AQA Specification focus:
‘The possibility of conflict arising, at least in the short run, when attempting to achieve these objectives.’
Government economic policy aims to achieve multiple objectives, but in the short run these objectives often clash, creating trade-offs that limit simultaneous success in all areas.
Core Conflicts in Macroeconomic Objectives
The main macroeconomic objectives are:
Economic growth (rising real GDP).
Price stability (low and stable inflation).
Minimising unemployment (ensuring jobs for those willing and able to work).
A stable balance of payments on current account (sustainable external trade position).
In practice, achieving these together is difficult. Short-run conflicts occur because policies that promote one goal can undermine another. These conflicts are central to understanding government decision-making.
Conflict between Economic Growth and Price Stability
Demand-Pull Inflation Pressure
When the government stimulates growth through expansionary fiscal or monetary policy, aggregate demand rises. If the economy is close to capacity, this can create demand-pull inflation.
The Demand-Pull Inflation diagram shows how an increase in aggregate demand (AD) raises the price level (P), demonstrating inflationary pressures arising from growth policies. Source
Demand-Pull Inflation: Inflation caused when aggregate demand rises faster than aggregate supply, pushing up the general price level.
Thus, a policy that boosts GDP and reduces unemployment may undermine price stability. Governments often face the choice between tolerating higher inflation or restraining growth.
Phillips Curve Insight
The Phillips Curve suggests a short-run trade-off between inflation and unemployment. Efforts to cut unemployment through demand stimulus typically increase inflationary pressure.
The Short-Run Phillips Curve demonstrates the inverse relationship between inflation and unemployment, highlighting the trade-off governments face between reducing unemployment and maintaining price stability. Source
Conflict between Growth and Balance of Payments Stability
Import Growth in Expansions
Strong economic growth boosts consumer spending, including demand for imports. If exports do not rise equally, the current account deficit widens.
Current Account: A measure of a country’s trade in goods and services, plus net primary and secondary income flows with the rest of the world.
For example, higher national income may raise imports of consumer electronics or raw materials, damaging external balance.
Exchange Rate Impacts
Persistent deficits can weaken the exchange rate, which may eventually fuel imported inflation, again creating a link back to price instability.
Conflict between Low Unemployment and Price Stability
Wage-Push Inflation
Reducing unemployment strengthens workers’ bargaining power. Rising wages increase unit labour costs, which firms may pass on as higher prices.
Unit Labour Costs: The average cost of labour per unit of output, calculated by dividing total labour costs by total output.
This creates cost-push inflation, conflicting with the goal of price stability. Governments must balance between a fully employed economy and inflation risks.
Conflict between Unemployment Reduction and Balance of Payments
Domestic vs External Stability
Policies to reduce unemployment, such as stimulating domestic demand, may worsen the current account. With more jobs and incomes, households buy more imports, increasing external deficits.
This demonstrates the tension between internal policy goals (employment) and external objectives (current account balance).
Policy-Making and Short-Run Priorities
Role of the Economic Cycle
Conflicts are most visible during the economic cycle:
Booms: Growth is high, but inflation and current account deficits worsen.
Recessions: Inflation falls and trade deficits may shrink, but unemployment rises.
This cycle forces governments to prioritise objectives differently depending on short-run conditions.
Supply-Side Constraints
If growth outpaces improvements in productivity or supply-side capacity, inflationary pressures emerge. Supply-side policies can ease these conflicts, but they take longer to implement.
The Problem of Time Lags
Policies take time to affect the economy. For example:
Expansionary fiscal policy may cut unemployment quickly but worsen inflation within months.
Supply-side reforms (e.g., education and training) reduce unemployment sustainably but only in the long run.
Thus, governments face short-run trade-offs even if long-run compatibility between objectives exists.
Examples of Policy Trade-Offs
Expansionary fiscal policy: Cuts unemployment and boosts growth but risks inflation and a worsening current account.
Contractionary monetary policy: Improves price stability and current account by reducing demand, but increases unemployment and slows growth.
Export promotion policies: Strengthen balance of payments and support growth, but may require subsidies, straining budgetary balance.
Additional Considerations
Global shocks: Oil price rises or financial crises intensify conflicts by raising inflation while reducing growth.
Political choices: Governments often prioritise employment over inflation during recessions, or price stability over growth when inflation is high.
Short vs Long Run: In the short run, conflicts dominate. In the long run, growth can reduce unemployment and stabilise budgets, potentially aligning objectives.
FAQ
Short-run conflicts occur because aggregate demand policies, such as fiscal and monetary stimulus, affect inflation, employment, and trade balances almost immediately.
In the long run, supply-side improvements can ease these tensions, as productivity gains allow economies to grow without triggering inflation or worsening the current account.
During a boom, demand pressures make inflation and balance of payments issues more likely, even if unemployment falls.
In a recession, unemployment is the dominant problem, and inflation or external deficits usually ease, reducing conflicts.
Supply-side policies primarily target the long run, but some can ease short-run conflicts. Examples include:
Training schemes reducing structural unemployment.
Infrastructure investment improving productivity.
However, their impact is gradual, and governments often rely on demand management in the short run.
Highly open economies rely heavily on imports and exports. Stimulating demand quickly increases imports, worsening the current account.
Less open economies experience weaker external effects, so conflicts between growth and the balance of payments are less pronounced.
If workers and firms expect inflation to rise following growth policies, they may adjust wages and prices upwards.
This accelerates inflation beyond the initial demand-pull effect, intensifying the conflict between low unemployment and price stability.
Practice Questions
Identify one government macroeconomic objective that may conflict with the objective of achieving low unemployment in the short run. (2 marks)
1 mark for identifying a valid macroeconomic objective (e.g., price stability, economic growth, or balance of payments stability).
1 additional mark for briefly stating why there is a conflict (e.g., reducing unemployment may increase inflation through higher demand and wage pressures).
Explain how attempts to increase economic growth may create a short-run conflict with the objective of maintaining a stable balance of payments on the current account. (6 marks)
1 mark for defining economic growth (increase in real GDP).
1 mark for recognising the balance of payments current account as the record of trade in goods, services, and income flows.
1–2 marks for explaining that higher growth increases incomes, leading to higher imports.
1–2 marks for explaining that if imports rise faster than exports, the current account deficit widens.
1 mark for linking this explicitly to the conflict between achieving higher growth and maintaining external stability.
