Benefits of Macroeconomic Aims and the Need for a Policy Mix

Answer

Part (a)

Governments pursue low unemployment, stable economic growth and low inflation because achieving each yields benefits to the economy.

Low unemployment. Unemployment — those able and willing to work but without a job — represents idle resources. A low rate (1–3%) means fewer idle resources and so less forgone output that could have been produced had those resources been employed. Reducing unemployment thus raises actual output towards the economy’s capacity.

Low inflation. Inflation is a sustained rise in the general price level; a low rate (0–3%) preserves the value of money and purchasing power. Stable prices encourage saving and investment by giving certainty over future costs and returns, raising the marginal efficiency of investment. Higher investment — domestic or foreign — raises productive capacity. For Singapore, low inflation is doubly important: it underpins the FDI the economy relies on, and it keeps export prices competitive, supporting a healthy balance of trade.

Economic growth. Economic growth — a sustained rise in real GDP — raises the standard of living. Higher average incomes raise purchasing power and material well-being; and higher tax revenue lets the government spend more on healthcare and education, raising non-material well-being too.

Part (b)

When these aims are not met, a government must act, and most use a mix of policies to pursue them simultaneously. The reasons are three: conflicts between objectives, the multi-causal nature of macroeconomic problems, and the constraints a government faces. My thesis is that all three justify a policy mix, but conflicting goals is the most fundamental reason, because it alone arises directly from the impossibility of hitting all the internal aims at once with a single instrument.

Conflicting goals. Demand-management used to raise aggregate demand for actual growth and lower unemployment can trigger demand-pull inflation as the economy nears capacity. To grow without inflation, a government must pair demand-side policy with supply-side policy that raises aggregate supply — a mix. Evaluation: the severity of the conflict depends on the state of the economy — expansionary policy in a deep recession is unlikely to cause inflation — and on the economy’s nature, since for an import-dependent economy an appreciation to fight imported inflation erodes export competitiveness, again requiring a supply-side complement.

Multi-causal problems. A single problem often has several causes needing several instruments. Unemployment may be demand-deficient (needing expansionary fiscal or monetary policy) and structural or frictional (needing supply-side policy); inflation may be demand-pull (needing contractionary demand policy) and cost-push (needing deregulation). Evaluation: most macroeconomic problems are indeed multi-causal, and the causes themselves are often linked to the economy’s nature — a small open economy’s cyclical unemployment may be externally induced, its structural unemployment driven by offshoring — so the policy mix must be tailored accordingly.

Constraints. A government’s choice is bounded. One with a budget deficit may lack the funds to spend out of recession and must lean on lower interest rates; one already at near-zero rates must turn to fiscal or exchange-rate policy. Evaluation: constraints too depend on the nature of the economy — under the policy trilemma, a small open economy targeting free capital flows cannot freely use the interest rate, forcing a particular mix.

Judgement. All three reasons are valid and each can be linked to the nature of the economy, so a policy mix is generally necessary. But of the three, only conflicting goals arises directly from a government’s inability to achieve all the internal macroeconomic aims simultaneously with a single policy — multi-causality and constraints explain why particular combinations are chosen, but conflicting goals explains why a single policy is insufficient in the first place. The need for a policy mix is therefore most fundamentally a response to conflicting goals, with multi-causality and constraints shaping the precise composition of that mix.