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The key four macroeconomic objectives are:
- Sustained economic growth.
- Full employment.
- Low and stable inflation.
- A satisfactory balance of payments
Some governments may have additional objectives, such as:
- Income and wealth inequality at a satisfactory level.
- Environmental protection.
- Budget balance.
Here are the key macroeconomic tradeoffs:
Growth vs low inflation
There is a tradeoff between economic growth and low stable inflation.
Consider expansionary monetary policy, such as persistently low interest rates for a decade in the UK and quantitative easing peaking at £895 billion. This has reduced the cost of borrowing and the reward for saving.
This encourages consumption and investment through standard monetary policy channels (see here for more on monetary policy).
This boosts aggregate demand, as consumption and investment are components of AD: AD = C + I + G + X – M.
Also there is a multiplier effect. This means a change in a component of AD leads to an even greater change in AD and real GDP. For example higher investment increases business revenues and profits for firms that receive the investment funds, increasing incomes of workers.
These workers then spend more in local areas, thus increasing consumption and AD. Altogether AD shifts right from AD to AD2.
This boosts economic growth, leading to higher real GDP from Y to Y2. However it also boosts inflation, with the price level rising from PL to PL2. This is demand-pull inflation.
Evaluation
This depends on the position of the economy on the Keynesian AS or LRAS curve.
On the flatter part of the Keynesian AS, real GDP is lower.
Here, a given increase in real GDP only leads to a small increase in price level and inflation.
As there is high spare capacity, an increase in aggregate demand does not raise wages, costs and hence prices very much. Workers have low bargaining power as unemployment is high, so cannot ask for much higher wages.
So the tradeoff between economic growth and inflation is weaker when there is high spare capacity.
Full employment vs low inflation
There is a tradeoff between unemployment and inflation.
Falling unemployment means workers can bargain for greater wage rises. This is because workers have more bargaining power – firms will find it harder to replace workers when unemployment is low.
Greater wage rises increase firm costs. In the UK economy in early 2023, unemployment was low at 3.7% while inflation was high at 10.5%.
Firms may pass on cost rises to consumers in the form of higher prices, generating cost-push inflation.
The Phillips curve diagram below shows this. As unemployment falls from U to U1, inflation rises from I to I1 along the short-run Phillips curve.
In addition, low unemployment, for given wages, means higher total incomes across the whole economy. This increases real disposable incomes, increasing consumer spending. This boosts aggregate demand, so AD shifts right, which leads to a higher price level.
Evaluation
But this depends on the slope of the Phillips curve.
Globalisation means a greater percentage of goods come from abroad.
So import prices are more important to the consumer basket. Import prices are largely determined by global supply and demand, less by domestic unemployment.
So a change in unemployment does not affect the prices of a significant proportion of the basket of goods. This means there is less of a tradeoff between unemployment and inflation.
Growth vs current account on balance of payments
There may not be a tradeoff between economic growth and a satisfactory balance of payments if growth is driven by increased productivity.
Consider Rishi Sunak’s policy to have everyone learn maths until age 18.
This will shift the long-run aggregate supply of the UK economy to the right. This achieves growth without being inflationary by increasing UK productivity.
Specifically there will be a lower price level, making exports more price competitive relative to imports. This increases export demand and reduces import demand, as domestic products are now less expensive compared to import prices. So net exports may increase, reducing the size of the current account deficit.
This depends on the cause of economic growth. The analysis above assumed the growth is driven by supply-side policies. However growth may be driven by rising aggregate demand, for example because of higher consumption.
This shifts AD right, raising the price level and real GDP. A higher price level makes exports less price competitive, reducing export demand. Higher real incomes may increase import demand.
So net exports fall and the current account deficit worsens.
So whether there is a tradeoff between growth and the current account position depends on the drivers of growth.
Growth vs environment
Higher growth corresponds to a higher level of production. One side effect of production is pollution. So the more production, the more pollution.
For example, construction projects require raw materials and transport that release pollution. Such construction projects may also damage biodiversity. Deforestation of the Amazon rainforest to clear the forest for farming is an example.
Higher economic growth corresponds to higher real incomes, higher disposable income and hence consumption. This may increase consumer side pollution, including pollution from traffic from cars as well as plastic waste.
But technological innovations may make production and consumption less polluting. Modern methods of construction, such as building offsite, can increase efficiency while reducing emissions. Electric vehicle use may reduce the pollution consequences of cars.
Whether there is a tradeoff depends on which sectors drive growth. If green sectors drive growth, then growth may reduce emissions.
As economic growth occurs, firms may adapt products. This is in response to increased demand for environmentally friendly products as incomes grow.
Growth vs inequality
Automation
Suppose economic growth occurs because of more automation. Automation reduces firms’ wage bill as they have to hire fewer workers for the same job. This increases productivity and the long run aggregate supply of the economy.
Automation also reduces demand for labour, particularly low-skilled labour. By reducing wage costs, firm profits may increase. This leads to higher pay for top managers and higher dividends for shareholders. Thus, inequality increases.
With the prevalence of automation, there will be higher demand for skilled workers like IT and engineering workers. These workers are complements to automation and are likely high paid workers.
But automation may also reduces wages of high skilled workers. Demand for lawyers and coders could be reduced by Chat-GPT.
Globalisation
Globalisation has led to freer trade with the rest of the world. Globalisation may lead to outsourcing of production abroad to economies with lower labour costs, especially for low skilled labour.
There is also greater international competition for goods and services, which may drive higher wage companies and countries out of particular markets.
For example UK coal and steel have both faced significant job losses due to greater international competition. This reduces domestic demand for labour and hence wages fall.
As multinational firms can lower labour costs, they see higher profits. They also see higher demand for exports. Altogether, higher profits enrich top managers, increasing income inequality. Also globalisation has led to higher demand for certain jobs, such as in financial services and IT. These jobs are likely highly paid.
Automation and globalisation, by reducing labour costs, may increase economic growth and reduce the price level. This increases employment and makes goods and services more affordable. This may improve living standards or even reduce inequality.
The impact of automation and globalisation on inequality depends on the government response. Governments can provide welfare support and appropriate training schemes. This will prevent occupational immobility of labour and structural unemployment from persisting. Thus reducing the impact on income inequality.
The cause of growth may not be globalisation or automation. Instead, if training or a strong welfare state drives growth, this may reduce income inequality or keep it constant.
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