Question

In relation to inflation and Economic growth.

Why government or decision makers try to achieve these TWO macroeconomic objectives

Key problems which may be encountered when attempting to balance these two objectives

Evaluate the macroeconomic measures, employing fiscal and or monetary policies, which could be taken to balance these two objectives.

Answer 1

It is possible to maintain employment in the short run along with ensuring economic growth, keeping inflation low and and also maintaining govt. deficit at low levels. This needs a proper combination of demand side and supply side policies both in the short run as well as well in the long run.

During an inflationary level, govt. can adopt contractionary fiscal policy(Raising tax rates and decreasing govt. spending) and central bank can have contractionary monetary policy ( raising interest rates and lowering money supply ). This will lead to low borrowings by investors and business persons and overall output in an economy will go down. Inflation will be in control.

During an deflationary level, govt. can adopt expansionary fiscal policy(lowering tax rates and increasing govt. spending) and central bank can have expansionary monetary policy ( lowering interest rates and increasing money supply ).

However, both these policies have policy conflicts. Example to raise economic output expansionary policies may lead to inflation and cause vicious cycle in an economy.

To avoid these conflicts, a solid supply side policies are needed. These policies are of two types- Market based and interventionist based.

In market based- labour market reforms, encouraging competition and creating a business friendly environment is involved. In Interventionist based policy focus is on creating human and physical capital. If this capital is supporting the policies implemented by govt and central bank then policy conflicts can be lowered and long run solid development can be achieved. However, it should be noted that supply side policies are long term ,need time and investments.

Hence if policymakers want to maintain short term employment at highest level and does not want to stress govt. budget then capacity building through supply side policy along with proper combination of monetary and fiscal policies is needes so that economy is kept busy without inflationary impacts.

Along with these policies exchange rate policies like devaluation or revaluation can also be considered.

For exports to be promoted and ultimately the manufacturing industry to promote job growth devaluation can be suggested. It helps exports more competitive.

Innovation promotion is a part of supply side policy. It mainly aims to create human capital. Human capital along with innovation promotion through research and development makes it effective.

These policies(supply side) are of two types- Market based and interventionist based.

In market based- labor market reforms, encouraging competition and creating a business friendly environment is involved. In Interventionist based policy focus is on creating human and physical capital. If this capital is supporting the policies implemented by govt and central bank then policy conflicts can be lowered and long run solid development can be achieved. However, it should be noted that supply side policies are long term ,need time and investments.

Govt. can promote better schools, colleges and can create schools of excellence . New start ups can also be given incentives. Incubation centers and new labs can be started. Fellowships can be given more.

Innovation through private firms should be respected with patent laws and govt. should focus on creating innovation friendly environment.