Government macroeconomic intervention

Economics · Government and the macroeconomy. 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

Macroeconomics looks at the whole economy. A government has six main macroeconomic aims: economic growth, full employment (low unemployment), stable prices (low inflation), balance of payments stability, redistribution of income and environmental sustainability.

Governments often set a target for an aim, such as inflation of 2% a year, so that success can be measured.

The hard part is that aims can conflict: a policy that helps one aim may harm another. Higher total demand creates jobs, but it can also pull prices up and bring in more imports. Faster growth can use up resources and add to pollution. So a government must decide which aim matters most at the time.

Rules to remember

Economic growth: a rise in the economy's output (real GDP) over time, which can raise living standards
Full employment: nearly everyone who is willing and able to work has a job. It means low unemployment, not zero
Stable prices: a low and steady rate of inflation, so money keeps its value and firms and households can plan
Balance of payments stability: over time, money coming in from abroad roughly matches money going out, with no large, lasting deficit
Redistribution of income: narrowing the gap between rich and poor through taxes and benefits
Environmental sustainability: meeting present needs without harming future generations' ability to meet theirs
Conflicts: full employment against stable prices; economic growth against environmental sustainability; full employment against balance of payments stability

Common mistake

Saying that stable prices means prices stay the same or fall. It means a low, steady rate of inflation: prices still rise, but slowly.

Worked example

A government raises income tax on the highest earners and uses the money to pay larger benefits to poor families. Which macroeconomic aim is this for, and which other aim might it harm?

Money moves from high-income to low-income households, so the income gap narrows: the aim is redistribution of income.
Higher tax lowers the reward for extra work and for starting or expanding a business.
If some people work or invest less, output grows more slowly.

Answer: The aim is redistribution of income. It may conflict with economic growth if higher taxes reduce the incentive to work and invest.

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