Economics (9640) | The objectives of government economic policy

The Objectives of Government Economic Policy: Managing the Macroeconomy

Hello Economists! This chapter is super important because it moves us from looking at individual markets (microeconomics) to studying the economy as a whole (macroeconomics). We are going to explore the big goals that governments set for their countries.

Think of the government as the manager of a giant country-sized football team. They can't just score one goal; they need to balance several key objectives simultaneously—and sometimes, trying to score one goal means conceding another! Understanding these objectives is the first step in understanding all macroeconomic policy.

Quick Review: What is Macroeconomic Policy?
Macroeconomic policy involves actions taken by the government or central bank to influence the entire economy, focusing on broad aggregates like national output, inflation, and unemployment.

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The Main Macroeconomic Objectives (The Big Four)

Governments typically aim for four main goals to ensure a healthy and stable economy. A simple way to remember them is the acronym GPUE:

• Growth (Economic Growth)
• Price Stability (Low Inflation)
• Unemployment (Minimising Unemployment)
• External Stability (Stable Balance of Payments)

1. Economic Growth

What it means: Economic growth is an increase in the productive capacity of the economy, usually measured by the increase in Real GDP (Gross Domestic Product) over time.

Analogy: If the economy is a cake, economic growth means making a bigger cake this year than last year.

Why it's important:

• Higher average incomes and living standards.
• Increased consumption possibilities.
• More job creation (derived demand for labour).
• Governments collect more tax revenue without increasing tax rates (fiscal dividend).

The Goal: To achieve sustainable economic growth – growth that can be maintained without creating other problems (like high inflation or environmental damage).

2. Price Stability (Controlling Inflation)

What it means: Price stability means keeping the general level of prices constant or, more commonly, ensuring that inflation remains low and stable.

Key Term: Inflation is the sustained increase in the general price level of goods and services in an economy over a period of time.

The Goal: Most modern governments and central banks aim for a low, positive rate of inflation, often around 2%. Why not 0%?

• A small positive rate provides a buffer against deflation (falling prices), which can be very damaging to an economy.
• It makes it easier for wages to adjust in the labour market.

Why High Inflation is Bad: High inflation erodes the value of money, makes economic planning impossible, and harms people on fixed incomes (like pensioners).

3. Minimising Unemployment (Moving towards Full Employment)

What it means: The goal is to keep the number of people who are able and willing to work, but cannot find a job, as low as possible.

The Goal: Governments aim for Full Employment. This does not mean 0% unemployment.

Did you know? Even at "full employment," there will always be some level of unemployment—known as the natural rate of unemployment. This includes people changing jobs (frictional) or those whose skills are outdated (structural).

Why it's important: High unemployment leads to:

• Lower national output (the economy is operating inside its PPC).
• Increased government spending on benefits and lower tax revenue.
• Social problems like poverty and inequality.

4. Stable Balance of Payments on Current Account

What it means: The Balance of Payments (BoP) is a record of all financial transactions between a country and the rest of the world. The Current Account tracks trade in goods, services, and income flows.

The Goal: To avoid large, sustained surpluses or deficits on the current account.

• Current Account Deficit: When a country spends more abroad than it earns. If sustained, it requires borrowing from the rest of the world, leading to rising debt.
• Current Account Surplus: When a country earns more abroad than it spends. While seemingly good, a sustained large surplus can lead to under-consumption domestically or friction with trading partners.

The desired objective is stability – avoiding extremes that could destabilise the exchange rate or lead to unmanageable debt.

Key Takeaway (The Big Four)

The government's job is to steer the economy towards high growth, low and stable inflation, low unemployment, and a sustainable external trade position (GPUE).

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Other Important Policy Objectives (Beyond the Core)

The syllabus highlights that governments pursue other critical goals that affect the well-being of their citizens and the environment.

5. Achieving an Equitable Distribution of Income and Wealth

What it means: Ensuring fairness in how income (flow of money) and wealth (stock of assets) are distributed among the population.

• Equality means everyone has the same amount.
• Equity means fairness or justice. This involves a value judgement (a belief about what is fair).

Policy Action: Governments use progressive taxation (higher earners pay a larger percentage of income tax) and welfare spending to redistribute resources and reduce inequality.

6. Protecting the Environment and Promoting Sustainability

What it means: Ensuring that current economic activity does not harm the ability of future generations to meet their own needs.

The Link to Macro: Rapid economic growth often uses up non-renewable resources or creates pollution (a negative externality). Governments must intervene through regulation (e.g., limits on carbon emissions) or taxes (e.g., carbon tax) to ensure growth is environmentally responsible.

7. Balancing the Government Budget

What it means: Managing the difference between government revenue (mostly tax) and government expenditure (spending).

• Budget Deficit: Spending > Revenue (leads to higher National Debt).
• Budget Surplus: Revenue > Spending.

The Goal: While short-term deficits are often necessary (especially during a recession), the long-term objective is usually to keep the budget sustainable to avoid excessive national debt, which future generations must repay.

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The Crucial Problem: Conflicts Between Objectives

This is where economics gets complicated! Unfortunately, policies designed to achieve one objective often make it harder to achieve another.

The Trade-off between Economic Growth/Unemployment and Inflation

This is the most famous conflict, often illustrated using the concept of the Phillips Curve (though you do not need to draw this curve for this section, you need to know the concept).

The Conflict:

• If the government stimulates Aggregate Demand (AD) to boost economic growth and reduce unemployment (e.g., cutting interest rates), the economy uses up its spare capacity.
• Once the economy is close to full capacity, further increases in AD lead mainly to higher prices, resulting in demand-pull inflation.

Simple explanation: If you make the economy run faster (low unemployment/high growth), it often 'overheats,' causing inflation.

Other Key Policy Conflicts

Growth vs. Environment

Rapid, short-run economic growth often requires high levels of production and consumption, which can lead to resource depletion and pollution. This is a trade-off between current material well-being and long-term sustainability.

Growth vs. Equity

Policies aimed at promoting rapid growth (e.g., low taxes on corporations and high earners) are designed to boost investment and innovation. However, these policies can increase the gap between the rich and the poor, leading to greater inequality.

Inflation vs. Balance of Payments

High domestic inflation makes a country's exports more expensive and imports relatively cheaper. This tends to worsen the Balance of Payments Current Account Deficit.

Prioritisation: Why Objectives Change

Because these conflicts exist, governments cannot achieve everything at once. They must prioritise their objectives, and the importance attached to different objectives will affect the policies adopted.

• During a Recession: The priority shifts to Economic Growth and Minimising Unemployment. The government is willing to tolerate a temporary budget deficit or a small rise in inflation to get people back to work.
• During a Boom: The priority shifts to Price Stability and Balancing the Budget (to avoid overheating).
• Political and Social Factors: A government facing strong public concern over climate change will prioritise environmental protection, even if it slows down growth.

Example: After the 2008 Financial Crisis, many countries prioritised low unemployment and recovery, using large government borrowing (fiscal policy), even though this meant accepting large budget deficits and an increase in national debt.