3.33 - Macroeconomic Objectives - Conflict
Low unemployment and low inflation
Macroeconomic policies aimed at achieving low unemployment can often lead to higher inflation, while those targeting low inflation may increase unemployment. This trade-off is a key challenge in economic management.
Policy impacts on unemployment and inflation
The two policy stances pull the two objectives in opposite directions, as the table below shows.
| Policy stance | Instruments | Effect on unemployment | Effect on inflation |
|---|---|---|---|
| Expansionary | Increased government spending or tax cuts (fiscal), lower interest rates (monetary) | Falls, because higher aggregate demand raises output and firms take on more workers | Rises, because the extra demand pulls prices up (demand-pull inflation) |
| Contractionary | Reduced government spending or tax rises (fiscal), higher interest rates (monetary) | Rises, and cyclical unemployment in particular, because slower activity cuts the demand for labour | Falls, because weaker aggregate demand takes the pressure off prices |
The short-run Phillips curve
The short-run Phillips curve illustrates an inverse relationship between unemployment and inflation, particularly in higher-level (HL) analysis.
Key implications:
- With an upward-sloping Monetarist short-run aggregate supply (SRAS) curve or the middle upward-sloping section of a Keynesian aggregate supply (AS) curve, increases in aggregate demand raise real gross domestic product (GDP) and lower unemployment but also increase the price level, leading to inflation.
- Research indicates that inflation accelerates when unemployment falls more than one percentage point below a country's natural rate of unemployment (NRU), which represents the lowest unemployment rate achievable without accelerating inflation.
- The NRU is not fixed and can decrease over time due to factors like improved labour market efficiency.
High economic growth and low inflation
Pursuing high economic growth through rising aggregate demand can generate inflationary pressures, especially as the economy approaches full capacity. Effective policy requires balancing these objectives.
Causes of inflationary pressures from growth
- As aggregate demand rises the Keynesian AS curve begins to slope upwards, because bottlenecks appear in some sectors before the whole economy reaches full employment.
- As aggregate demand increases, capacity constraints create shortages in resources like labour or materials, pushing up prices.
- The closer the economy operates to its potential output (full employment), the more likely further growth will cause inflation to accelerate.
- Policymakers face uncertainty, as they cannot predict exactly when additional growth will trigger rising inflation; premature tightening of monetary policy may control inflation but unnecessarily extend high unemployment.
Role of supply-side policies in resolving the conflict
- Successful supply-side policies can enable economic growth without inflation by increasing the economy's productive capacity.
- These policies shift the long-run aggregate supply (LRAS) curve to the right, allowing aggregate demand to rise without increasing the price level.
- Examples include investments in education, infrastructure, or technology to boost productivity and efficiency.
Economic growth and environmental sustainability
Economic growth can harm the environment through resource depletion and pollution, but it can also enable investments in sustainable practices. Balancing these requires targeted policies.
Environmental effects of growth
- Economic growth often requires natural resources and generates emissions and waste, potentially exceeding the Earth's carrying capacity.
- The environmental Kuznets curve suggests that as per capita incomes rise with growth, pollution initially increases but then decreases after a critical income level, as wealthier societies invest in cleaner technologies.
- This curve may apply mainly to local externalities (e.g., air quality in cities) rather than dispersed ones like global carbon emissions.
Policies to promote sustainable growth
Governments can implement measures to make growth more environmentally friendly. The table below sets out what each measure involves and how it makes growth more sustainable.
| Measure | What the government does | How it makes growth more sustainable |
|---|---|---|
| Reducing harmful subsidies | Ceases subsidies for fossil fuels and for activities that deplete common pool resources, such as fishing | Stops public money speeding up the depletion of the resources that future growth depends on |
| Regulatory and market-based tools | Introduces stricter environmental regulations, and prices emissions through carbon taxes or cap-and-trade schemes | Puts both a legal limit and a price on pollution, which pushes firms towards cleaner practices |
| Investments in green technologies | Provides subsidies for firms adopting clean production methods and funds research into sustainable innovations | Makes cleaner methods cheaper to adopt, so firms can expand output using them |
| Shifting production | Encourages a move away from pollution-intensive goods and towards less pollution-intensive production technologies | Cuts the pollution generated per unit of output, so the same rate of growth does less damage |
Economic growth and equity in income distribution
While economic growth can provide resources for redistribution, it often exacerbates income inequality if benefits are not shared widely. Inclusive growth is essential for long-term stability.
How growth affects income distribution
Economic growth can both improve and worsen equity.
Positive effects through redistribution:
- Growth enables direct redistribution via social welfare systems, such as pensions or unemployment benefits.
- It supports indirect measures like poverty alleviation programmes focused on agricultural productivity, infrastructure, health, and education.
Negative effects leading to inequality:
- Income inequality has risen in many growing economies.
- Growth may not be inclusive if it is driven by only a few industries, concentrated in specific regions, reliant on particular skills, or results in jobless growth (where output rises without creating employment).
Implications for economic resilience
- Non-inclusive growth, where benefits accrue mainly to the wealthiest, is less resilient and sustainable.
- The distribution of growth benefits determines its longevity; in unequal societies, policies to revive the economy may lack broad support if long-term gains are not shared evenly.
TermDefinition
Aggregate demandThe total demand for goods and services in an economy at a given time and price level.
Short-run Phillips curveA curve illustrating the inverse short-run relationship between the unemployment rate and the inflation rate.
Natural rate of unemployment (NRU)The lowest unemployment rate an economy can sustain without causing inflation to accelerate.
Supply-side policiesGovernment policies aimed at increasing the productive capacity of the economy, shifting the long-run aggregate supply curve to the right.
Environmental Kuznets curveA theory suggesting that environmental degradation first increases and then decreases as a country's per capita income grows.
Common pool resourcesNatural or human-made resources where one person's use subtracts from another's, but it is difficult to exclude anyone from using them.
Cap-and-trade schemesMarket-based systems that set a legal limit on total emissions and allow firms to buy and sell pollution permits.
Jobless growthAn increase in an economy's total output that does not result in the creation of new employment opportunities.