JC Econs Essay Macroeconomic Policies & Conflicts in Objectives Model Answers
One of the bigger concerns for the Singapore government to the relative lack of appropriate macro econs policies to achieve her macroeconomics goals and objectives.
However, the attempt to achieve one or more macro aims may lead to a worsening of another macro goal, as we will see in this essay.
Question
“The four macroeconomic policy objectives of low unemployment, low inflation, high and sustained economic growth and a balance of payments equilibrium cannot be achieved simultaneously. A government has to make a choice between the goals, because achieving success in one always leads to failure in another.” How far do you agree with the statement? [25]
Macroeconomic Policies & Conflicts in Objectives
Introduction:
The government has four macroeconomic policy objectives: high economic growth, low unemployment, low inflation and a balance of payments equilibrium.
Economic growth is an increase in real national income over a period of time. Although there is no standard measure of the standard of living, it is commonly believed that the welfare of people depends to a large extent on the amount of goods and services available for consumption and this is directly, though not perfectly, related to real national income. Therefore, high economic growth leads to a rapid rise in the standard of living.
Inflation is a rise in the general price level over a period of time. Some monetary economists, however, reserve the term inflation for a sustained rise in the general price level and refer to a one-off rise as a price shock. High inflation reduces the real value of savings. In other words, the same amount of savings can be used to buy a smaller amount of goods and services. High inflation may cause domestic output to become relatively more expensive than foreign output. To the extent that this happens, net exports will fall. High inflation tends to be less stable and this will lead to more difficulties for firms when estimating their costs and revenues. Other things being equal, they will decrease investment expenditure. Low inflation helps the economy avoid the above problems.
Unemployment is the state of the economy in which some workers are not employed in the production of goods and services. The unemployed are persons of working age who are without work, but who are available for work at current wage rates. High unemployment leads to a loss of output in the economy. From the unemployed’s perspective, there is a loss of income, and if the unemployment period prolongs, they may even lose their skills and knowledge. The ensuing hardship and depression may lead to an increase in crime and broken family. Further, firms, the employed and the government will also suffer from high unemployment. Low unemployment helps the economy avoid the above problems.
The balance of payments is a record of all the transactions between the residents of the economy and the rest of the world over a time period. A persistent balance of payments deficit, which occurs when money outflows persistently exceed money inflows, may lead to adverse consequences such as higher imported inflation, higher cost-push inflation, lower economic growth, higher unemployment or an unsustainable level of foreign debt, depending on the exchange rate system adopted by the central bank. A persistent balance of payments surplus is also undesirable because if the surplus had been used to purchase imports, the standard of living would have been higher. A balance of payments equilibrium helps the economy avoid the above problems.
Although the benefits of achieving the four macroeconomic policy objectives are evident, due to potential conflicts between the objectives, achieving success in one may lead to failure in another. If the government increases aggregate demand (AD) to reduce unemployment, inflation will rise.
(Sketch a diagram as an exercise.)
When the unemployment rate decreases from H0 to Hi1 the inflation rate increases from P1 to P2 , Further, if the economy initially has a balance of payments equilibrium, the increase in national income and the general price level caused by the increase in aggregate demand may lead to a decrease in net exports. To the extent that this happens, the balance of payments will move into a deficit. Under the fixed exchange rate system, the balance of payments deficit will be persistent, other things being equal. Under the flexible exchange rate system, although a depreciation of domestic currency will correct the balance of payments deficit, it may induce people to sell domestic currency in anticipation of further falls in the exchange rate and this may lead to currency instability. To the extent that this happens, inward foreign direct investments may fall and hence economic growth may slow down.
If the government decreases aggregate demand to reduce inflation, economic growth will fall. In addition, unemployment will rise. When the inflation rate decreases, the unemployment rate rises. Further, if the economy initially has a BOP equilibrium, the decrease in national income and the general price level caused by the decrease in aggregate demand may lead to an increase in net exports. To the extent that this happens, the balance of payments will move into a surplus. Under the fixed exchange rate system, the balance of payments surplus will be persistent, other things being equal.
If the government increases aggregate demand (AD) to achieve economic growth, inflation will rise. In addition, if the economy initially has a balance of payments equilibrium, higher import growth caused by higher economic growth will lead to a balance of payments deficit. Under the fixed exchange rate system, the balance of payments deficit will be persistent, other things being equal. Further, if the government increases productivity growth to increase economic growth by increasing expenditure on research and development, skills and knowledge will become obsolete at a faster pace and this may lead to a rise in structural unemployment. Similarly, ff the GOV lowers AD to correct a persistent BOP deficit, unemployment will rise and economic growth will fall. If it increases aggregate demand to correct a persistent balance of payments surplus, inflation will rise.
Although there are potential conflicts among the four macroeconomic policy objectives, achieving success in one does not always lead to failure in another. For instance, if the government increases aggregate demand to increase economic growth, unemployment will fall. In addition, if the economy initially has a persistent balance of payments surplus, higher import growth caused by higher economic growth may correct the surplus. Similarly, if the economy initially has a persistent balance of payments deficit and the government decreases aggregate demand to reduce inflation, the deficit may be corrected. If there is deflation in the economy initially and the government increases aggregate demand to reduce unemployment, this may simply lead to low inflation which is beneficial to the economy.
Evaluation:
Which is top priority of objectives?
Which aim can help support another aim?
De3pends on type of economy, existing economic situation, etc.
In conclusion, although there are potential conflicts between the four macroeconomic policy objectives, achieving success in one does not always lead to failure in another. Depending on the initial state of the economy, it is possible for the government to achieve certain macroeconomic policy objectives simultaneously.
Econs Tuition teacher’s Remarks:
1.Most students should expect at least 20 out of 25m for this simple essay question. More on this in our Econs revision lessons.)
2. If the government increases aggregate demand (AD) to reduce unemployment, inflation will rise and this short-run trade-off can be shown by the short run Phillips curve. Note that the Phillips Curve is no longer in syllabus (for 9732 and 9757).
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