Macroeconomic Policy
→ Macroeconomic policy refers to government measures designed to influence the performance of the whole economy.
→ Governments use policies to achieve important macroeconomic objectives.
The key objectives in this topic are:
| Objective | What the government aims to achieve |
|---|---|
| Price stability | Keep inflation low and stable |
| Low unemployment | Ensure people who are willing and able to work can find jobs |
| Economic growth | Increase the economy’s real output over time |
→ These objectives are often connected, but achieving one objective can sometimes make another more difficult.
Price Stability
Meaning of Price Stability
→ Price stability means keeping the general price level relatively stable, with low and predictable inflation.
→ It does not mean that every individual price remains unchanged.
→ Governments generally aim to avoid both high inflation and prolonged deflation.
Why Governments Aim for Price Stability
→ Stable prices make it easier for households and firms to plan spending, saving and investment.
→ Low and predictable inflation helps protect the purchasing power of money.
→ It reduces uncertainty for businesses making long-term investment decisions.
→ It can help maintain international competitiveness if domestic inflation is kept under control compared with trading partners.
Policies Used to Achieve Price Stability
Monetary policy
→ The central bank can increase interest rates when inflationary pressure is too high.
→ Higher interest rates → borrowing becomes more expensive → consumption and investment may fall → aggregate demand falls → inflationary pressure may decrease.
Fiscal policy
→ Government can reduce its spending or increase taxation.
→ Government spending ↓ / taxation ↑ → aggregate demand ↓ → pressure on prices may decrease.
Supply-side policies
→ Policies that increase productivity and productive capacity can reduce cost pressures over time.
→ Productivity ↑ → production costs per unit may fall → productive capacity ↑ → greater output can be produced without the same degree of inflationary pressure.
Low Unemployment
Meaning of Low Unemployment
→ Unemployment occurs when people who are able and willing to work and actively seeking employment cannot find a job.
→ The government aims to keep unemployment low and increase employment opportunities.
Why Governments Aim for Low Unemployment
→ More people employed → household incomes ↑ → consumption ↑.
→ Employment provides people with income and can improve living standards.
→ More employment → income tax revenue ↑ → government revenue may increase.
→ More employment → government spending on unemployment benefits may decrease.
→ Using available labour resources helps the economy produce closer to its potential output.
Policies Used to Reduce Unemployment
Expansionary fiscal policy
→ Government spending ↑ or taxation ↓ → aggregate demand ↑ → firms receive more orders → production ↑ → demand for labour ↑ → unemployment may fall.
Expansionary monetary policy
→ Interest rates ↓ → borrowing becomes cheaper → consumption and investment may increase → aggregate demand ↑ → firms may increase production → employment may increase.
Supply-side policies
→ Education and training → workers gain skills → employability ↑ → structural unemployment may fall.
→ Improved labour mobility → workers can move between occupations or regions more easily → mismatch between vacancies and workers may decrease.
→ Policies that encourage investment and entrepreneurship can create additional employment opportunities.
Important Point
→ The most appropriate policy depends on the type of unemployment.
→ For example, increasing aggregate demand may help reduce cyclical unemployment, while training and retraining are more directly relevant to structural unemployment.
Economic Growth
Meaning of Economic Growth
→ Economic growth is an increase in a country’s real output over time.
→ It is commonly measured by the percentage change in real GDP.
→ Real GDP is used because it removes the effect of changes in the general price level.
Why Governments Aim for Economic Growth
→ Real output ↑ → more goods and services available.
→ Economic growth can lead to higher real incomes and improved living standards.
→ Higher production → employment opportunities may increase.
→ Higher incomes and profits → tax revenue may increase.
→ Higher government revenue can provide greater scope for spending on healthcare, education and infrastructure.
Policies Used to Promote Economic Growth
Expansionary fiscal policy
→ Government spending ↑ → aggregate demand ↑ → firms increase production → real output may increase.
→ Government investment in infrastructure can also increase productive capacity in the long run.
Expansionary monetary policy
→ Interest rates ↓ → borrowing becomes cheaper → consumption and investment ↑ → aggregate demand ↑ → real output may increase.
Supply-side policies
→ Education and training → human capital ↑ → productivity ↑.
→ Investment in machinery and technology → capital stock ↑ → productivity and productive capacity ↑.
→ Improved infrastructure → production and distribution become more efficient.
→ These policies can increase potential output, supporting long-run economic growth.
Conflicts Between Macroeconomic Objectives
→ Governments may find it difficult to achieve all objectives simultaneously.
Economic Growth and Price Stability
→ Strong growth in aggregate demand → demand for goods and services ↑ → firms increase production → if the economy is close to full capacity, inflationary pressure may increase.
→ Therefore, very rapid demand-led growth can create a conflict with price stability.
Economic Growth and Unemployment
→ Economic growth → production ↑ → demand for labour may ↑ → unemployment may fall.
→ However, if growth is mainly caused by automation or productivity improvements, output can increase without a similar increase in employment.
Low Unemployment and Price Stability
→ Very low unemployment → labour becomes scarce → wages may rise.
→ Higher wages → firms’ costs ↑ → firms may increase prices → inflationary pressure ↑.
→ This means reducing unemployment to very low levels can sometimes create inflationary pressure.
Choosing the Appropriate Policy
→ Governments consider the cause of the economic problem before selecting a policy.
| Economic problem | Possible policy response | Main mechanism |
|---|---|---|
| High inflation | Higher interest rates | AD ↓ → inflationary pressure ↓ |
| High inflation | Higher taxes/lower government spending | AD ↓ |
| Cyclical unemployment | Lower interest rates | C and I ↑ → AD ↑ → employment ↑ |
| Cyclical unemployment | Higher government spending | AD ↑ → production and labour demand ↑ |
| Structural unemployment | Education and training | Skills ↑ → employability ↑ |
| Slow long-run growth | Investment in infrastructure/capital | Productive capacity ↑ |
| Slow productivity growth | Education, training and technology | Productivity ↑ → potential output ↑ |
Key Policy Chains
→ Price stability:
Higher interest rates → borrowing ↓ → consumption and investment ↓ → AD ↓ → inflationary pressure ↓
→ Low unemployment:
Government spending ↑ → AD ↑ → output ↑ → labour demand ↑ → unemployment ↓
→ Economic growth:
Education/training + investment + technology → productivity ↑ → productive capacity ↑ → potential output ↑ → long-run economic growth
→ The effectiveness of any policy depends on the economic situation, time period, size of the policy and responsiveness of households and firms.