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“Governments should focus primarily on a low and stable rate of inflation.” Discuss. [15]



(b) “Governments should focus primarily on a low and stable rate of inflation.” Discuss. [15]

This essay discusses the macroeconomic aims of governments. This essay argues that, while low inflation is an important macroeconomic aim, governments should also focus equally on other macroeconomic aims such as low unemployment, economic growth, and a stable balance of payments. There are a few types of policies that governments can use to achieve their aims. First, monetary policy is the manipulation of monetary variables such as money supply, interest rate and the exchange rate. Second, fiscal policy refers to the use of government spending and taxation to achieve macroeconomic objectives. However, other than such demand-side policies, governments can also use supply-side policies, which increase the quantity and quality of resources, and improving technology.

Targeting Inflation

First and foremost, clearly there are good reasons for governments to use demand-management or supply-side policies to tackle inflation. This is because a persistent and sustained increase in the general price level hurts fixed-income wage earners and retirees on pensions, as well as consumers of goods and services, who find that their incomes buy fewer goods and services. Inflation reduces the real value of their incomes. In addition, inflation makes it difficult for trading and exchanges within an economy, for instance due to menu costs – the costs of constantly updating prices. Furthermore, inflation makes it difficult for a country to engage in international trade. This is because cost-push inflation reduces the competitiveness of a country that depends on exports, for instance, Singapore, which might suffer from imported inflation. These culminate in a wider socio-political impact: for instance, the hyperinflation in Weimar Germany in 1923 led to socio-political unrest and the collapse of the Weimar government.

Targeting Unemployment

Yet, inflation is not the main goal or the only focus of government policies. Another important goal of government can be to increase employment, or lower unemployment. Unemployment refers to the situation where people able and willing to work are unable to find jobs, and can be structural, demand-deficient, frictional, or seasonal. Being unemployed causes financial hardships for citizens, therefore governments have to ensure that there is job creation for citizens. For example, during 2008-2010, in the depths of the financial crisis and economic recession, there was massive unemployment in many developed economies, especially in the West. Governments can also tackle structural, frictional, and seasonal unemployment by focusing on these problems rather than concentrating their efforts on inflation.

In fact, reducing inflation sometimes leads to increased unemployment. This is because if the inflation comes from demand pressures, policies that lower AD might inadvertently cause demand-deficient unemployment. In a similar vein, focusing on solving unemployment might lead to higher inflation. This is because of government failure – governments do not always know where the AD and AS curves of the economy are, and their actions suffer from time lags and delays, due to imperfect information. If governments use demand side policies such as Keynesian fiscal policy, and the economy is near the full employment level, then an overshooting AD might lead to inflation. Therefore, there is a trade-off between inflation and unemployment.

Targeting Economic Growth

Another goal of government can be to raise economic growth, which leads to a rise of the standards of living in a country, which will generally make citizens better off. Economic growth is measured by percentage increases in real Gross Domestic Product (GDP), which measures the production of an economy. Generally, a higher real GDP per capita means a higher standard of living for the people of that country. There are two aspects to growth: actual growth measures the rate of change in the volume of output produced within the country in a year, and increases mean increased employment, another of the government’s goals. Potential growth is the percentage annual increase in the economy’s capacity to produce. Economic growth can be increased via increasing aggregate demand and increasing aggregate supply. Thus, the government may introduce demand management policies, such as monetary and fiscal policy, as well as supply-side policies in order to aid actual and potential economic growth respectively. Supply-side policies generally lower inflation by shifting LRAS to the right, and therefore it would seem that there is no trade-off.

However, increasing actual economic growth sometimes results in more inflation, because the AD shifts rightwards, and there might be a trade-off to be made between economic growth and a low rate of inflation; higher rates of economic growth are generally accompanied by higher rates of inflation, ceteris paribus.

Targeting the BOP

Another possible macroeconomic aim of government is to maintain a balance of payments (BOP) surplus. Generally, some governments like Singapore run BOP surpluses for most years, where export values exceed import values. For example, Asian countries such as China have been running huge BOP surpluses, vis-à-vis their trading counterparts, mainly western countries; they have been selling more exports than imports they buy, and this provides a net inflow of capital into their countries rather than an outflow.

However, running a current account surplus might lead to demand-pull inflation because exports (X) exceed imports (M), if the economy is already near or at the full employment level. Therefore there is a trade-off decision to be made between a current account surplus and demand-pull inflation.

Conclusions

In conclusion, one disagrees with the statement posed. All the macroeconomic aims of government are important and the government has to maintain a balancing act, considering various trade-offs. Also, governments may have to tackle different problems at different time periods, and thus inflation should not be the primary focus. In the final analysis, governments should use a combination of demand-management and supply-side policies to manage society’s macroeconomic aims, and not merely focus primarily on inflation, because it is one problem among many.


JC Economics Essay - Tutor's Comments: This is the second part to a question on inflation. There are many relevant real life examples in this essay, and this "A" grade essay also tackles a wide range of macroeconomic aims and  policies, which makes it a balanced, sound, and well-written Economics paper. In addition, the conclusion is considered, evaluative, and generally quite interesting to read. Overall, it is very well done! However, the usual question applies: if you were an Economics tutor, what would you do to make this Economics paper better? How would you improve on it? To take a specific case: if you were going to edit or correct the conclusion, what better conclusion, or what alternative conclusion to this Economics essay could you come up with? Think, think, think; thanks for reading and cheers!

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