(b) “Governments should focus primarily on
a low and stable rate of inflation.” Discuss. [15]
This
essay discusses the macroeconomic aims of governments. This essay argues that,
while low inflation is an important macroeconomic aim, governments should also
focus equally on other macroeconomic aims such as low unemployment, economic
growth, and a stable balance of payments. There are a few types of policies
that governments can use to achieve their aims. First, monetary policy is the
manipulation of monetary variables such as money supply, interest rate and the
exchange rate. Second, fiscal policy refers to the use of government spending
and taxation to achieve macroeconomic objectives. However, other than such
demand-side policies, governments can also use supply-side policies, which
increase the quantity and quality of resources, and improving technology.
Targeting Inflation
First
and foremost, clearly there are good reasons for governments to use
demand-management or supply-side policies to tackle inflation. This is because
a persistent and sustained increase in the general price level hurts
fixed-income wage earners and retirees on pensions, as well as consumers of
goods and services, who find that their incomes buy fewer goods and services.
Inflation reduces the real value of their incomes. In addition, inflation makes
it difficult for trading and exchanges within an economy, for instance due to
menu costs – the costs of constantly updating prices. Furthermore, inflation
makes it difficult for a country to engage in international trade. This is
because cost-push inflation reduces the competitiveness of a country that
depends on exports, for instance, Singapore , which might suffer from
imported inflation. These culminate in a wider socio-political impact: for
instance, the hyperinflation in Weimar Germany in 1923 led to socio-political unrest
and the collapse of the Weimar
government.
Targeting Unemployment
Yet,
inflation is not the main goal or the only focus of government policies.
Another important goal of government can be to increase employment, or lower
unemployment. Unemployment refers to the situation where people able and
willing to work are unable to find jobs, and can be structural,
demand-deficient, frictional, or seasonal. Being unemployed causes financial
hardships for citizens, therefore governments have to ensure that there is job
creation for citizens. For example, during 2008-2010, in the depths of the
financial crisis and economic recession, there was massive unemployment in many
developed economies, especially in the West. Governments can also tackle
structural, frictional, and seasonal unemployment by focusing on these problems
rather than concentrating their efforts on inflation.
In
fact, reducing inflation sometimes leads to increased unemployment. This is
because if the inflation comes from demand pressures, policies that lower AD
might inadvertently cause demand-deficient unemployment. In a similar vein,
focusing on solving unemployment might lead to higher inflation. This is
because of government failure – governments do not always know where the AD and
AS curves of the economy are, and their actions suffer from time lags and
delays, due to imperfect information. If governments use demand side policies
such as Keynesian fiscal policy, and the economy is near the full employment
level, then an overshooting AD might lead to inflation. Therefore, there is a
trade-off between inflation and unemployment.
Targeting Economic Growth
Another
goal of government can be to raise economic growth, which leads to a rise of
the standards of living in a country, which will generally make citizens better
off. Economic growth is measured by percentage increases in real Gross Domestic
Product (GDP), which measures the production of an economy. Generally, a higher
real GDP per capita means a higher standard of living for the people of that
country. There are two aspects to growth: actual growth measures the rate of
change in the volume of output produced within the country in a year, and
increases mean increased employment, another of the government’s goals.
Potential growth is the percentage annual increase in the economy’s capacity to
produce. Economic growth can be increased via increasing aggregate demand and
increasing aggregate supply. Thus, the government may introduce demand
management policies, such as monetary and fiscal policy, as well as supply-side
policies in order to aid actual and potential economic growth respectively.
Supply-side policies generally lower inflation by shifting LRAS to the right,
and therefore it would seem that there is no trade-off.
However,
increasing actual economic growth sometimes results in more inflation, because
the AD shifts rightwards, and there might be a trade-off to be made between
economic growth and a low rate of inflation; higher rates of economic growth are
generally accompanied by higher rates of inflation, ceteris paribus.
Targeting the BOP
Another
possible macroeconomic aim of government is to maintain a balance of payments
(BOP) surplus. Generally, some governments like Singapore run BOP surpluses for
most years, where export values exceed import values. For example, Asian
countries such as China
have been running huge BOP surpluses, vis-à-vis their trading counterparts,
mainly western countries; they have been selling more exports than imports they
buy, and this provides a net inflow of capital into their countries rather than
an outflow.
However,
running a current account surplus might lead to demand-pull inflation because
exports (X) exceed imports (M), if the economy is already near or at the full
employment level. Therefore there is a trade-off decision to be made between a
current account surplus and demand-pull inflation.
Conclusions
In
conclusion, one disagrees with the statement posed. All the macroeconomic aims of
government are important and the government has to maintain a balancing act,
considering various trade-offs. Also, governments may have to tackle different
problems at different time periods, and thus inflation should not be the primary focus. In the final
analysis, governments should use a combination of demand-management and
supply-side policies to manage society’s macroeconomic aims, and not merely
focus primarily on inflation, because it is one problem among many.
JC Economics Essay - Tutor's Comments: This is the second part to a question on inflation. There are many relevant real life examples in this essay, and this "A" grade essay also tackles a wide range of macroeconomic aims and policies, which makes it a balanced, sound, and well-written Economics paper. In addition, the conclusion is considered, evaluative, and generally quite interesting to read. Overall, it is very well done! However, the usual question applies: if you were an Economics tutor, what would you do to make this Economics paper better? How would you improve on it? To take a specific case: if you were going to edit or correct the conclusion, what better conclusion, or what alternative conclusion to this Economics essay could you come up with? Think, think, think; thanks for reading and cheers!
