Policy objectives and conflicts

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Main macroeconomic policy objectives

  • Full employment/low unemployment
  • Economic growth and higher living standards
  • A fair or equitable distribution of income and wealth
  • Control of inflation (target 2.0)
  • Satisfactory balance of payments or particular exchange rate target
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Keynsian macroeconomic policy and free-market macr


  • Focused on the use of demand management policies to achieve full employment and economic growth
  • Regard full employment and economic growth as the principal policy objectives
  • Keynsian fiscal policy includes tax cuts and increases in government spending to manage AD

Free-market macroeconomic policy

  • Belief that inflation is caused by an excessive rate of growth of the money supply so this must be controlled in order to control inflation
  • Inflation control is the main priority
  • Belief that governments should actively use monetary policy to control inflation
  • Associated with supply side economics
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Conflicts between objectives

There are 3 significant policy conflicts and policy trade offs:

  • Full employment/growth and satisfactory balance of payments - strong GDP growth may lead to increased levels of consumer demand which could lead to b.o.p. worsening when marginal propensity to import is high. An improvement in b.o.p. (due to surge in exports for example) may cause demand pull inflation depending on stage of economic cycle and size of the output gap.
  • Full employment and control of inflation - during periods of strong GDP growth, fall in unemployment could lead to demand-pull/cost-push inflation (phillips curve). Contractionary policies to reduce AD could lead to reduction in GDP and increase in unemployment. Deflation could also lead to increase in unemployment.
  • Above can be resolved if - increase in PPF through higher labour productivity, innovation allows businesses to produce more at lower unit costs, expectations of inflations remain stable
  • Economic growth and equal distribution of wealth - free market supply side economists have argued that progressive taxes reduce entrepreneurial and personal incentives in labour market, inhibit growht and make market less competitives.
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Which policies are used for which objectives?

  • Contractionary fiscal policy -  involves restricting government spending and increasing taxation, contracts AD. Used to combat inflation, achieve a satisfactory B.O.P. and if tax on wealthy is used can improve distribution of wealth. 
  • Contractionary monetary policy - involves increasing interest rates to increase the reward for saving and cost of borrowing. Contracts AD by reducing investment and consumption and is used to combat high inflation and b.o.p. 
  • Expansionary fiscal policy - involves increasing government spending and decreasing taxation and increases AD by increasing consumption. Targets cyclical unemployment and economic growth policy objectives
  • Expansionary monetary policy - involves decreasing interest rates to decrease the reward for saving and the cost of borrowing. Low interest rates encourage consumption and investment so increases AD to achieve satisfactory b.o.p and increase economic growth.
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  • Policy objective - a target or goal which policy makers wish to achieve 
  • Reflationary monetary policy - fiscal or monetary policy used to increase aggregate demand, shifting the AD curve to the right
  • Supply side policies - these aim to make markets function more efficiency and competitively, thereby shifting the LRAS curve to the right and the economy's PPF outward
  • Policy trade offs - aiming for satisfactory performance with regard to 2 or more policy objectives, assuming it is impossible to achieve all the objectives simultaneously. 
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