Macroeconomic objectives

Full employment is a situation in which everyone who is willing and able to work, and is actively seeking a job, is able to find one (1) — in practice interpreted as a low unemployment rate of around 3-5%, since some frictional and structural unemployment always remains (1).

A government aims for low (e.g. ~2%) rather than zero inflation for two main reasons. First, to avoid deflation (2 marks): aiming for zero leaves no safety margin, so the economy could easily slip into deflation (falling prices), which can cause a damaging deflationary spiral (consumers delay purchases, demand falls further). Second, to keep the economy flexible (2 marks): a little inflation encourages spending now rather than later, and lets firms adjust real wages by holding nominal pay steady while prices rise — easier than cutting wages. Mild, stable inflation is also a normal sign of a growing economy. So a small positive target is safer and more useful than zero.

The four objectives often conflict, so achieving them all at once is difficult. Growth vs inflation: policies that boost growth raise aggregate demand, which — if demand outstrips capacity — causes demand-pull inflation, so pursuing growth can undermine low inflation. Unemployment vs inflation: reducing unemployment tightens the labour market and pushes up wages and prices (the Phillips-curve trade-off), so lower unemployment can mean higher inflation, and vice versa. Growth vs the balance of payments: faster growth raises incomes, so consumers buy more imports, which can worsen the current-account deficit. Because the objectives pull in different directions, a government usually cannot maximise all four simultaneously — for example, expansionary policy to cut unemployment may raise inflation and worsen the trade balance. It must therefore prioritise depending on the economy's situation. So the objectives are not all compatible, which is why macroeconomic policy involves trade-offs and choices.

Economic growth means producing more goods and services, and this can damage the environment in several ways. More pollution: higher production means factories and power stations burn more fossil fuels, releasing carbon dioxide and other pollutants that cause air pollution and climate change. Resource depletion: growth uses up more non-renewable resources such as oil, coal and minerals, leaving less for the future — an inter-generational cost. Habitat destruction: expanding industry, farming and housing can cause deforestation and loss of biodiversity. These are negative externalities — costs imposed on third parties and future generations that the market price ignores. Severe environmental damage can even reduce the economy's future capacity (e.g. degraded farmland yields less, extreme weather destroys infrastructure), so growth that ignores the environment may not be sustainable. So pursuing growth raises output and incomes today but can impose serious environmental costs, which is why sustainability is increasingly a policy concern. The conflict can be eased by green growth — using cleaner technology to grow with less damage.

It is very difficult for a government to achieve all its macroeconomic objectives simultaneously, though not always impossible. Why it is difficult: the objectives often conflict. Boosting growth and cutting unemployment tend to raise inflation (the Phillips-curve and demand-pull effects) and worsen the balance of payments (more imports as incomes rise); conversely, squeezing inflation may raise unemployment and slow growth. Because the objectives pull in different directions, achieving one fully often means sacrificing another, so the government must prioritise. Why it is sometimes possible: in favourable conditions — for instance when supply-side improvements raise the economy's capacity — growth and jobs can rise without much inflation, so several objectives improve together; a country with spare capacity coming out of recession may see growth, falling unemployment and stable inflation at once for a time. Judgement: in normal circumstances a government cannot achieve all objectives to the maximum at the same time, because of the trade-offs, so it must choose priorities based on the economy's situation. However, well-designed supply-side policies that raise productive capacity can reduce the conflicts and let several objectives improve together. So perfect achievement of all four at once is unlikely, but skilful policy — especially raising capacity — can move the economy closer to all of them.

Whether reducing unemployment should rank above economic growth is a matter of judgement and circumstances. Why reducing unemployment might be more important: unemployment causes direct hardship — lost income, poverty, poorer health and social problems — concentrated on individuals and families; it also wastes resources (output below potential) and strains government finances (more benefits, less tax). Tackling it brings immediate welfare gains. Why growth might be more important: economic growth raises average incomes and living standards for everyone over time, generates the tax revenue to fund public services, and is what ultimately creates jobs — so growth and lower unemployment are often linked (growth tends to reduce unemployment). Prioritising growth may therefore reduce unemployment as well. For a developing country, growth may be essential to escape poverty. Judgement: the priority depends on the economic situation. In a deep recession with mass unemployment, reducing unemployment may rightly come first, because the human cost is severe and urgent. In normal times, pursuing sustainable growth may be wiser, since it raises living standards and creates jobs over the long run. Because growth and employment are closely connected, the choice is often about emphasis rather than either/or. So neither is always more important — it depends on whether unemployment is the economy's most pressing problem.