2.1.1 The Objectives of Government Economic Policy

Overview

Governments typically aim for a mix of macroeconomic objectives rather than focusing on only one.

These objectives often involve trade-offs, so improving performance in one area may worsen outcomes in another.

Economic Growth

Aim: Achieve sustainable economic growth, for example around 2-3% in the UK.

Why it matters: Economic growth raises incomes, living standards, employment, and tax revenues. It is also widely seen as a key measure of economic success.

Low Unemployment

Aim: Achieve a rate close to full employment, for example around 4-5% in the UK to allow for frictional unemployment.

Why it matters: Low unemployment helps maximise output, reduce poverty and inequality, and improve social welfare.

Low and Stable Inflation

Aim: Maintain a low, stable rate of inflation, such as the UK CPI target of 2%.

Why it matters: Low and stable inflation provides certainty for consumers and firms, protects savings, supports international competitiveness, and avoids the costs of hyperinflation or deflation.

Balance of Payments Equilibrium on the Current Account

Aim: Maintain a sustainable current account position, ideally with only a small surplus or deficit.

Why it matters: Persistent large deficits suggest a country is living beyond its means and relying on foreign borrowing. Large surpluses can also create international tension.

Balanced Government Budget

Aim: Balance government revenue and expenditure over the economic cycle.

Why it matters: A more balanced fiscal position helps control national debt. High budget deficits can raise debt-servicing costs, damage confidence, and reduce future policy flexibility.

Greater Income Equality

Aim: Reduce income inequality, often measured by the Gini coefficient, to socially acceptable levels.

Why it matters: Greater equality can promote social cohesion, support economic growth through higher consumption, and is often viewed as fairer. However, complete equality is not usually desirable because it may weaken incentives.

Environmental Protection

Aim: Promote sustainability and reduce negative externalities, for example through targets such as the UK's net-zero commitments.

Why it matters: Environmental protection helps support long-term economic viability and improves quality of life.

Conflicts in Objectives

When the Government pursues one objective, it may involve a trade-off with another objective, especially in the short run. Some common examples include:

• Economic growth vs. low inflation: Rapid growth can lead to demand-pull inflation, while policies to reduce inflation may slow growth.
• Economic growth vs. environmental protection: Growth may increase pollution and resource depletion, while environmental policies may restrict growth.
• Low unemployment vs. low inflation: Reducing unemployment may increase wage pressures and inflation, while anti-inflationary policies may increase unemployment.
• Low unemployment vs. balance of payments equilibrium: Policies to reduce unemployment may increase imports and worsen the current account balance, while policies to improve the current account may reduce domestic demand and increase unemployment.