Macroeconomic Policy Conflicts and the Phillips Curve: Question 10
Syllabus 10.1, 10.3
A government wants to raise its rate of economic growth, reduce unemployment, keep inflation low, and improve its current account of the balance of payments, all at the same time. Which of the following policies is most likely to make progress towards all four objectives together, rather than requiring a trade-off between them?
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Worked solution
Step 1: Recognise why demand-side policies involve trade-offs
Options A and C are both expansionary demand-side policies: they work by raising aggregate demand. This can reduce unemployment and support growth, but as the economy moves closer to its productive capacity this also creates demand-pull inflation, and higher incomes typically raise spending on imports, worsening the current account. These policies therefore make progress on some objectives (growth, unemployment) at the cost of others (inflation, the current account), a trade-off, not simultaneous progress on all four.
Option D is a contractionary demand-side policy. It can bring inflation down, but by reducing aggregate demand it is likely to slow growth and raise unemployment, again a trade-off, just in the opposite direction.
Step 2: Recognise why supply-side policy is different
Option B, investment in vocational education and training, is a supply-side policy. By raising the skills and productivity of the workforce, it increases the economy’s productive capacity (shifting long-run aggregate supply) and helps unemployed workers find jobs matching employer needs, reducing structural unemployment. Because this works through supply rather than by directly boosting demand, extra output and lower unemployment can be achieved without the same demand-pull inflationary pressure created by options A and C. A more productive, skilled workforce can also make domestic firms more internationally competitive over time, supporting export performance and helping the current account, rather than worsening it.
Step 3: Conclusion
Because option B raises productive capacity and reduces structural unemployment without relying on a rise in aggregate demand, it is the option most likely to make progress towards higher growth, lower unemployment, low inflation and an improved current account together, rather than requiring the government to accept an improvement in some objectives at the cost of others.
Final answer
Option B. Supply-side investment in skills and training can advance growth, unemployment, inflation and the current account together, unlike the demand-side options, which each involve a trade-off between objectives.