Reasons behind the choice of aims and the criteria that governments may set for meeting each aim

Government and the Macro‑economy – Why Governments Choose Particular Aims and How They Try to Meet Them

1. Why governments pick specific macro‑economic aims

In the Cambridge IGCSE 0455 syllabus the reasons behind the choice of aims must be linked to political, social and economic pressures. The table below summarises the main drivers for each of the five standard aims.

2. Main macro‑economic aims – definition, indicators, typical targets & criteria

3. Conflict matrix – how the aims interact

The syllabus expects a clear statement of the main conflicts. The matrix below links each pair of aims to the typical trade‑off.

4. Government policy tools

4.1 Fiscal policy

Definition: The use of government spending (G) and taxation (T) to influence aggregate demand (AD) and, indirectly, the macro‑economic aims.

Government budget

• Budget balance = G – T
• Budget deficit – when G > T (the government borrows to finance the gap).
• Budget surplus – when T > G (the government can pay down debt or save).

Calculation example

G = £350 bn,   T = £300 bn  
Budget balance = £350 bn – £300 bn = £50 bn deficit  
Deficit as % of GDP (GDP = £2 000 bn) = (50 / 2000) × 100 = 2.5 %

Key elements of fiscal policy

• Government spending (G) – Directly adds to AD. Examples: road building, NHS funding, subsidies for research.
• Taxation
  • Direct taxes – income tax, corporation tax (affect disposable income and profits).
  • Indirect taxes – VAT, excise duties (affect consumption prices).
  • Progressive vs. regressive – influences income distribution.
• Budget stance
  • Expansionary – deficit financing or tax cuts → AD shifts right.
  • Contractionary – surplus or tax rises → AD shifts left.

Effect on AD (short‑run)

• ΔAD = ΔG – ΔT (ignoring multiplier for simplicity).
• With a multiplier (k), the total change in output = k · (ΔG – ΔT).

Diagram suggestion: AD–AS diagram showing an expansionary fiscal package (right‑shift of AD) and the resulting movement along the short‑run Phillips curve.

4.2 Monetary policy

Definition: The control of the money supply (M) and the policy interest rate by the central bank to influence AD, inflation and exchange rates.

Key tools

• Policy (base) interest rate – Determines borrowing costs for households and firms.
• Open‑market operations (OMO) – Buying government securities injects money (expansionary); selling withdraws money (contractionary).
• Reserve requirements – Changing the proportion of deposits banks must hold alters the money multiplier.
• Exchange‑rate interventions – Buying or selling foreign currency to influence the domestic currency’s value.

Money‑multiplier illustration

Reserve ratio = 20 % → multiplier = 1 / 0.20 = 5  
If the central bank creates £10 bn of reserves, total money supply can rise by £10 bn × 5 = £50 bn.

Effect on AD (short‑run)

• Lower interest rates → cheaper credit → consumption and investment rise → AD shifts right.
• Higher rates → opposite effect.

Diagram suggestion: AD–AS diagram with a right‑shift of AD after an expansionary monetary move, plus a short‑run Phillips‑curve illustration.

4.3 Supply‑side policies

Supply‑side measures aim to shift the long‑run aggregate‑supply curve (LRAS) to the right, increasing the economy’s productive capacity without creating inflationary pressure.

• Human‑capital development – Education, vocational training, apprenticeships → higher labour productivity.
• Physical‑capital investment – Infrastructure (roads, broadband) → lower production costs.
• Deregulation & competition policy – Removing unnecessary licences, encouraging entry → more efficient markets.
• Tax incentives for investment – Accelerated capital allowances, reduced corporation tax for R&D.
• Labour‑market reforms – Flexible working hours, reduced redundancy payments, active job‑search programmes.

Diagram suggestion: LRAS shifting right while AD stays unchanged, showing higher potential output with stable price level.

5. How criteria influence policy choice – trade‑offs in practice

When a government sets quantitative criteria (e.g., “inflation ≤ 3 % for three years”), every policy decision must be judged against those limits while still moving other aims toward their targets.

1. Low‑unemployment target may need expansionary fiscal or monetary policy, but the same stimulus could breach the inflation ceiling.
2. Strict inflation target often forces higher interest rates, which can slow growth and raise unemployment.
3. Current‑account balance can be improved by a strong currency (tight monetary policy) yet that weakens export‑led growth and job creation.
4. Equitable income distribution may require higher progressive taxes; excessive rates can dampen work incentives and private investment, harming growth.

Consequently, governments usually adopt a **policy mix** – a combination of modest demand‑side stimulus, targeted supply‑side reforms and carefully calibrated fiscal/monetary settings – to respect all criteria as far as possible.

6. Summary diagram checklist for the exam (Cambridge IGCSE)

• AD–AS diagram showing (a) expansionary fiscal policy, (b) expansionary monetary policy, and (c) a right‑shift of LRAS from supply‑side reforms.
• Short‑run Phillips curve illustrating the unemployment‑inflation trade‑off.
• Laffer‑curve sketch to discuss the relationship between tax rates and tax revenue (relevant to equitable distribution).
• Balance‑of‑payments diagram linking exchange‑rate movements to the current‑account balance.

7. Quick revision table – aims, typical conflicts & most likely policy response