Trade off between Macroeconomic objectives

Four main macroeconomic objectives:

1. Low and stable inflation (~2% target).
2. Low unemployment / full employment.
3. Steady economic growth (potential growth ~2-3% in mature economies).
4. Equitable income distribution AND sustainable balance of payments.

These often CONFLICT.

Phillips curve. Originally observed by A.W. Phillips (1958) — inverse relationship between unemployment and wage inflation in UK data.

In the SHORT RUN:

• AD stimulation → output rises → unemployment falls → labour market tightens → wages and prices rise faster → inflation rises.
• Conversely, tight policy → unemployment rises → inflation falls.

This is a SHORT-RUN trade-off — but policy makers face it constantly.

Long-run Phillips curve. Friedman and Phelps (1968) argued workers eventually anticipate inflation, demand wage increases, so SR Phillips curve shifts up. The LONG-RUN Phillips curve is VERTICAL at the natural rate of unemployment.

Implication: persistent attempt to reduce unemployment below natural rate via stimulus produces ACCELERATING inflation without lasting unemployment reduction. (Confirmed by 1970s stagflation.)

Other trade-offs:

Growth vs inflation. Sustained high growth near full employment generates demand-pull inflation. Cooling inflation requires slowing demand → growth slows too.

Growth vs external balance. Strong domestic growth raises demand for imports → trade deficit widens; may require currency depreciation or import restrictions.

Inflation vs employment. As Phillips curve shows.

Equity vs efficiency. Redistributive taxation may reduce work incentives; deregulation may boost growth but raise inequality.

Tinbergen rule. Jan Tinbergen (1952): need at LEAST as many independent policy instruments as goals. Often governments have fewer tools than goals → must accept some trade-offs.

Real-world example. Central banks pursue inflation target above all (monetary policy single tool). Fiscal policy can target growth/distribution. Currency interventions may target BoP. But fiscal stimulus can stoke inflation, requiring tighter monetary policy — coordination matters.