Macroeconomic Objectives and Policies

All governments have the long-term objectives of raising living standards and achieving full
employment. In their attempts to do so, there are short-term trade-offs of the methods used in the
form of inflation and a balance of payments deficit. Thus in order to solve the short-term
difficulties, the government may have to slow down or temporarily suspend the long-term
objectives.

Both in the case od developed and developing countries governments adopt expansionary
policies to stimulate aggregate demand. Based on the Keynesian Theory an increase in aggregate
demand leads to a multiple rise in national output and income. The rise in income can only be
due to an increase in employment of resources. This raises living standards, provided the
population growth rate is less than the economic growth rate.

In an expansionary monetary policy, the government increases money supply. This causes
interest rates to fall which stimulates household consumption and business investment to
increase. In case of expansionary fiscal policy, the government may reduce direct tax rates to
increase disposable income and corporate profits. This enables them to spend more. The
government on its part increases expenditure on public goods and services. An expansionary
fiscal policy might mean that the government will face a budget deficit (PSBR) that will have to
be financed by borrowing.

In developing countries, the government normally takes the lead in increasing income because of
an inadequate private sector. Mainly through borrowing and aid, the government spends on
infrastructure and development of new industries, especially in the secondary and tertiary
sectors.

The above description on how governments try to create jobs and income, definitely leads to one
thing, it increases aggregate demand. If output and income increase proportionately then the
objective would be achieved. However, if output fails to rise proportionately to increase in
expenditure it would cause a rise in the inflation rate.

The causes of income and output not increasing may be due to the following;

Firstly, there might be structural rigidities. Factors of production might be unable to respond to
the increase in demand i.e. factor immobility. The infrastructure in the country might be
inadequate and labour productivity low. Entrepreneurs may be incapable of increasing output
due to lack of management capability. Even political instability and social unrest can be hinder
growth in output.
If the inflation rate rises to 10% or more it would have adverse effects on the economy. It is
counter productive. Real income would fall and workers would therefore negotiate higher wages.
The vicious wage-price spiral eventually causes a loss of competitiveness, business failure and
unemployment. Generally, output and employment fall due to this destruction in the economy.

In order to reduce inflation, the government will be compelled to apply deflationary policies,
with contraction of money supply and reduction in government expenditure while direct tax rates
may rise. However, these short-term objectives will be at the expense of the long-term aim of full
employment because the contractionary policies will slow down the economic growth rate.
Without strong aggregate demand there would be no increase in aggregate supply. Thus, there
will no need to employ additional workers and existing workers might become redundant and
laid off.

In its attempt to achieve full employment and a higher standard of living, a country may find
itself importing goods and services excessively from abroad. This causes balance of payments
deficit resulting in a decrease of forex reserves and depreciation of local currency. If the main
component of imports is in the form of capital goods such as machinery, it will enhance
productive capacity thus enabling a country to achieve long-term stable economic growth in
future. However, if mainly finished consumer goods are imported then although it may reduce
inflation in the short-term by filling shortages, it would be unsustainable in the long-term by
endangering domestic industrialization. This particularly affects developing countries. Hence
barriers to trade would have to be imposed to correct the BoP deficit and to achieve exchange
rate stability.

In conclusion, it can be seen that the macroeconomic aims and policies are inter-related and may
conflict with each other from time to time. This requires continuous diligent political and
economic management by governments.