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Objectives of Government Policy


What is macroeconomics?

Macroeconomics is concerned with issues, objectives and policies that affect the whole economy. All economic analysis that refers to aggregates is macro. The UK unemployment rate, the UK inflation rate, the rate of economic growth in the UK; these are all UK aggregates and therefore macro issues.


What Are The Major Objectives Of Macroeconomic Policy?

The four major objectives are (i) full employment, (ii) price stability, (iii) a high, but sustainable, rate of economic growth, and (iv) keeping the Balance of Payments in equilibrium. First, we will look at the way in which these objectives are measured. Secondly, we shall discuss the relative importance of these objectives. Thirdly, we shall see how successful recent governments have been in achieving these goals. Finally, we will look at the difficulties that governments have in trying to achieve all the objectives at once.


Which Objective Is The Most Important?

In the 1960s, the Balance of Payments was considered very important. A deficit was considered highly embarrassing in the days when many still believed, mistakenly, that Britain was a world power. The long term sustainability of a deficit was a big problem in the days before global free movements of capital, and so sterling would be affected which was unacceptable within the 'Bretton Woods' fixed exchange rate system. Nowadays, with a floating pound and huge global capital flows, many economists believe that balance of payments deficits or surpluses simply do not matter. This was reflected in the fact that nobody seemed to bat an eyelid at the continual deficits of the 90s.


Full employment was considered very important after the Second World War. It was probably the number one objective of the socialist government of the late 40s and continued to be at the front of politicians' minds for the next three decades. Unemployment exploded under Thatcher in the 80s, but it was seen as an inevitable consequence of the steps taken to make industry more efficient. It was painful at the time but the lower levels of unemployment today are due, in part, to the structural changes made in the 80s. The fact that de-industrialisation was occurring throughout the western world also made higher unemployment feel inevitable, and so this objective became much less important than it had been.


Growth and low inflation have always been important. Without growth peoples' standard of living will not increase, and if inflation is too high then the value of money falls negating any increase in living standards. Nowadays these are definitely the two most important objectives of UK macroeconomic policy. The Chancellor is always going on about 'sustainable growth', meaning growth without inflation. Probably the biggest piece of economic news each month is the decision taken by the Monetary Policy Committee (MPC) over interest rates, their sole objective being the 2.5% target for the growth in RPIX (plus or minus 1%). It is probably worth noting at this stage: do not confuse objectives of macroeconomic policy with the instruments used to achieve these aims. Low inflation is an objective, the rate of interest is an instrument used to control inflation, not an objective in itself.


If one had to pick the most important objective today, it would have to be inflation. Although it should be growth, all government's efforts are devoted to the control of inflation. If this goal is missed, it is felt, then the goal of higher growth will not be attainable either.


How Successful Have Recent Governments Been In Achieving These Goals?

On growth, there tends to be periods of strength (booms) followed by periods of weak or even negative growth (recessions). This is known as the economic cycle. All governments have a goal of eliminating this cycle. In other words, they want continual, reasonable growth that never ignites inflation, perhaps 2% - 3% per annum. Recent governments have moved closer to this 'Goldilocks' scenario (not too hot and not too cold). Notice that the growth rate has been over 2% without getting out of hand for six years. Following the bust/boom/bust of the early 80s/late 80s/early 90s, this is quite an achievement.



Inflation has also been remarkably subdued by historical standards. Following the horribly inflationary 70s (peaked at 25%) and the near 10% figure ten years ago, RPIX has been growing at 3% pa or less for six years.


The goal of full employment has effectively been consigned to the history books. Unemployment reached one million in the 80s for the first time since the 30s, and then proceeded to reach 3 million (or 4 million, depending on the definition) within three years. Having said that, 'full employment' does not mean that everyone has a job. Even in the 'full employment' era of the 50s there were still 300,000 unemployed. Today's figure is falling towards one million which some consider to be fairly close to full employment given the increased flexibility of the UK labour .


It is a sad fact of economic life that UK consumers prefer imported goods to those made in Britain. The extent of the current account deficit mainly depends, therefore, on how well we export our services. Unfortunately, services are not quite as exportable as goods, so the UK is always fighting a losing battle. Hopefully the changes in technology, and our abilities to exploit them, will allow us to increase our exports of services by enough in the future to allow for the deficit in goods. Some economists believe that there is no problem, because in a world of perfectly mobile capital, the UK no longer relies entirely on their own pool of foreign reserves to pay for its imports. Nowadays, if you want something from abroad but you do not have the foreign currency, then just buy it on the Foreign Exchange Markets.




E-mail Steve Margetts