AS: T HE MEASUREMENT OF MACROECONOMIC PERFORMANCE The objectives of government economic policy Can you name 4 macroeconomic variables? In relation to each variable what will the government want to achieve?

2.1.1 T HE OBJECTIVES OF GOVERNMENT ECONOMIC POLICY  The main objectives of government macroeconomic policy:  economic growth, price stability, minimising unemployment and a stable balance of payments on current account  The possibility of conflict arising, at least in the short run, when attempting to achieve these objectives  You should be aware that governments may also have other objectives of macroeconomic policy, such as balancing the budget and achieving an equitable distribution of income  You should be aware that the importance attached to the different objectives changes over time

O BJECTIVES The following 4 variables are used to measure national economic performance, and thus form the basis of the government’s macroeconomic policy objectives 1. Economic Growth 2. Unemployment 3. Inflation 4. Balance of Payments

1. E CONOMIC G ROWTH  This measures the “rate of change of a country’s output”  The key measure is GROSS DOMESTIC PRODUCT (GDP), which calculates the sum of a country’s output over 1 year  The pursuit of economic growth, both in terms of actual and potential productivity, is seen as a crucial goal of macroeconomic performance To what extent is economic growth more important than inflation?

W HY IS E CONOMIC G ROWTH AN O BJECTIVE ? Key benefits include:  Job creation  Rising incomes  Improved standards of living  Improved international competitiveness of the UK economy  Multiplier and accelerator benefits  Improved confidence of:  consumers to spend  businesses to invest  Lower government spending on job seekers allowance and associated benefits  Tax revenues are likely to increase allowing the government to re-invest in infrastructure or spend on public services

2. U NEMPLOYMENT  Unemployment is a major problem because it represents a waste of resources  High unemployment is generally an indicator of poor economic performance  Economies that have strong economic growth are likely to have low unemployment  Therefore, governments wish to pursue a policy of low unemployment Watch the video and read the article on UK unemployment. What are the benefits of lower unemployment?

B ENEFITS OF L OW U NEMPLOYMENT  Higher consumption and aggregate demand  Higher incomes  Improved standards of living  Higher tax revenue for government  Lower government spending on unemployment related welfare  Improved productivity of UK economy  Reduced poverty (absolute and relative)  Social benefits (reduced crime, improved wellbeing) It is often assumed that full employment is not an achievable target as there will always be people moving between jobs or seeking work post education, so low unemployment becomes the default target. Although precisely what defines “low” is a matter of political debate.

3. I NFLATION  Inflation is the “rate of change of average prices in an economy” as measured by the Consumer Price Index (CPI)  Inflation is important because it affects the value of £s in your pocket, workers‘ wage demands and consumer confidence  High, or rising inflation, damages the real value of money and erodes spending power  The inflation target has been made independent of the UK government in order to give a key component of macroeconomic policy more transparency and credibility following a number of periods of high inflation in the UK through the 1970’s and 1980’s  A target of 2% has been designated to the Bank of England  Within this, the target also includes price stability, and for inflation to be maintained within a range of +/- 1% of the target

UK I NFLATION Look at the chart tracking UK CPI inflation over the last decade. How would you assess the government’s and Bank of England's performance in reaching its inflation target? Source: ONS

4. B ALANCE OF P AYMENTS  This measures the UK’s record of economic activities with other countries  There are many components of the UK’s transactions with other countries, but we are principally concerned with the current account and our trade with other countries, in other words, imports and exports If Exports > Imports = Surplus If Imports > Exports = Deficit  Given that deficits have to be funded (often by borrowing) it is assumed that a surplus or equilibrium on the current account is the desired objective Read the article on the UK balance of trade. Why do you think the UK has a deficit in goods and a surplus in services?

B ALANCE OF P AYMENTS – H OW MUCH DOES IT MATTER ? 1  The UK has been running, for a sustained period, a significant deficit on the current account in terms of our trade in goods  This is offset to a degree by a surplus in our trade in services  Overall, the UK has had a sustained and persistent deficit on the Balance of Payments, and this has received relatively little attention from successive governments (in comparison to other targets)  The UK economy is heavily skewed towards the tertiary sector, which is a key driver of jobs and income

B ALANCE OF P AYMENTS – H OW MUCH DOES IT MATTER ? 2  Whilst a high level of imported goods might be seen as a negative, it provides consumers with a wider choice of goods, which may be of higher quality and lower prices All of this enhances consumers ‘standards of living and welfare  Firms may also benefits from cheaper or higher quality imported components or raw materials, which may reduce costs, either enhancing profits or lowering prices further for customers  As a result, it is viewed by many economists that a deficit on the balance of trade overall, is not necessarily detrimental to the wider economy

T O SUMMARISE... Government objectives are considered to be: 1. Sustainable growth 2. Low and stable inflation 3. Low unemployment 4. Strong balance of payments position Why are these objectives desirable? Which one do you think is the most important?

L INKS B ETWEEN O BJECTIVES The achievement of one objective can often lead to other objectives being met. Example 1 If the government invests in education and training, this may result in more skilled workers who can be more productive and produce higher quality goods and services. These can then be exported potentially at more competitive prices, which may improve the balance of payments. As this is a component of aggregate demand, greater economic growth will occur, which may in turn create more jobs and lower unemployment. Example 2 If the Bank of England consistently meet its inflation target, this may give firms more confidence to invest. Higher capital spending will boost long term productive potential, again assisting unemployment and enhancing the competitiveness of UK exports and the balance of payments as a consequence.

M ACROECONOMIC P OLICY C ONFLICTS (1) 1) Consider a government wishes to lower unemployment. 2) It may increase G to achieve this, so AD shifts to the right to AD 1. Price Level Real National Output SRAS P Y AD 3) This has the effect of increasing real national output and creating jobs as the economy moves along the SRAS curve. AD 1 P1P1 Y1Y1 4) However, this has been at the expense of a rise in the price level from P to P 1.

M ACROECONOMIC P OLICY C ONFLICTS (2) Real National Output 3) As a result AD will shift to the left. 4) This will be effective in reducing inflationary pressure as the price level falls from P to P 1. 1) Imagine the economy is in equilibrium at PQ, and the government is concerned about inflation. Price Level LRAS P1P1 FE AD 1 Y1Y1 2) It may increase taxes in order to reduce consumption. AD P Y 5) As consumers have reduced disposable income, they may spend less on imports, so improving the balance of payments. 6) However, as AD falls so does real national output and economic growth. It is also likely that with lower AD, unemployment would rise.

S O, WHICH OBJECTIVE ?  The achievement of one objective may also help to meet additional objectives  However, the objectives also inherently conflict, so progress towards one, may hamper the progress towards others  As a consequence, governments have to prioritise which objective they consider to be the most important Read the article on macroeconomic objectives and policy. What impact will Mark Carney’s forecast of higher interest rates have on Government economic objectives?

M ULTIPLE C HOICE 1  Choosing between faster economic growth and a satisfactory balance of payments best illustrates a) choice between different macroeconomic policy instruments b) that the short-run aggregate supply curve is vertical c) a possible conflict between competing policy objectives d) a government sacrificing future consumption in favour of current consumption Can you explain your answer?

M ULTIPLE C HOICE 2  An economy is operating at full employment. Which one of the following is most likely to lead to an increase in real national output without an increase in the rate of inflation in the short term? a) An increase in exports b) A reduction in interest rates c) An increase in manufacturing productivity d) An increase in government expenditure Can you explain your answer?

M ULTIPLE C HOICE 3  An economy is experiencing a balance of payments deficit and inflation. All other things being equal, which policy is likely to reduce both the balance of payments deficit on the current account and the rate of inflation? a) A fall in government spending b) A cut in interest rates c) A decrease in the rate of income tax d) A reduction in the exchange rate Can you explain your answer?