2.6 Macroeconomic Objectives and Policies

• Possible macroeconomic objectives:

  • Economic growth: UK's long run trend is about 2.5%
  • Governments aim for sustainable economic growth
  • In emerging and developing economies, aim to increase economic development before growth to improve living standards, life expectancy, and literacy rates
• Low unemployment:

  • Aim for full employment, accounting for frictional unemployment
  • Target unemployment rate around 3%
  • Labour force should be employed in productive work
• Low and stable inflation:

  • UK government target is 2%, measured by CPI
  • Aims to provide price stability for firms and consumers
  • Governor of the Bank of England writes a letter to the Chancellor of the Exchequer if inflation falls 1% outside the target
• Balance of payment equilibrium on the current account:

  • Important for sustainable financing of the current account
  • Essential for long term growth
• Other macroeconomic objectives:

  • Balance government budget to control state borrowing
  • Protection of the environment for long run stability and sustainable resource use
  • Greater income equality to minimize the rich-poor gap
• Monetary policy:

  • Interest rates: MPC changes the official base rate to tackle inflation
  • Rise in interest rates leads to a fall in AD through mechanisms like increased borrowing costs and decreased consumer confidence
• Quantitative easing:

  • Bank of England buys assets to increase money supply during low demand
  • Increases consumption and investment, ensuring inflation target is met
  • Risks include high inflation, increased demand for second-hand goods, and dependency concerns
• Role of the Bank of England:

  • MPC controls monetary policy to keep inflation at 2%
  • Committee consists of nine members, including Bank of England representatives and independent experts
• Fiscal policy:

  • Rise in income tax reduces disposable income and consumption
  • Rise in government spending increases AD
• Government budgets:

  • Budget deficit when spending exceeds revenue, surplus when revenue exceeds spending
• Indirect and direct taxation:

  • Direct taxes paid directly to the government by the individual taxpayer
  • Indirect taxes passed on to consumers by suppliers
  • Major revenue-raising taxes include income tax, national insurance, VAT, and corporation tax
• Problems with fiscal policy:

  • Impact on LRAS and quality of public services
  • Impact on inequality and incentives
  • Considerations for government spending and taxation effects
• Decisions aimed to reduce/increase demand may increase income inequality
• High taxes reduce incentives
• Government may be unwilling to raise taxes to reduce demand to avoid being voted out of government
• Expansionary fiscal policy is difficult to undertake during austerity
• Impact of fiscal policy depends on the multiplier: bigger multiplier leads to bigger impact on AD
• Classical economists argue multiplier is almost zero

  <|>Keynesian economists argue it can be large if targeted correctly
• Issues with demand-side policies:

  • Classical economists believe demand management has no effect on long-run output
  • Keynesians argue it can affect long-run equilibrium
  • Impact of changes in AD depends on where the economy is operating
  • Significant time lags between policy introduction and full effect
  • Expansionary policy is inflationary while deflationary policy brings unemployment
• Monetary policy:

  • Increases demand without increasing government spending
  • Classicists argue only monetary policy should be used
• Fiscal policy:

  • Can impact supply side of the economy
  • More effective at targeting specific groups and reducing poverty
  • A range of demand-side policies should be used alongside other policies
• Great Depression:

  • Started in the 1930s
  • UK unemployment over 15%, US almost 25%
  • Primary and manufacturing industries most affected in the UK
• Causes of the Great Depression:

  • Wall Street Crash of 1929
  • Loss of consumer and business confidence
  • US banking system issues
  • Protectionism
  • UK commitment to the gold standard
• Policy responses in the UK:

  • Balanced government budget key to recovery
  • Emergency budget cut public sector wages and raised income tax
  • UK left the gold standard in 1931
• Policy responses in the USA:

  • Balanced budget initially
  • Franklin Roosevelt's New Deal in 1932
  • USA reached full employment in 1943
• Global Financial Crisis (2008/9):

  • Started in the US
  • Causes include issues in mortgage lending
• Policy responses in the UK and the USA:

  • Nationalised banks and building societies
  • Used expansionary monetary policies
  • USA had a more expansionary fiscal policy
• Supply-side policies:

  • Aimed at increasing the productive potential of the economy
  • Market-based and interventionist methods
• Policies to increase incentives:

  • Reduction in benefits/taxes
  • Encouraging parts of the workforce back to work
  • Taxes on firms when they take on new staff
  • Reduction/removal of the minimum wage
• Promote competition
• • Deregulation and privatisation may lead to poorer quality services and environmental issues
• Promote competition:

  • Privatisation: selling nationalised companies to private sectors
  • Deregulation: reducing restrictions on businesses to make them more competitive
  • Competition policy is used to prevent monopolies and make cartels and price fixing agreements illegal
  • The CMA in the UK ensures markets are competitive
  • The Competition Act (1998) and Enterprise Act (2002) aim to promote competition
  • Competition is necessary to make firms efficient as they have to offer better services in a competitive market
• Reform the labour market:

  • Increasing retirement age can lead to more goods and services being produced
  • Making the labour market more flexible can make it more efficient
  • Weakening of unions can increase flexibility
  • Businesses have attempted to be more flexible by changing employment contracts, e.g., zero-hour contracts
  • Flexibility can be improved by higher mobility of labour and easier job changes
  • Minimum wage set above equilibrium level can cause increased unemployment
  • Reduction of benefits can increase incentive to work and reform the labour market
• • All methods aim to reduce unemployment and increase production
• Improve skills and quality of the labour force:

  • Increase spending on education and training to create a more educated and skilled workforce
  • Introduce regulations forcing businesses to continuously train their staff
  • Increase high skilled migrants to improve the quality of the workforce
  • Improvements in skills lead to more efficient workers and increased production of goods and services
  • Improving education may have no effect if skills are not relevant to the workforce
  • Increasing education may incur opportunity costs and take time to see effects
• Improve infrastructure:

  • Offer tax incentives or subsidies on investment to improve infrastructure
  • Government spending on infrastructure projects like building new roads
  • Improvements in technology lead to more efficient production
  • Some issues include adverse effects on government budget and not all investments being successful
  • UK ranks 24th in the world for infrastructure, indicating the need for more action
• Evaluation of supply-side policies:

  • Supply side policies can increase output and decrease prices
  • They lead to long-term economic growth
  • Directed at increasing exports to improve balance of payments
  • Two approaches: market-based and interventionist
  • Not effective when LRAS is elastic, requiring demand-side policies in the short run
  • Some policies may not work as intended or cause conflicts
  • May lead to budget deficits and undesirable impacts on aggregate demand
• Conflicts and trade-offs between objectives and policies:

  • Economic growth vs. protection of the environment
  • Economic growth vs. balance of payments
  • Unemployment vs. inflation
  • Expansionary vs. deflationary fiscal and monetary policies
  • Changes in interest rates affect investment and wealth distribution
  • Supply-side policies aim to increase aggregate supply and improve long-term growth
  • Fiscal deficits may lead to reduced government spending and increased taxes, affecting income equality and short-term economic growth