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Macroeconomic Objectives and Conflicts
Macroeconomic Objectives and Conflicts
Macroeconomic Objectives and Conflicts
When the economy is growing very quickly, firms have difficulty employing
sufficient skilled labour; this can lead to wage inflation and higher wages cause
higher prices. Also, if demand grows faster than supply, firms will respond to
shortages by putting up prices.
Inflationary growth
In this diagram, there is an increase in AD, when the economy is close to full
capacity. We get an increase in real GDP but also an increase in the inflation
rate.
Economic growth without inflation. AD and LRAS increasing at the same rate.
The UK between 1993-2007, had a long period of economic expansion. But, this
prolonged economic growth did not cause inflation. This is sometimes known
as the great moderation.
The UK great moderation from 1992 to 2008 – low inflation, positive economic growth.
A government may feel it needs to reduce the budget deficit. This will require
higher taxes and lower spending. However, this tightening of fiscal policy will lead
to a fall in AD and lead to lower economic growth.
Similarly, if the government wants to boost the rate of economic growth it could
pursue expansionary fiscal policy (tax cuts/spending rises). This should increase
aggregate demand and help economic growth – but there will be a side effect,
the budget deficit will rise.
Evaluation
If policies to reduce a budget deficit lead to unemployment and lower growth, the
government will need to pay more on benefits and will get lower tax receipts.
Therefore the deficit may experience only a small reduction. This has been a
dilemma for European governments since the austerity measures of post-2010.
However, it depends on how you reduce a budget deficit. For example, if you
raised the retirement age and made it more difficult to get welfare benefits, then
you can reduce government spending, but there is little negative impact on
economic growth (in fact, people have to work longer, increasing LRAS). Though
there may be side effects on issues of equality and fairness.