It is quite often the case that the government
will face conflicts between its various economic objectives. This is highlighted by the Phillips
' curve. In this case, lower unemployment
can be achieved at the cost of higher inflation and vice versa. Keynesian Aggregate Demand
/ Aggregate Supply
analysis shares the same conclusion as the Phillips' curve relationship. In the Keynesian analysis
, unemployment is reduced as the economy moves towards the full employment level of national income, but this is achieved at the price of higher inflation - as seen in the Keynesian AD/AS diagram.
In general, the four government macroeconomic objectives can be split into two pairs of two that go together. Low unemployment and a good rate of economic growth tend to go together, but tend to conflict with the economic objectives of low inflation and a Balance of Payments balance. This is because the first two objectives would benefit from a high level of demand in the economy because this will mean more demand for workers to produce these goods that are demanded. The economy will also tend to grow more rapidly in times of buoyant demand, because domestic producers will expand production to meet the high level of demand. (This is assuming of course that the economy has not reached full capacity). A high level of demand, however, may lead to increasing inflation and a current account defecit on the Balance of Payments. A high level of demand may lead to rising inflation, especially if supply cannot increase to satisfy demand due to supply constraints. Imports may also flood in to satisfy demand if it cannot be satisfied by domestic supply.
Low inflation and balance on the Balance of Payments will tend to be best achieved in times of lower levels of Aggregate Demand. When demand in the economy is low, demand for imports will tend to be low, improving the Balance of Payments situation. A low level of demand will also reduce the possibility of demand-pull inflation. However, in conditions of low Aggregate Demand, the government may find it difficult to achieve its objectives of low unemployment and economic growth. A low level of demand for goods and services will tend to reduce the demand for workers to produce these goods and services, meaning higher unemployment. Similarly, the economy is likely to growl less rapidly if there is a reduced demand for goods and services.
The conflict of objectives highlighted above was evident in the 1950s and 1960s and brought about the implementation of so-called 'Stop-Go' policies. During the 1970s a new phenomenon was encountered called 'Stagflation.' This involved unemployment and inflation rising at the same time, along with very little economic growth. The mid 1980s onwards have seen a return to the situation where inflation and unemployment seem to have inverse relationship with each other, although at the moment the government seems to be able to maintain a low level of inflation, whilst reducing unemployment.
In the classical model of AS/AD, there is no conflict between the government's economic obhectives. Indeed, in this model an increase in AS will tend to achieve a higher rate of economic growth, lower unemployment and put downwards pressure on inflation all at the same time. Many classical economists argue that a low rate of inflation is a pre-requisite for the achievement of the government's major macroeconomic goals.