Macro Economic Targets

Readers Question: I’ve been reading various materials in preparation for an impending interview, and something that occurs frequently is the fact that low inflation has not always been the main macro target. When and why was a low inflation target made the primary objective?

Main Macro Economic Objectives

  1. Maintain positive economic growth (e.g. target growth of around 2.5% which is UK’s long run trend rate)
  2. Maintain low inflation (UK’s target is CPI 2% +/-1)
  3. Maintain full employment
  4. Maintain satisfactory balance of payments (e.g. limit deficit on current account balance of payment)
  5. Maintain stable exchange rate
  6. Keep government borrowing low.

Other possible targets

  • Reduce inequality
  • protect environment

In the post war period, I think it was fair to say, the primary goal was full employment. From the backdrop of the Great Depression, policy makers wished to avoid the blight of very high unemployment levels. Broadly speaking, western governments used demand side policies to try to attain full employment, even if this led to higher inflation. Between 1940 and the mid 1970s, governments were generally successful in keeping inflation low.

Unemployment v Inflation 1949-2010

% annual change in growth and inflation

In the 1970s, cost push inflation factors, made it harder to keep unemployment low without causing high rates of inflation. The old Phillips curve trade-offs seemed to be giving a worse trade-off.

In the early 80s, both UK and US government’s gave greater importance to inflation. In fact the UK tried to keep inflation low through targeting the Money Supply. By seeking to control money supply and inflation,  unemployment rose to 3 million. Many economists criticised the excess importance of controlling inflation, when unemployment was so high.

In 1990, the UK temporarily joined the ERM and sought to target the exchange rate as a way of controlling inflation. This was seen as a failure as the UK was forced to ignominiously withdraw. It was after 1992, that the UK government set a direct inflation target. In 1997, the Bank of England was given independence to set interest rates and target the inflation rate of 2%.

However, bear in mind, the Bank of England’s remit isn’t just about inflation. They also have to consider wider macroeconomic objectives such as growth. Hence why they cut interest rates even with inflation of 5%

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