A government’s fiscal and monetary policies can take on two main forms; expansionary and contractionary demand-management policies. Fiscal policy refers to the manipulation of government spending and direct taxes, while monetary policy refers to central banks manipulating money supply and thus interest rates, to affect the AD of an economy. To argue that these demand management policies should lean more towards keeping inflation low and stable essentially implies that these policies must necessarily be contractionary. A low and stable rate of inflation translates, for most governments of developing countries, to a rate of about 2-3%. This paper argues that, while on the one hand one could agree that in light of the numerous benefits of low inflation, the monetary and fiscal policies of a government should be biased to achieving this end, on the other hand it is imperative to consider the other macroeconomic goals – low unemployment, high economic growth, and a stable balance of payments – a country may also wish to pursue, and in the light of these, may want to reconsider the focus of these demand-management policies.
First and foremost, a government’s decision to focus fiscal and monetary policies on achieving low inflation has many benefits. Primarily, a low inflation rate protects the real income of the majority in the country. Secondly, affordable prices serve to cater to both low and high income groups who can satisfy their basic needs or save, and therefore does not widen the income gap. A low inflation rate also encourages savings at the expense of consumption, since in a high-inflationary environment, the general price level rises rapidly, which implies that rapidly rising prices – especially those of big-ticket items such as houses or cars – mean that consumers will try to make purchases sooner rather than later, before they become even more expensive. High inflation then creates a disincentive to save. Savings together with the atmosphere of stability, confidence and security that low inflation provides promotes investment, which in turn promotes capital accumulation, and hence long run economic growth.
It can thus be argued that another argument for low inflation is that low and stable inflation in fact stimulates economic growth. This would translate to an increase in productive capacity with the building of more factories, hence contributing to the potential growth of the economy, as well as an increase in employment as firms seek out more workers to increase production, as labour is a derived demand. Wages also increase as firms seek to improve productivity which would increase the real income of the masses and hence improve material standards of living. Increase in real income would in turn translate to higher levels of consumption and investments that would, through the multiplier process, cause an additional increase in the national income of the country, more than the initial injection amount.
However, despite these benefits of inflation, given a country’s current economic situation, there may be other more pressing macroeconomic objectives that need to be met that conflict directly with the objective of low inflation rates. Some pressing problems a country may face include firstly low economic growth and material standard of living; a recession, or perhaps the desire of a developing country, one such as China and India, to catch up with the more advanced economies of the world. It is thus not wise in such situations to focus contractionary monetary and fiscal policies on achieving low inflation as it is relatively less important to them at their level of development at the present time. Another problem countries, such as Indonesia and the Philippines, may face is massive unemployment, the situation where people are willing and able to work but are unable to find employment at current prevailing wage rates, and uncontrollable birth rates that could lead to social upheaval, political turbulence, and overall unrest, especially if the government chooses not to address the problems at hand.
Yet another problem faced by a country would be having a huge current account surplus, where exports far exceed imports. Examples of such countries include Japan and China who have been registering record current account surpluses, to the extent that they have proven inflationary, and are under pressure to increase their imports. There is hence a conflict between inflation and maintaining this surplus or giving in to the demands of the rest of the world that governments need to choose between. These conflicts between the other macroeconomic goals of a country and inflation need to be thoroughly analysed first before a conclusive decision can be made.
In conclusion, when it comes to competing macroeconomic aims, there is never an easy answer of whether fiscal and monetary policies should be targeted at achieving low inflation or some other macroeconomic goal, given that there are real and pressing trade offs. Each macroeconomic aim is important in its own way and deserves a policy response from the government. Inflation in the short run is inevitable and a government must carefully consider reducing or ameliorating high inflation. For a country facing a recession, with low growth and unemployment, as well as countries that need to catch up with the more developed economies of the world, focusing monetary and fiscal policies on expansionary intent would be more beneficial. In the light of the problems of slow growth and inflation, a government would be better off choosing to ignore the lesser of the two evils, in this case inflation. Slow economic growth brings with it, not only unemployment but lower standards of living that could translate to social and political turbulences that could impede, not only the efforts of the government in bringing social, political and economic stability to the country, but ultimately hinders the progress of the nation as a whole. Inflation thus becomes a necessary evil by-product of pursuing expansionary monetary and fiscal policies that counter the greater evil of a recession and its dire consequences to the country.
JC Economics Essays - H2 A level economics essay about the macroeconomic goals of governments (part (a) was focused on the causes of inflation) with economics tutors' comments. This economics essay is about the macroeconomic aims and goals of governments and is more broad-based, exploratory, and wide ranging than an "explain" question. Do remember to always take note of the command word and the keywords in addressing the economics question. There can be several ways of approaching this economics topic, but this essay approach seems to be the best and most effective, most productive way to discussing the topic at hand. For improvement: it could bring in more economics concepts, such as Tinbergen's Principle, or could bring in the idea of addressing efficiency versus equity. However, overall, this economics essay is a well written piece of work that adequately addresses the requirements of the question. Remember: always answer the question posed. Do also think of ways in which you would better answer this economics question, or how you would make improvements to this particular method of answering. What would an alternative approach be? How effective is this method of writing? Thank you for reading and all the best for your economics revision.
