Macroeconomic Objectives & Policies

This is where it all comes together: the goals governments pursue, why those goals conflict, and the demand-side and supply-side tools used to hit them. Expect this material in the 20-mark essay.

Learning objectives — by the end of 2.6 you can…

- state the main macroeconomic objectives and explain how they conflict; - explain the short-run Phillips curve trade-off; - analyse demand-side policy (fiscal & monetary) and the role of central banks; - analyse supply-side policy and evaluate its strengths and weaknesses.

Objectives & the conflicts between them

Spec: 2.6.1

The main macroeconomic objectives

- Economic growth — steady and sustainable; - Low and stable inflation — typically around a 2% target; - Low unemployment — close to full employment; - Balance of payments equilibrium on the current account; - A balanced government budget — sound public finances; - Greater income equality.

The hard part is that these objectives conflict — pursuing one often damages another:

Inflation vs unemployment — the short-run Phillips curve trade-off (below);
Growth vs the environment — more output, more pollution;
Inflation vs the current account — a booming economy sucks in imports and can raise inflation;
Growth vs income equality — the gains from growth may be unevenly shared.

Demand-side policies: fiscal & monetary

Spec: 2.6.2

Demand-side policies work by shifting AD. Reflationary (expansionary) policy boosts AD to raise growth and cut unemployment; deflationary (contractionary) policy reduces AD to control inflation.

The role of the central bank

- Implements monetary policy and sets the base interest rate; - aims to achieve the inflation target; - acts as banker to the government; - acts as banker to the banks — the lender of last resort.

Evaluation — strengths & weaknesses

- Time lags: both policies act with a delay, so they can be mistimed. - Crowding out: government borrowing may push up interest rates and squeeze private investment. - Low rates can be weak: if confidence is poor, cheap money may not revive spending (a "liquidity trap"). - Demand-side only treats the symptoms: it can't fix structural problems such as low productivity or skills gaps — that needs supply-side policy.

Supply-side policies

Spec: 2.6.3

Supply-side policies aim to raise productivity, competition and incentives, shifting LRAS to the right and increasing the economy's potential output. They split into two camps:

Evaluation — strengths & weaknesses

- Strengths: they tackle the root causes of weak growth, can raise output without inflation (LRAS shifts right), improve international competitiveness and reduce structural unemployment. - Weaknesses: long time lags before results appear; interventionist policies are expensive; market-based policies (lower welfare, deregulation) can worsen inequality; success is not guaranteed; and they do little to lift an economy out of a demand-deficient recession on their own.

Exam Tip — the killer evaluation move

Top answers combine policies: demand-side to manage the cycle in the short run, supply-side to raise potential in the long run. Always judge a policy against the economy's starting position — a stimulus that works with spare capacity just causes inflation at full capacity.

2.6 Recap — nail these

Six objectives: growth, low inflation, low unemployment, BoP equilibrium, balanced budget, income equality — and they conflict.
Short-run Phillips curve: inflation–unemployment trade-off.
Demand-side = fiscal (spending & tax) + monetary (interest rates, QE); shifts AD.
Supply-side = free-market vs interventionist; shifts LRAS; tackles structural problems.