The macroeconomic aims of government: full employment/low unemployment

Government Macro‑economic Intervention

1. The Five Macro‑economic Aims (Cambridge IGCSE 0455)

Students must be able to define each aim, explain why it is important and identify the main conflicts that can arise between them.

• Economic growth – increase in real national income (real GDP).
• Full employment (low unemployment) – keep cyclical unemployment as low as possible while accepting a natural rate of frictional + structural unemployment.
• Price stability – keep inflation low and predictable.
• Balance‑of‑payments stability – avoid large, persistent deficits (or surpluses) in the current account.
• Equitable distribution of income – reduce poverty and inequality (often linked with sustainable development).

1.1 Typical Conflicts Between the Aims

2. Why Full Employment Matters

• Reduces waste of labour resources and raises national income.
• Keeps wage pressures moderate, helping to contain the cost of living.
• Improves social stability and reduces spending on unemployment benefits.
• Broadens the tax base, giving the government more resources for public investment.

3. Measuring Unemployment

Unemployment rate (U) – the main indicator used in the syllabus:

\$U = \frac{\text{Number of unemployed people}}{\text{Labour force}} \times 100\$

Other useful measures (often examined in exam questions):

• Under‑employment rate – people working part‑time who would like full‑time work.
• Long‑term unemployment – unemployed for 12 months or more.
• Youth unemployment – unemployment rate for people aged 15‑24.

4. Types and Causes of Unemployment

5. Government Tools to Promote Full Employment

5.1 Fiscal Policy

Definition: Government decisions about the level of government spending (G) and taxation (T) to influence aggregate demand (AD).

Government budget

• Revenue = taxes + other income (e.g., fees, dividends).
• Expenditure = current spending + capital spending + interest payments.
• Budget balance:

  • Budget deficit = (G + interest payments) − T
  • Budget surplus = T − (G + interest payments)

Reasons for taxation (Cambridge syllabus)

• Raise revenue for public services.
• Redistribute income (progressive tax).
• Influence behaviour (e.g., fuel duty to reduce pollution).
• Control aggregate demand (indirect taxes can be used to cool the economy).

Types of tax

Fiscal multiplier (simplified)

\$\Delta AD = k \times \Delta G \qquad\text{or}\qquad \Delta AD = k \times (-\Delta T)\$

where k is usually between 1 and 2 for the IGCSE.

Worked numeric example

1. Government decides to increase spending on a new road network by £20 million.
2. Assume a multiplier of 1.8 (typical IGCSE range).
3. Increase in AD = 1.8 × £20 m = £36 million.
4. The extra demand raises real output, moving the economy towards full employment and reducing cyclical unemployment.

Typical expansionary measures to combat cyclical unemployment

• Increase G – e.g., build schools, hospitals, infrastructure.
• Cut T – e.g., reduce income tax rates or introduce tax credits for low‑income households.

5.2 Monetary Policy

Definition: Actions by the central bank to control the money supply (M) and the policy interest rate (i), thereby influencing aggregate demand.

Key tools (Cambridge syllabus)

• Policy interest‑rate (base rate) – set by the central bank.
• Open‑market operations – buying or selling government securities.
• Reserve‑requirement ratio – proportion of deposits banks must hold as reserves.
• Quantitative easing – large‑scale asset purchases (optional for A‑Level).

Interest‑rate channel (simplified)

1. Central bank lowers the policy rate.
2. Commercial banks can borrow cheaper → they lower loan rates for firms and households.
3. Cheaper credit encourages investment (I) and consumption (C).
4. Higher C + I raises AD, moving output toward the full‑employment level.

When monetary policy works best

• Economy has spare capacity (output gap is large).
• Inflation expectations are low.
• Financial system is functioning (banks willing to lend).

5.3 Supply‑side Policies (Long‑run focus)

These policies aim to increase the economy’s productive capacity, making it easier for labour to be employed and reducing structural unemployment.

1. Education and vocational training – raise skill levels and adaptability.
2. Labour‑market flexibility – reduce hiring/firing costs, reform unemployment benefits, promote part‑time and flexible contracts.
3. Enterprise and entrepreneurship – simplify start‑up procedures, provide business‑advice services, protect property rights.
4. Tax incentives for investment – accelerated capital allowances, lower corporation tax for firms that create jobs.
5. Infrastructure investment – improve transport, communications and energy networks to lower production costs.
6. Promoting competition – remove barriers to entry, enforce antitrust law, deregulate sectors where appropriate.

5.4 Exchange‑rate and Balance‑of‑Payments Policies (optional for A‑Level)

To maintain balance‑of‑payments stability governments may use:

• Exchange‑rate policy – devaluation to make exports cheaper and imports more expensive (improves the current account).
• Export promotion – subsidies, tax relief for export‑oriented firms.
• Import controls – tariffs or quotas (used sparingly because they can provoke retaliation).
• Capital‑flow management – controls on short‑term speculative inflows/outflows.

6. Policy Evaluation – Points for Exam Answers

When assessing any policy, students should consider the following criteria (aligned with IGCSE evaluation marks):

• Impact on the five macro‑economic aims – does the policy help growth, employment, price stability, BOP stability and income distribution?
• Inflationary pressure – expansionary demand‑side policies may push AD beyond potential output.
• Budget deficit & public debt – higher G or lower T can increase borrowing, leading to future tax burdens.
• Crowding‑out – large government borrowing may raise interest rates, reducing private investment.
• Time lags – recognition, implementation and impact lags can cause policies to act too late or too early.
• Distributional effects – who benefits? Tax cuts may favour higher‑income households; public‑work programmes target the unemployed.
• Supply‑side vs. demand‑side – supply‑side measures improve long‑run potential but take time; demand‑side measures give quicker results but risk inflation.
• External sector considerations – expansionary fiscal policy can worsen the current‑account deficit if imports rise faster than exports.
• Political feasibility – public opinion, lobbying groups and electoral cycles can affect the choice and timing of policies.

7. Illustrative AD‑AS Diagram (description)

• Vertical axis: price level (P); horizontal axis: real output (Y).
• Potential output (Yₚ) = full‑employment level of output.
• If AD is left of Yₚ, the economy has an output gap → unemployment.
• Expansionary fiscal or monetary policy shifts AD rightward (AD₁ → AD₂), moving equilibrium from point A (high unemployment) to point B (closer to Yₚ) and reducing cyclical unemployment.
• If AD is shifted beyond Yₚ, the new equilibrium lies above potential output, generating inflation.

8. Key Points to Remember

1. Full employment aims to keep cyclical unemployment low while accepting a natural rate of frictional + structural unemployment.
2. Demand‑side policies (expansionary fiscal and monetary policy) are the most effective tools for reducing cyclical unemployment in the short run.
3. Supply‑side policies tackle structural problems and raise the economy’s long‑run growth potential.
4. Balance‑of‑payments stability is a core macro‑economic aim; expansionary policies can worsen the current account, so policymakers must balance the trade‑off.
5. Policy makers must weigh the benefits of lower unemployment against risks such as inflation, larger deficits, crowding‑out, time lags, distributional impacts and external‑sector effects.
6. Understanding how the five macro‑economic aims interact helps explain why governments sometimes prioritise one aim over another.