Conflicts and Trade-Offs Between Macroeconomic Objectives
A policy conflict occurs when a change that helps a government achieve one macroeconomic objective simultaneously makes another objective harder to achieve.
Before you start
Make sure you're comfortable with these topics first:
Method
- Learn the short-run Phillips curve relationship, an inverse relationship between inflation and unemployment, as the classic example of a policy conflict, and be able to sketch or describe it.
- Learn that many economists argue there is no long-run trade-off, since the long-run Phillips curve is vertical at the natural rate of unemployment, because once inflation expectations adjust, only supply-side policy, not demand management, can permanently lower unemployment.
- Learn the growth-versus-current-account conflict: strong domestic demand growth raises spending on imports via the marginal propensity to import, worsening the current account even as growth and employment improve.
- Learn the growth-versus-inflation conflict: demand-led growth beyond the economy's spare capacity is inflationary, whereas supply-led growth, driven by a rightward shift of LRAS, can raise output without the same inflationary pressure.
- Learn the growth-versus-environment conflict, and how it is discussed in current UK economics, e.g. green growth and decoupling arguments, and carbon taxes as an attempt to address the externality without sacrificing all growth.
- For any 'explain the conflict between X and Y' question, state the mechanism precisely: which policy or change causes X to improve, then trace the specific channel through which Y worsens as a direct result.
- Evaluate whether a conflict is inevitable or can be reduced, e.g. through supply-side policy raising the economy's capacity so growth is less inflationary, a floating exchange rate partly correcting a current account effect, or credible inflation targeting anchoring expectations.
Worked example
A central bank cuts interest rates to reduce unemployment. Explain the resulting conflict with the inflation objective, referring to the Phillips curve.
- A lower interest rate reduces borrowing costs, raising consumption and investment, which shifts AD rightward.
- Higher AD, working through firms' derived demand for labour, raises employment and lowers cyclical unemployment as firms produce more output.
- If the economy has limited spare capacity, the same rise in AD also pushes the price level upward, since firms raise prices as they approach the limits of what they can produce in the short run.
- This trade-off, falling unemployment alongside rising inflation, is exactly the relationship described by the short-run Phillips curve, a movement down and to the right along the curve.
- The conflict shows why the central bank cannot pursue the lowest possible unemployment and the lowest possible inflation with the same interest rate decision at the same time.
Practice questions
Try each question, then tap to reveal the answer.
Q1What relationship does the short-run Phillips curve show?Show answer
Answer: An inverse relationship between the rate of inflation and the rate of unemployment.
Q2What shape is the long-run Phillips curve usually drawn as, and why?Show answer
Answer: Vertical, at the natural rate of unemployment, because once inflation expectations fully adjust, demand management cannot permanently lower unemployment below its natural rate.
Q3Explain briefly why faster economic growth can worsen the current account balance.Show answer
Answer: Faster growth raises household incomes, and since some of any extra income is spent on imports, the marginal propensity to import, import spending rises, which can widen a current account deficit.
Q4Give one reason growth driven by a rightward shift of LRAS is less likely to cause inflation than growth driven by a rightward shift of AD alone.Show answer
Answer: A rightward shift of LRAS raises the economy's productive capacity, so it can produce more output without needing higher prices to ration scarce capacity, unlike a pure AD-driven rise near an unchanged LRAS.
Q5Give one policy that could help reduce the trade-off between growth and inflation.Show answer
Answer: Supply-side policy, e.g. investment in skills, infrastructure or technology, that raises LRAS, allowing higher output with less inflationary pressure.
Q6State one conflict between economic growth and environmental objectives.Show answer
Answer: Growth is often associated with higher output and consumption, which can raise carbon emissions and resource use unless growth is decoupled from environmental damage.
Q7Why might a government use a carbon tax rather than simply restricting growth to address the growth-environment conflict?Show answer
Answer: A carbon tax makes producers and consumers pay for the negative externality of emissions, incentivising cleaner production and consumption, while still allowing output and growth to continue where it is not especially carbon-intensive.
Exam-style questions
Written in the style of a A Level Economics exam paper, with a full mark scheme.
Explain, using the Phillips curve, the short-run trade-off a government faces between reducing unemployment and controlling inflation.
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Evaluate the view that conflicts between macroeconomic objectives make it impossible for a government to achieve all of them at once.
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See real A Level Economics past-paper questions, with official mark schemes →
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