Government macroeconomic policy objectives

Economics A2 · Government macroeconomic intervention. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Governments set aims for the whole economy and are judged against them. The main ones are low and stable inflation, low unemployment, steady economic growth and a sustainable balance of payments position. Wider aims are economic development, sustainability and a fairer distribution of income and wealth.

Each aim is usually a target or a range, not an extreme. Price stability means low positive inflation, often about 2% a year, not zero. Full employment means low unemployment, not none, because some frictional and structural unemployment always exists.

To judge performance, compare each indicator with its target and remember that reaching one aim can move the economy away from another.

Rules to remember

Price stability: a low, stable inflation target (often around 2%). A little inflation allows real wages to adjust and keeps the economy away from deflation.
Unemployment: low, close to the natural rate, not zero.
Growth: a steady, sustainable rise in real GDP in line with the growth of potential output.
Balance of payments: a sustainable current account; a large persistent deficit must be financed by borrowing or by selling assets.
Redistribution: a lower Gini coefficient shows income is more equally shared.
Development is wider than growth: it includes health, education and living standards, for example a rising HDI.
Sustainability: targets that protect resources for future generations, such as limits on carbon emissions.

Common mistake

Students say the aims are zero inflation and zero unemployment. Governments aim for low and stable inflation and low unemployment, because zero in either case is harmful or impossible.

Worked example

A country has an inflation target of 2%. Its data show inflation 2.1%, unemployment 4%, real GDP growth 2.5%, and a current account deficit of 7% of GDP for five years. Which objective is not being met?

Inflation is almost exactly on target, so price stability is met.
Unemployment is low and growth is steady, so those two aims are met.
A deficit of 7% of GDP year after year must be financed by borrowing from abroad or selling assets, which cannot continue for ever.

Answer: The balance of payments objective, because the current account deficit is large and persistent.

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