-side policies can be vital in overcoming some of these trade-offs and improving overall economic performance • External factors (e.g. changes in the global economy) can have a major effect on which macro objectives are achieved.
- 5. Examples of Possible Macro Conflicts Unemployment and inflation (price stability) Economic growth and inflation Economic growth and the balance of payments Economic Growth and Inequality Conflicting Aims? Views about which macroeconomic aim / objective ought to be given most importance involve making value judgements
- 6. The Phillips Curve – Unemployment and Inflation The Phillips Curve shows a trade-off between inflation and unemployment. A demand-side policy to reduce unemployment could conflict with price stability Unemployment Inflation P1 A favourable trade-off because the economy SRAS is elastic when unemployment is high
- 7. The Phillips Curve – Unemployment and Inflation The Phillips Curve shows a trade-off between inflation and unemployment. A demand-side policy to reduce unemployment could conflict with price stability Unemployment Inflation P1 P2 P3 U2U3 A favourable trade-off because the economy SRAS is elastic when unemployment is high Trade-off is worsening as the economy comes up against capacity constraints
- 8. The Phillips Curve – Unemployment and Inflation The Phillips Curve shows a trade-off between inflation and unemployment. A demand-side policy to reduce unemployment could conflict with price stability Unemployment Inflation P1 P2 P3 U2U3 A favourable trade-off because the economy SRAS is elastic when unemployment is high Trade-off is worsening as the economy comes up against capacity constraints As the rate of unemployment falls, labour shortages may cause an increase in wage inflation and higher unit labour costs When an economy is booming, so does the derived demand for and prices of components and raw materials – leading to higher costs Rising demand and falling unemployment can lead to suppliers raising their prices to increase their profit margins
- 9. Unemployment and Inflation Rates in the UK Economy Consumer price inflation (%) Unemployment rate (per cent) Inflation Unemployment 2007 2.3 5.3 2008 3.6 5.7 2009 2.2 7.6 2010 3.3 7.9 2011 4.5 8.1 2012 2.8 8.0 2013 2.6 7.6 2014 1.5 6.2 2015 0.1 5.3
- 10. Why is the rate of inflation in the UK so low? Falling global commodity prices including oil Slow wage growth in the labour market Falling food prices (globally + supermarket price wars) Sustained price deflation in technology products Slower real economic growth – falling towards 2% Still some spare capacity on the supply-side of the economy
- 11. A Worsening Trade-Off between Growth and Inflation General Price Level Real GDP AS AD1 AD2 AD3 AD4 AD5 An outward shift in AD from AD3 to AD4 causes a sharp rise in the general price level because AS in elastic (output is close to capacity levels) GPL4 Y3 Y4 GPL5
- 12. Possible Conflicts between Growth and Inflation An overheating (fast-growing) economy may suffer accelerating inflation which then has negative effects on trade performance, business profits and jobs The risk of accelerating inflation is greatest when short run aggregate supply is inelastic i.e. When the economy has low spare capacity If an economy suffers high inflation and a slowdown in economic growth – this is called stagflation The conflict between growth and inflation can be resolved by having effective supply-side policies to increase productive potential GPL Real GDP GPL2 AS Y2 AD2AD1 Y1 GPL1
- 13. Possible Conflicts between Growth and Inflation An overheating (fast-growing) economy may suffer accelerating inflation which then has negative effects on trade performance, business profits and jobs GPL Real GDP GPL2 AS Y2 AD2AD1 Y1 GPL1 GPL Real GDP GPL2 AS1 Y2 AD2 AD3 Y3 AS2
- 14. Economic Growth and the Balance of Payments A period of rapid economic growth may come into conflict with a country’s balance of payments. Much depends on the income elasticity of demand for internationally traded goods and services When real incomes are rising at a rapid rate, consumers will tend to buy more imports – leading to a worsening of the trade balance Fast growing countries may suffer from high inflation which worsens the competitiveness of domestic industries including exporters Businesses will need to import extra raw materials, components and capital equipment to help expand production.
- 15. UK Economic Growth and the BoP Current Account Real GDP Growth (% per annum) BoP Current Account Balance (% of GDP) 2007 2.6 -2.7 2008 -0.3 -3.7 2009 -4.3 -2.8 2010 1.9 -2.6 2011 1.6 -1.7 2012 0.7 -3.7 2013 1.7 -4.5 2014 3.0 -5.5 2015 2.2 -5.2 The data in the table shows the growth of real national output and the current account balance. Britain has run a current account deficit in each year during the economic recovery.
- 16. Policies to Improve Growth and the Trade Balance Supply-Side Policies • Reforms to improve labour productivity • Incentives to boost research & development & innovation • Measures to increase investment in export sectors Exchange Rate Depreciation • A depreciation of the currency (in theory) makes exports more price competitive and imports are more expensive • But the effects are dependent on price elasticity of demand Sound / Effective Macro Economic Policies • Monetary policy to help keep inflation low relative to the inflation of major trading competitors • Infrastructural investment to increase export competitiveness
- 17. Macro Trade Offs