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Analyse different macroeconomic objectives and policies and summarise the major differences between free market and Keynesian economists’ macroeconomic policies and objectives.Your essay will need to show the difficulties of setting and measuring objectives. It should identify and review the two broad types of policy instruments and explain the idea of policy conflict. You should review the contrasting Keynesian and monetarist’s models of the economy and explain the differences between the 2.
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Analyze different macroeconomic objectives and policies and summarize the major differences between free market and Keynesian economists’ macroeconomic policies and objectives.
Solution
Objectives and policies of Macroeconomics
Objectives:
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Full employment: When government achieves the level of full employment, then its performance is regarded as good. The health of the economy is judged by the number of people who are employed. So the aim of government is to reduce the unemployment and rate of inflation.
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Price stability: It means that fewer fluctuations in the prices are happening in the economy. The government aims to maintain the prices so that a reasonable rate of inflation is maintained in the economy.
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Economic growth: The government tries to increase the rate of output in the economy over time so that the economy gets boosted up and it grows with time. Economic growth is the most important thing to be considered by the government, so it is one of the major objectives of the macroeconomics (Persson, 1990).
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Equilibrium in BOP and stability of exchange rate: The countries aimat maintaining a balanced flow of goods and services so that the monetary reserves of the country remain stable. The balance of Payments has to be maintained by the government. Similarly, the rate of exchange has to be kept balanced so that the currency appreciation and depreciation does not affect the economy much (Blanchard, 2010).
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Social objectives: This policy is also used for attaining the social ends and welfare i.e. the distribution of income is aimed to be fairer and equitable.
These objectives are very difficult to set and achieve because the world is globalized today. If a single country or the government tries to achieve something for the economy like controlling inflation, then the rates and prices of commodities affect the policy of that country. So there are several factors that are to be considered before seeing and meeting these objectives(Persson, 1990).
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Policies:
There are two major policy instruments that are used to achieve the objectives in macroeconomics: Monetary policy and Fiscal policy. The monetary policy is that policy that employs the control of central bank for the money supply. It attempts to stabilize the aggregate demand as it influences the rate of interest in the economy (Cecchetti, 2000). Fiscal policy influences the aggregate demand by altering the program for tax expenditure and debt. Basically, two types of activities are done by the government in fiscal policy- either the government changes the amount of taxes to increase or decrease the money supply, or it changes its spending(Blanchard, 2010).
Policy conflict
When the government tries to achieve more than one objective, or one objective needs to be sacrificed for achieving some other then, policy conflict occurs. Conflicts also occur between different goals for the macro economy and policy makers face a dilemma when none of the policies achieve the desired goals(Blanchard, 2010). Sometimes additional policy measure is used by the government like income policy, price control, etc. For example, conflict occurs between full employment and inflation when the government tries to create jobs by pumping in more money in the form of investment, and hence, the prices go up. So inflation increases when the government tried to achieve full employment.
Review of Keynesian and monetarist’s models of the economy and differences between the two models:
Keynesian economics was developed by British economist, John Maynard Keynes in 1993 in an attempt to understand the Great Depression. Keynes advocates expansionary fiscal policy, which involves increased government expenditure and lower taxes to stimulate Aggregate Demand (AD). Adam Smith developed classical economics in the late 18th and early 19th century. They believe that the market works best when they are left alone and that there is only a small amount of government involvement. The approach is laissez-faire, ‘classical economics focuses on the growth in the wealth of nations and promotes policies that create national expansion' Boundless (2016). In this essay, I will be discussing the different views Keynesian, and Classical economists have on macroeconomic objectives and policies(Cecchetti, 2000).
Maintaining full employment is very difficult as there will always be some frictional unemployment as people are looking for new jobs or leaving education. Full employment implies the economy is operating at full capacity, and there is no output gap or demand deficient unemployment. As well as trying to ensure those who are willing and able to work have jobs, governments are increasingly trying to encourage more people of working age to enter the labor force, according to Bamford et al. (2008, p.107). To achieve full employment, Keynesian economists believe that it is essential for the government to intervene and increase AD when the economy is in a recession. An increase in AD can be attained by expansionary fiscal policy. Keynesian economists believe that expansionary fiscal policy will reduce unemployment. As illustrated below, increasing AD (from AD1 to AD2) will cause Real GDP to increase (Y1 to Y2).
This represents firms producing more goods and services thus increasing the demand for labor. However, this method of attempting to reduce unemployment may cause crowding out according to monetarist economists, this refers to the extent to which an increasing budget deficits leads to higher interest rates and taxation, thus reducing private sector expenditure as consumption and investment spending are adversely affected, according to Lawrence and Stoddard (2009, p.163). Keynes, however, argued that crowding out doesn't always occurs, for instance in a recession and liquidity trap, crowding out wouldn't occur because the government is simply spending unused resources. According to Pettinger (2015), Keynsian argues that in the liquidity trap the liquidity-money curve is elastic. Therefore, increased government spending doesn't increase interest rates.
Monetarist's economists, on the other hand, argue that in the long run, equilibrium in the economy will be at virtually full employment ‘if wages and prices are flexible' (Powers, 2012). Monetarist economists believe that unemployment occurs when wages rise too high to maintain equilibrium. Therefore, when wages increase, firms are unable to pay as many employees thus some may be laid off, increasing unemployment. In this instance, people will have less disposable income causing a fall in consumption and thus AD and prices to fall. Illustrating the monetarist's view that the economy is self-correcting, they argue a high unemployment will mean more people will be seeking work giving firms more variety in who they employee and for how much, resulting in decreasing wages (Branson, 1975). The monetarist's view states that the unemployment rate will constantly go through cycles, however, will always correct itself to the natural unemployment rate. Keynesian economists, however, disagree with this theory, believing that it is vital for the government to intervene in periods of low growth and high unemployment in order to increase the demand for goods and services and encourage businesses to borrow and invest.
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Persson, T., &Tabellini, G. E. (1990). Macroeconomic policy, credibility and politics (Vol. 38).Taylor & Francis.
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Blanchard, O., Dell’Ariccia, G., & Mauro, P. (2010).Rethinking macroeconomic policy. Journal of Money, Credit and Banking, 42(s1), 199-215.
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Cecchetti, S. (2000).Making monetary policy: Objectives and rules. Oxford Review of Economic Policy, 16(4), 43-59.
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Mundell, R. A. (1962). The appropriate use of monetary and fiscal policy for internal and external stability. Staff Papers-International Monetary Fund, 70-79.
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Arestis, P., & Sawyer, M. (2004).Re-examining monetary and fiscal policy for the 21st century. Books.
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Branson, W. H. (1975). Monetarist and Keynesian models of the transmission of inflation. The American Economic Review, 65(2), 115-119.
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Laidler, D. (1981). Monetarism: an interpretation and an assessment. The Economic Journal, 91(361), 1-28.
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Frenkel, J. A., Gylfason, T., &Helliwell, J. F. (1980).A synthesis of monetary and Keynesian approaches to short-run balance-of-payments theory. The Economic Journal, 90(359), 582-592.
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