Macroeconomic Objectives

Hello,

I'm Dr Paul Single and I'm reader in the Economics of Development at King's College.

London in this module will give an overview

of government policies to achieve macroeconomic objectives.

So let's start with the basic objectives of macroeconomic policy,

their price stability, low unemployment and good economic growth.

First, let's talk about price stability,

so price stability doesn't mean zero inflation.

What it really means is that people don't have

to worry about inflation in the economic decisions.

So most high income countries have inflation targets of about 2%.

Some developing countries have higher targets than that.

Then what central banks do is they try to make sure they stick to that target.

That inflation stays at or close to that target

to ensure that people have confidence in them.

But in terms of the cost of inflation itself,

as opposed to the cost of the reputation of the central bank,

which people do think about a lot,

people don't really worry about inflation from a macro economic point of view,

if it's say 5% or less.

In fact,

there's no evidence that inflation is bad for

growth until it gets really rather high,

and we're talking about maybe over 40% or so,

so

very high. Inflation is very bad for growth,

but people worry about inflation because it's kind of inconvenient

and interferes with their decision making at much lower levels.

And for that reason,

central banks tend to try to keep inflation well below 5% and often around 2%.

The second goal I mentioned is low unemployment,

and that's both because of the direct impact on the unemployed.

Those are people who lose income.

They're more likely to fall into poverty and also becoming unemployed.

It makes you much more likely to become depressed.

So it's very bad for the individuals involved,

but also because unemployment means potential workers

are not contributing to the overall economy.

So it's also bad for the wider economy.

And then the third goal I mentioned was economic growth.

And of course, that's to make us all better off in the long run,

including to reduce poverty

In addition, macroeconomic outcomes have a big impact on other objectives,

including environmental sustainability

and the distribution of income and wealth.

But those aren't the main focus of what we'll be talking about today.

Now let's start by talking about price, stability and unemployment,

which is also what we call short run stabilisation.

So short run stabilisation means trying to maintain price

stability or low inflation while having low unemployment.

We can think of macroeconomic policy making from this dimension of short run.

Stabilisation is based on two basic policy tools and two relationships.

So the two basic policy tools are fiscal policy and monetary policy,

out of which can be expansionary or contractionary.

And I'll talk more about them a bit later.

And the two relationships are one.

That expansionary policy increases aggregate demand

while contractionary policy reduces aggregate demand

and to a rise in aggregate demand reduces unemployment and increases inflation,

holding all else equal.

Now the fact that inflation goes up as unemployment

goes down is what we call the Phillips curve.

So short run stabilisation,

meaning keeping price stability and low unemployment.

That's a balancing act between enough stimulus to keep unemployment low,

but not so much stimulus has to lead to rising inflation.

In theory, we think there's a point

where we can have decent levels of both,

but the difficulty arises when we have to face shocks in the economy.

So first let's consider a positive demand shock, like a construction boom

that could be driven simply by high levels of investor confidence.

Then that positive

shock to

demand

is going to bring a lot of people into construction work

and therefore reduce unemployment.

But then, if unemployment falls very low,

then what the Phillips curve tells us is that inflation is likely to start to rise.

In that case,

the government will want to implement contractionary macroeconomic policy,

which could mean raising interest rates with monetary policy.

Or it could mean using fiscal policy

and either raising taxes or cutting public spending

that's going to reduce aggregate demand.

Some people will probably lose their jobs.

Overall, spending will decline and inflation should also come down.

On the other hand,

if you have a negative demand shock like a decline in investor confidence,

then the government will notice the unemployment is rising.

Inflation is probably declining to,

and then they'll want to implement expansionary policy.

So that means, in turn,

reducing the interest rate with monetary policy or using

fiscal policy to cut taxes or increase public spending

again, this policy should increase aggregate demand,

bring more people into work and reduce unemployment,

and we'll also tend to lead to rising inflation,

hopefully just bringing it back up to target.

A more problematic example is a negative supply shock,

in contrast to the demand shocks I just talked about.

And if you think about it abstractly,

that's because the policies of the government can implement in the short

run to moderate the economic cycle are essentially demand management policies.

They can increase or reduce demand with government policy.

So if you have a supply shock, you can do something to change the outcomes.

But you can't directly counter that supply shock.

You can't immediately change supply in a way you can immediately change demand.

So consider a negative supply shock,

like the example of Russia's invasion of Ukraine.

In addition to the human tragedy involved.

It's negative supply shock to the world,

particularly via wheat and gas production,

meaning there's less to go around,

which leads inevitably to some combination

of lower output and higher unemployment,

along with higher inflation.

Now, policy can't avoid this,

but policy can determine to what extent

we take more unemployment versus more inflation,

and, importantly,

policy can also determine who are the main losers within the economy.

If the economy has to be poorer,

we don't yet know who in the economy is going to be poorer.

If the government simply let's food and gas prices rise,

then in proportionate terms, it's probably going to hit poorer households more

because food and energy are a larger

share of household budgets for poorer households.

So that means a relatively large increase in poverty is going to result.

Alternatively,

the government could provide some combination of taxes on rich households

and subsidies or benefits for poorer households

to ensure that the people who take that inevitable hit to the

economy and remember the government can't stop the hit to the economy,

they can just manage it.

So what they can do is ensure that whoever takes that hit

are the better off households who are more able to afford it.

So I've been talking about price, stability and unemployment.

How about economic growth is the

third key macroeconomic objective of governments.

Now the most important ingredient to economic growth is investment.

That means investment in what we call fixed capital, meaning things like machines,

buildings, roads, ports

and other physical objects that help us to produce goods and services.

But crucially, it also includes investment in technologies.

And that's in the broad sense of working out ways

of producing better goods and services in more efficient ways.

So technology includes something like the development of led based light bulbs,

which are much more efficient than filament lightbulbs,

meaning we can light our spaces using much less energy.

So we get the same fundamental good that is lighting

and much lower resource cost. That's one type of increasing technology.

But an improvement technology also includes things like working out better

ways to organise work to enable us to produce more efficiently.

The biggest innovation in work practises that led to

massive improvements in productivity was the division of Labour,

and Adam Smith wrote about this over two centuries ago.

But there are countless improvements that firms are making

all the time within their processes to improve workflow

and efficiency of working.

And that also counts as improvements in technology because

it means we can produce more using fewer resources.

Economic growth also depends heavily on the education or skill levels

of the workforce and what we call the institutional environment,

meaning things like the rule of law or where

the businesses and investors are confident that contracts are enforceable