Justifying a combination of policies — the Excellence criterion
The exact wording
Excellence: "justifying a combination of government policies that achieves specific policy objectives relating to one contemporary economic issue and minimises any negative flow-on effects on two other contemporary economic issues", together with "integrating changes shown on economic models into detailed explanations of direct impacts and flow-on effects."
Three requirements:
- A combination — more than one policy.
- It must achieve the objective for the target issue.
- It must minimise the negative flow-ons on the two other issues.
- A single policy cannot meet this criterion, however well justified. The word is combination.
Why a combination works when one policy cannot
- A single demand-side policy shifts AD one way, so it helps one issue and hurts another. There is no way around that with one instrument.
- A combination can use different instruments on different channels:
- One policy shifts AD to hit the target.
- A second policy shifts AS or targets the group bearing the cost, offsetting the flow-on.
The four ways to minimise a negative flow-on:
| Technique | How it works |
|---|---|
| Add a supply-side policy | Shifts AS right — raises growth and lowers the price level, so it offsets both an inflation flow-on and a growth flow-on |
| Target the group bearing the cost | Fiscal policy can reach a region, sector or group that monetary policy cannot |
| Phase or sequence the policies | Spread the adjustment so the flow-on is smaller at any one moment |
| Choose the low-leakage option | Spending with low import content keeps more of the effect in New Zealand, so a smaller policy achieves the same result |
The structure of an Excellence answer
1 — State the objective and the target issue.
2 — Explain the main policy and its direct impact, with the model integrated.
3 — Explain both negative flow-ons, with models.
4 — Introduce the second (and third) policy, and explain specifically which flow-on it reduces and how.
5 — Justify the combination:
- Why this combination rather than the main policy alone?
- Why these policies rather than alternatives?
- What does the combination cost, and why is it worth it?
6 — State the limits.
- What could go wrong; what the combination cannot fix.
Combinations that work
Target: inflation. Problem: unemployment and growth flow-ons.
- Contractionary monetary policy (raise the OCR) to hit the inflation objective, plus
- Targeted fiscal support — income support, training places — for the workers bearing the cost, plus
- Supply-side fiscal spending on infrastructure and skills, which shifts AS right, raising output and lowering the price level.
- Why it works: the supply-side element reduces inflation without the AD contraction, so a smaller OCR rise achieves the same disinflation — a smaller negative flow-on on growth and jobs.
Target: unemployment. Problem: inflation and trade flow-ons.
- Expansionary fiscal policy, but supply-side and labour-intensive — infrastructure, training, home insulation — rather than cash transfers.
- Why it works: infrastructure raises capacity (AS right), which offsets the inflation flow-on; labour-intensive domestic spending has low import content, which reduces the trade flow-on.
Target: economic growth. Problem: inflation and trade flow-ons.
- Supply-side fiscal policy (infrastructure, R&D, skills) plus deregulation that lowers business costs, plus free trade agreements that give firms cheaper imported inputs.
- Why it works: all three shift AS right and the PPF outward, so growth rises while the price level falls — there is no inflation flow-on to minimise.
Worked ExampleA justified combination
Inflation is at 6.5%, well above the RBNZ's target band. If the OCR is raised far enough to bring inflation back quickly, unemployment will rise sharply and export industries will be squeezed by an appreciating NZ$.
Justify a combination of policies that achieves the inflation objective while minimising these negative flow-ons.
Step 1 — Objective and target issue
Target issue: inflation. Objective: return annual CPI inflation to the RBNZ's 1–3% band.
Step 2 — The core policy and its direct impact
Contractionary monetary policy — the RBNZ raises the OCR.
Higher OCR → retail rates rise → and fall → AD shifts left from AD to AD1 → the price level falls from PL to PL1. Reinforced by the exchange rate: higher rates raise demand for NZ$, the NZ$ appreciates, imported goods get cheaper in the CPI and AS shifts right.
This is unavoidable. The RBNZ is legally bound by its Remit, and no other instrument can bring inflation down as reliably. The question is not whether to use it but how far it must be pushed.
Step 3 — The two negative flow-ons
Unemployment. AD left → real GDP falls from Y to Y1 → derived demand falls → DL shifts left to DL1 → employment falls from Le to Le1. On the PPF, the economy moves inside its frontier.
International trade. The appreciation makes exports dearer overseas and imports cheaper here → falls, rises → the balance on goods and services worsens.
Step 4 — Second policy: supply-side fiscal spending
Policy: government investment in infrastructure, skills and training.
Which flow-on does it reduce, and how?
Infrastructure and skills are capital goods and human capital — factors of production. Once in place they lower firms' costs and raise productivity, so AS shifts right from AS to AS1 and the PPF shifts outward.
An AS right shift lowers the price level and raises real GDP at the same time. That means:
- It contributes to the inflation objective without contracting demand, so the OCR does not have to rise as far to achieve the same disinflation.
- A smaller OCR rise means a smaller AD contraction, so the unemployment flow-on is smaller and the appreciation is smaller, reducing the trade flow-on too.
One policy reduces both negative flow-ons, because it works on the opposite curve.
Step 5 — Third policy: targeted fiscal support
Policy: income support, retraining places and regional redeployment for the workers and regions bearing the unemployment.
Which flow-on does it reduce, and how?
Monetary policy is blunt — the OCR applies to every borrower equally and cannot protect anyone. Fiscal policy is targeted, so it can support the specific people losing jobs without adding significantly to economy-wide aggregate demand and therefore without undoing the disinflation.
It also prevents the worse outcome: unemployment that lasts long enough for skills to decay, converting cyclical unemployment into structural unemployment and shifting the PPF inward.
Step 6 — Justify the combination
Why not the OCR alone? It would achieve the objective, but at the maximum possible cost: the entire adjustment falls on AD, so growth, employment and exporters absorb all of it. It also risks the cyclical-to-structural conversion, which is a permanent loss.
Why not fiscal policy alone? Broad fiscal contraction could reduce AD, but the government cannot cut spending precisely or quickly enough, and cutting spending would worsen the unemployment flow-on rather than reduce it. And the RBNZ is bound to act on inflation regardless.
Why not do nothing? Persistent inflation entrenches expectations: workers negotiate to protect real wages, firms raise prices pre-emptively, and a wage–price spiral shifts AS left repeatedly. The disinflation eventually required would be deeper and produce more unemployment in total than acting now.
Why this combination works. Each element does something the others cannot:
- Monetary policy delivers the disinflation, reliably and quickly.
- Supply-side fiscal policy shifts AS right, which lowers the price level and raises output — so it reduces the amount of work the OCR has to do, shrinking both flow-ons.
- Targeted fiscal support protects the people bearing the residual cost without re-stimulating aggregate demand.
Step 7 — State the limits
- Supply-side policies are slow. Infrastructure and training take years, so they do little for inflation this year. Their value is that they reduce how far the OCR must go over the medium term.
- Targeted support costs money and worsens the operating balance, requiring borrowing.
- A smaller OCR rise means slower disinflation, and if inflation stays high too long, expectations may become entrenched anyway.
- Fiscal policy must not fight monetary policy. If the fiscal element is too large or too broad, it shifts AD right just as the RBNZ shifts it left, forcing an even higher OCR. It must be targeted and supply-side, not general stimulus.