Consequences for the Government When Macroeconomic Aims Are Not Achieved

Question

(a) Explain the consequences from a government’s perspective when macroeconomic aims in relation to full employment, price stability and sustainable growth are not achieved. [10]

Answer

The AD–AS framework can be applied to analyse the consequences, from a government’s perspective, of failing to achieve the three internal aims — full employment, price stability and sustainable growth. The unifying thread is that each failure strains the government’s budget and policy capacity, and through that, the standard of living of residents.

Failure of full employment. High unemployment means the country is not making full use of its human resources, with a contractionary effect on the economy. It erodes consumer and investor confidence, lowering C and I; via the reverse multiplier, national income falls by more than the initial fall in spending, and the economy forgoes the opportunity to enjoy higher material living standards. From the government’s standpoint, the salient consequence is fiscal: unemployment cuts tax revenue — the unemployed pay no income tax, prudent consumers pay less consumption tax (GST), and lower production cuts corporate-tax receipts. With less revenue, the government has fewer funds for infrastructure that would aid growth; for economies with welfare systems it must also spend more on transfers. If it is already running a budget deficit, the revenue loss may force spending cuts, which are themselves contractionary and worsen unemployment.

Failure of price stability. High and unstable inflation harms both macro and micro goals. It erodes the internal purchasing power of money: real incomes fall, and low-income households unable to keep pace with the rising cost of living suffer a lower standard of living. This may force cost-of-living adjustments — public demands for higher subsidies on essentials such as fuel and food (as in Indonesia) — necessitating higher government spending and a deteriorating budget position, leaving fewer resources for capacity-building and so hindering potential growth. Inflation also discourages investment: severe price instability makes future sales revenue, costs and returns hard to predict, so firms delay or cut investment in plant and premises, stifling growth and worsening unemployment by depressing the saving and investment on which long-run growth depends.

Failure of sustainable growth. Growth that is not sustainable — rapid industrialisation without careful management — degrades the environment: air and water pollution, industrial noise, congestion and traffic jams, all of which lower the non-material aspects of standard of living. The consequences for governments are tangible today: Beijing’s record 2015 smog forced factory and school closures; haze from Indonesian forest fires required coordinated regional action; New Delhi’s congestion prompted odd-and-even private-transport bans. Tackling these problems consumes resources and strains the government’s budget.

In sum, the failure to achieve the internal macroeconomic aims carries serious budgetary and policy consequences from the government’s perspective, and — material and non-material alike — damages the standard of living of a country’s residents.