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Macroeconomic Objectives

Price Stability

There are many costs due to inflation (shoe leather, unemployment and lower growth, menu, psychological and political and redistribution costs) but another effect of inflation is to affect the signalling system. The signal system is used in an economy to allocate the economies resources based on effective demand (demand backed up by payment).  When there is inflation it is hard for firms to interpret these price signals, is the price of a good increasing because there is more demand (and hence firms should increase production, and new firms should enter the market) or are prices just rising due to general inflation. If firms are unsure, then they may decide not to increase production, and new firms may not enter the market, this could lead to lower growth. Furthermore a misallocation of resources could occur.

Additionally inflation also makes it hard for firms to forecast future revenues and demand for the product. Because of this uncertainty they may hold back on investment projects reducing growth.

Other Objectives

Other macroeconomic objectives include; a balance of payments, sustainable economic growth, environmental credentials, maintaining a fair income distribution and full employment. Maintaining full employment is important for an economy due to the economic and psychological effects that unemployment imposes on society.

Conflict of objectives between Economic Growth and the Current Account

There is a conflict of objectives with economic growth and the current account; by attaining economic growth (that is relatively distributed evenly) real incomes per capita are likely to rise. Individuals in an economy will therefore have greater disposable incomes which they may decide (depending on their MPC) to spend on importing goods and services. This would therefore affect the current account and could push it into a deficit, therefore adversely affecting the governments other target of maintaining an evenly balanced current account.

Crowding Out

Crowding out occurs when governments borrow money from the financial markets, causing interest rates to rise. This is because governments are normally perceived as risk free and hence increased demand for funds by the government (assuming constant supply) will cause interest rates to rise. Therefore firms in an economy who also wish to borrow will have to pay higher yields because they are generally perceived as more risky than the government. This increases the cost of borrowing for firms in an economy and hence may deter them from investing. Crowding out is only likely to happen in a period of full-employment when there are limited funds to borrow from. During a recession there is likely to be excess savings which can be used to fund investment, and any increase in government borrowing (due to increases in spending, or reductions in tax) will have a negligible effect of interest rates in the economy.

Page last updated on 15/04/14