The variables that can be influenced by Macroeconomic policy are:

• Economic growth
• Full employment
• The balance of payments
• The rate of inflation

These targets are not always compatible and the history of macroeconomic policy making has often been characterised by confusion over which targets governments should aim for and, until relatively lately, an inability to achieve a sustainable balance between them. (see 4.2 Monetary Policy).

Policy aimed at providing a high level of economic growth and low levels of unemployment, for instance, risks pushing the rate of inflation above acceptable levels or causing a deficit in the balance of payments.

The former would occur if the rate of growth in gross domestic product accelerated above its long-term potential rate of growth (see Macroeconomic Policy 4.2 Monetary Policy - Estimating the trend rate of growth ) at a time when there was not enough spare capacity in the economy to cope with the extra demands.

A deterioration in the external balance, on the other hand, would occur if domestic demand (i.e. consumer spending plus government spending plus investment plus stockbuilding) were to grow faster than gross domestic product.

In this case, the gap between domestic demand and the economy’s ability to supply that demand would have to be filled by extra imports or by potential exports being shifted to the domestic market.

The rationale for this is that low and stable inflation is thought to be beneficial to long term growth.

The 1997-98 Financial Statement and Budget Report summed up the argument as follows:

“Economies work best when inflation is low and stable. Inflation imposes costs on the economy by distorting the economic decisions of consumers and producers. It arbitrarily redistributes income and wealth and distorts investment and saving decisions.”

In an article in the May 1995 Bank of England Quarterly Bulletin, Professor Robert Barro concluded that an increase in average inflation of ten percentage points would reduce the annual growth in real gross domestic product per head by 0.2 to 0.3 percentage points.