10. Government macroeconomic intervention

To compare countries or years: identify every given indicator; compare each with its explicit target, not merely zero; note the size and persistence of each gap; then make a balanced judgement across objectives. A country with strong growth but high unemployment or an unsustainable external deficit has not achieved all objectives.

Some goals can complement one another: higher sustainable growth often lowers cyclical unemployment, and low inflation may support external competitiveness. Others may conflict: demand expansion can reduce unemployment but intensify inflation or imports; rapid resource-intensive growth can weaken sustainability. The direction depends on spare capacity, supply conditions, time and policy design.

If an import-dependent economy's currency depreciates, external value falls immediately. Dearer fuel and raw materials then raise firms' costs and the price level, so internal value also tends to fall. The size and timing are not one-for-one.

Evaluate with relative—not domestic—prices, PED for exports/imports, import dependence, the exchange-rate regime, spare capacity, capital/primary-income flows and time. A current-account deficit and high inflation may also share a third cause such as excess AD.

Use the AD/AS mechanism and the time horizon. Spare capacity, expectations, imported costs and the position of LRAS determine whether more spending changes real output, the price level or both.

A recovery from recession may raise GDP with little inflation; a boom at capacity may raise prices; a technology improvement can raise output while lowering unit costs.

Start by identifying whether growth comes from domestic demand, export demand or productive capacity. Then trace imports, exports, primary income and financial flows separately. Compare short-run import costs with long-run capacity gains.

A construction boom using imported machinery can widen the current account now but raise export capacity later. If strong growth attracts foreign investment, the financial account and currency may strengthen even while the current account remains in deficit.

Adjustment sequence: (1) the economy begins at the natural rate with expected inflation equal to actual inflation; (2) expansionary fiscal or monetary policy raises AD, moving up-left along the current SRPC to lower unemployment and higher actual inflation; (3) workers and firms revise expected inflation upward and negotiate wages/prices; (4) SRPC shifts upward/right; (5) unemployment returns to the natural rate at higher inflation. Repeated attempts to hold unemployment below the natural rate cause accelerating inflation.

For data, a Phillips-consistent movement is inflation rising while unemployment falls, or inflation falling while unemployment rises, over a comparable period. It does not prove causation. Fiscal stimulus is more likely to reduce unemployment temporarily when spare capacity exists; near the natural rate and with adaptive expectations it mainly raises inflation.

Laffer curve analysis relates a direct-tax rate to tax revenue. Revenue is zero at a 0% rate and, in the stylised model, can fall near 100% because work, declared income, investment or residence shrink and avoidance/evasion rises. A revenue-maximising rate lies between, but its location is empirical and uncertain: below it, a tax cut lowers revenue; above it, a tax cut may expand the base enough to raise revenue. Revenue maximisation is not automatically the same as equity or welfare maximisation.

Evaluation routine: diagnose demand-pull, cost-push, structural or external cause; state the policy-to-AD/AS/exchange-rate chain; test spare capacity, responsiveness and regime; compare short and long run; identify effects on inflation, growth, employment, BOP, development, sustainability and distribution; then choose a policy mix and justify the decisive condition.

Financial crowding out chain: government borrowing sells more securities; attracting funds may require a higher yield; market interest rates rise; some private investment and consumption become unprofitable or unaffordable. Real-resource crowding out also occurs near full employment when government claims scarce labour/capital. In recession with idle resources or accommodating monetary policy, crowding out can be small and public investment may crowd in private activity.

Stagflation exposes a sharp conflict: expansionary fiscal policy can close a negative output gap but worsen inflation, while contraction can reduce demand pressure but deepen unemployment. Cause-matched supply measures may improve both later, but often have fiscal costs and long lags.

Decision test: define the original macro problem and market outcome; state the intervention and causal prediction; compare observed or expected benefits with all direct and indirect costs; compare with realistic alternatives, including modified policy and no intervention; then judge whether the policy is worse on balance and why.

Suppose higher top income tax is intended to raise revenue and fund services, but it induces scarce high-skilled workers to emigrate. The tax base, productive capacity and efficiency may fall. This is government failure only if those losses exceed the revenue/distribution benefits and a feasible alternative tax design would produce a better net outcome.