What is economic growth and why is it a possible macroeconomic objective?

Economic growth is the growth in real output of an economy over time. Economic growth is a possible macroeconomic objective as when the economy is growing, national income rises, meaning that most are likely to benefit from greater material living standards.

What is low unemployment and why is it a possible macroeconomic objective?

Low unemployment is where the rate of unemployment in an economy is low (for example at 3%). Low unemployment is a possible macroeconomic objective as during periods of low unemployment, lots of workers are likely to be working in a job and earning an income, meaning that the average incomes are higher compared to periods where there is high unemployment.

What is a low and stable rate of inflation and why is it a possible macroeconomic objective?

A low and stable rate of inflation is normally around 2%. A low and stable rate of inflation is a possible macroeconomic objective as it ensures price stability within the economy which helps to improve confidence.

What is a balance of payments equilibrium on the current account and why is it a possible macroeconomic objective?

A balance of payments equilibrium on the current account is where there is neither a surplus nor a deficit on the current account. A balance of payments equilibrium on the current account is a possible macroeconomic objective as it shows the stability of a country's international trade relationships. This can help to improve economic stability.

What is a balanced government budget and why is it a possible macroeconomic objective?

A balanced government budget is where the sum of tax revenues received by the government is equal to the sum of government expenditure on the economy. A balanced government budget is a possible macroeconomic objective as it shows that the government is practising fiscal responsibility, improving confidence within the economy.

What is meant by the protection of the environment and why is it a possible macroeconomic objective?

The protection of the environment is where measures are put into place to reduce the harm to the environment such as measures to reduce pollution and protect ecosystems. The protection of the environment is a possible macroeconomic objective as it promotes environmentally sustainable growth and development, helping to ensure that the use of resources is sustainable and mitigating the effects of pollution and climate change.

What is greater income equality and why is it a possible macroeconomic objective?

Income equality is where incomes are relatively evenly distributed amongst individuals within an economy. Income equality is a possible macroeconomic objective as it can result in improved levels of social cohesion within the economy.

What is the distinction between fiscal and monetary policy?

Fiscal policy is where the government controls government expenditure and tax policies to influence the economy. Monetary policy is where a central bank or government will attempt to manipulate the money supply to influence the economy.

What are the monetary policy instruments?

Interest rates: central banks or governments can change the base interest rate which influences the general interest rate in the economy. A high base interest rate is likely to lead to a fall in borrowing and an increase in saving as interest rates in the economy rise. This is because it is now more expensive to borrow as repayments are higher, and there is a greater incentive to save as economic agents can earn more on their savings. A lower base interest rate will encourage borrowing and reduce saving as it is now cheaper to borrow and savers don't earn as much on their savings due to the lower interest rate.

Asset purchases to increase the money supply (quantitative easing): quantitative easing is where a central bank or government purchases financial assets in order to increase the amount of money in the financial system, leading to an increase in liquidity within the financial sector. Improving liquidity in the financial sector is likely to lead to a fall in long-term interest rates, which is likely to lead to increases in borrowing in the future. Moreover, when a central bank or government purchases government bonds, it reduces the long-term interest rates on these bonds. This is because, by purchasing these bonds, the prices of these bonds rise, and as the prices of bonds have an inverse relationship with the interest rates on these bonds, there will be a fall in the interest rates on these bonds, stimulating economic activity.

What are the fiscal policy instruments?

The main fiscal policy instruments are government spending and taxation. An increase in government spending is likely to stimulate aggregate demand, likely stimulating economic activity. A fall in taxation is also likely to stimulate economic activity as economic agents pay less in the form of taxes, leading to them having more money to spend within the economy.

What is the distinction between government budget (fiscal) deficit and surplus?

A government budget (fiscal) deficit occurs when the sum of government spending on the economy exceeds the sum of tax revenues received by the government. Whereas, a government budget (fiscal) surplus occurs when the sum of government spending on the economy is lower than the sum of tax revenues received by the government.

What is the distinction between, and what are examples of, direct and indirect taxation?

Direct taxation is taxation on the income of economic agents, whereas indirect taxation is taxation on expenditure on goods and services.

Common examples of direct taxation include income tax (which is a tax on an individual's earnings) and corporation tax (a tax on the profits of firms).

Common examples of indirect taxation include VAT (VAT stands for Value-Added Tax and is a consumption tax on goods and services) and excise duties (these are taxes levied on goods that can prove harmful to the environment or public health).

How can AD/AS diagrams be used to illustrate demand-side policies?

The effects of demand-side policies in the long run can be shown using a Keynesian LRAS curve. These can be shown using the diagram below.

As shown above, demand-side policies can influence the position of the AD curve relative to the Keynesian LRAS curve. Expansionary fiscal and monetary policy can be employed to try to stimulate aggregate demand, potentially leading to aggregate demand being shifted, for example, from AD to AD1, leading to an increase in the price level and an increase in real output. However, outward shifts beyond AD1 are likely to have no effect on real output but lead to only increases in the price level as the economy is at full employment of resources at this point. Contractionary fiscal and monetary policy can also be employed to try to reduce aggregate demand in the economy, for example, in order to shift aggregate demand from AD to AD2. This is likely to result in a fall in the price level from P to P2, and a fall in real output from Y to Y2. However, any further shifts to the left of aggregate demand from AD2 are likely to have no effect on the price level but are likely to reduce real output as not many resources are fully or efficiently employed.

The effects of demand-side policies, in the long run, can also be shown using a Classical LRAS curve. These can be shown using the diagram below.

With a Classical LRAS curve, employing demand-side policies to either increase or decrease aggregate demand is likely to have no effect on real output. However, there will be an effect on the price level. For example, if expansionary fiscal and monetary policy are employed in order to boost aggregate demand from AD to AD1, there will be no change in real output (remains at Y), but an increase in the price level from P to P1. If contractionary fiscal and monetary policy are employed in order to reduce aggregate demand, for example from AD to AD2, there will be no change in real output (remains at Y), but a fall in the price level from P to P2. 

The effects of demand-side policies can also be shown in the short run using a SRAS curve. These can be shown using the diagram below.

If expansionary fiscal and monetary policy are employed in order to boost aggregate demand, aggregate demand may shift outwards from AD to AD1. As a result, there is an increase in the price level from P to P1 and an increase in real output from Y to Y1. If contractionary fiscal and monetary policy are employed in order to reduce aggregate demand, aggregate demand may shift inwards from AD to AD2. As a result, there is a fall in the price level from P to P2 and a fall in real output from Y to Y2.

What is the role of the Bank of England including the role and operation of the Bank of England's Monetary Policy Committee?

The Bank of England is the central bank in the UK, and the Bank of England is in charge of the UK's monetary policy. The Bank of England's main objective is to ensure price stability within the UK economy, with an inflation target of 2% measured by the Consumer Prices Index (CPI).

The Bank of England's Monetary Policy Committee (MPC) works in setting monetary policy in the UK. The MPC announces its policy 8 times a year and they hold several meetings to discuss the best way to achieve their objectives.

What are the different interpretations of demand-side policies in the Great Depression and the Global Financial Crisis of 2008?

In terms of different interpretations of policy responses, Keynesians would recommend large levels of government intervention in the US and UK economies following the Great Depression and the Global Financial Crisis of 2008 to try and support aggregate demand and the economy. However, Classical economists normally argue against large amounts of government intervention following events such as the Great Depression and the Global Financial Crisis of 2008 as they believe that large levels of intervention are unnecessary as they are likely to hinder the natural adjustment process following such crises.

What were the policy responses (including demand-side) used in the Great Depression and the Global Financial Crisis of 2008 in the US and UK?

Following the Great Depression, in the US, public work schemes were implemented to help create jobs and boost aggregate demand. However, initially, the Federal Reserve tightened monetary policy for fears of inflation which did not help the downturn. The UK struggled with its monetary policy as the UK was a part of the gold standard which it eventually abandoned in 1931 which helped to improve the flexibility of monetary policy. The UK also employed expansionary fiscal policies to try and create jobs and boost aggregate demand through public work schemes.

Following the Global Financial Crisis of 2008, in the US, the Federal Reserve cut interest rates to near zero and practised quantitative easing to try and boost the liquidity of the economy. Moreover, fiscal stimulus packages were given out to try and boost aggregate demand. In the UK, the Bank of England also cut interest rates aggressively to near zero and practised quantitative easing. Moreover, the UK government implemented temporary tax cuts to try and stimulate aggregate demand. 

What are the strengths and weaknesses of demand-side policies?

When analysing the effects of shifts of aggregate demand using a Keynesian LRAS, an increase in aggregate demand can help to boost economic growth when the economy has spare capacity, a strength of demand-side policies. However, using a Keynesian LRAS, if the economy is near full employment of resources, then any shifts of aggregate demand are likely to be purely inflationary, with no effect on real output, this is a weakness of demand-side policies.

The Classical perspective suggests that, in the long run, any increases in aggregate demand will be purely inflationary as Classical economists believe that in the long run, full employment of resources is achieved.

What is the distinction between market-based and interventionist supply-side policy methods?

Market-based supply-side methods aim to increase the productive capacity of the economy through increasing the role of the free market in the economy. Whereas, interventionist supply-side measures aim to increase the productive capacity of the economy through direct government intervention.

What are the types of market-based and interventionist supply-side policies? 

1. To increase incentives. Market-based supply-side policies could include tax cuts which can help to increase the incentives to invest and innovate, leading to greater levels of investment and innovation within the economy, and improving the productive capacity of the economy. Interventionist supply-side policies could include subsidies to firms which can also encourage investment, improving the productive capacity of the economy.
2. To promote competition. A market-based supply-side policy to promote competition could be deregulation which leads to the removal of the barriers to entry for firms wanting to join a market. This results in increased levels of competition, likely leading to improved efficiency and improving the productive capacity of the economy. An interventionist-based supply-side policy to increase competition could be an increase in antitrust enforcement in order to try and prevent anti-competitive practices. By increasing antitrust enforcement, competition levels are likely promoted, which may improve the efficiency of firms, improving the productive capacity of the economy.
3. To reform the labour market. A market-based supply-side method to reform the labour market could be the removal of a minimum wage in order to promote labour market flexibility which can improve the productive capacity of the economy. An interventionist-based supply-side method to reform the labour market could be the implementation of public works programs to improve the job opportunities available to workers in the labour market. This is likely to lead to more workers in employment, improving the productive capacity of the economy.
4. To improve the skills and quality of the labour force. A market-based supply-side policy to improve the skills and quality of the labour force could be the offering of tax incentives to organisations that provide training and educational programs for workers. This incentivises the creation of organisations that help to improve the skills and quality of the labour force, likely resulting in a more skilled labour force, and improving the productive capacity of the economy. An interventionist-based supply-side method to improve the skills and quality of the labour force could be the government directly investing in education to improve the skills and quality of the current and future workforce, likely leading to productivity gains, and improving the productive capacity of the economy.
5. To improve infrastructure. A market-based supply-side method to improve infrastructure could be tax incentives to firms that deliver infrastructure projects in order to encourage the development of infrastructure, likely improving the productive capacity of the economy. An interventionist-based supply-side method could be an increase in spending on infrastructure by the government, improving the infrastructure within an economy, and improving the productive capacity of the economy.

How can AD/AS diagrams be used to illustrate supply-side policies?

The diagram below shows the likely effect of supply-side policies when adopting the Keynesian model of the LRAS curve.

As a result of the supply-side policies, the Keynesian LRAS is likely to shift outwards from LRAS to LRAS1. In the example in the diagram above, an outward shift of LRAS from LRAS to LRAS1 has resulted in a fall in the price level from P to P1, with an increase in real output from Y to Y1.

The effect of supply-side policies can also be shown with a Classical LRAS curve.

As shown above, when adopting a Classical LRAS curve, the employment of supply-side policies is likely to result in the outward shift of the LRAS curve from LRAS to LRAS1. As a result, the price level has fallen from P to P1, and real output has increased from Y to Y1.

What are the strengths and weaknesses of supply-side policies?

Supply-side policies can lead to long-term economic growth as they promote improvements in productivity and innovation in the long run. However, supply-side policies have a significant time lag between their inception and their effects.

What are potential conflicts and trade-offs between the macroeconomic objectives?

One macroeconomic objective may have been achieved at the expense of another macroeconomic objective. This is known as a conflict or trade-off between macroeconomic objectives. Some examples are listed below.

There may be a potential conflict and trade-off between economic growth and the state of the environment. This is because economic growth may come about as a result of the over-exploitation of natural resources.

There may also be a potential conflict and trade-off between economic growth and inflation. This is because, during periods of economic growth, it is likely that inflation will rise above the target level, especially if the economy is near full capacity.

There may also be a potential conflict and trade-off between economic growth and the balance of payments. An increase in economic growth represents an increase in national income. This additional increase in income may be spent on imports, potentially leading to a worsening of the balance of payments.

There may also be a trade-off between the rate of unemployment and the rate of inflation which can be explained by the short-run Phillips curve which is discussed later on in this article.

What is the short-run Phillips curve?

The short-run Phillips curve shows the trade-off between the rate of inflation and the rate of unemployment. It suggests that there is an inverse relationship between the rate of inflation and the rate of unemployment. This is because the rate of inflation is likely to be high during periods of economic growth where the rate of unemployment is likely to be low as there is likely to be large amounts of derived demand for labour to produce more output. However, when the rate of inflation is low, there is likely to be low amounts of economic growth taking place, resulting in a high rate of unemployment. The short-run Phillips curve is shown below.

What are some potential policy conflicts and trade-offs?

Expansionary fiscal policy may lead to an increase in economic growth, however, there may be a potential conflict and trade-off with the objectives of monetary policy as expansionary fiscal policy is likely to lead to high inflation, and monetary policy may be aiming to reduce inflation in the economy. 

Moreover, supply-side policies which promote market efficiency may create a potential conflict or trade-off with fiscal policies which may be aiming to improve income equality within the economy.