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Tim Riley Publications Pty Ltd Year 12 Economics 2014

The Australian government has three key economic objectives it attempts to achieve. Firstly, ittries to sustain a rate of economic growth which leads to permanent employment creation, risingincomes and living standards. Secondly, the internal balance objective consists of trying toachieve price stability and full employment. Thirdly, external balance is the objective of achievinga sustainable current account balance, level of net foreign debt, and a stable exchange rate.

The three main policy instruments used by the Australian government to achieve these objectivesare monetary policy, fiscal policy and microeconomic policy. Monetary and fiscal policies can be

used for the stabilisation of aggregate demand and microeconomic policies (including industrialrelations policy) for long term improvements in resource allocation and productivity in the economy.

ECONOMIC ISSUES Analyse the opportunity cost of government decisions in addressing specic economic

problems or issues;

Investigate structural changes in the Australian economy resulting from microeconomicpolicies;

Apply economic theory to explain how a government could address an economic problem orissue in hypothetical situations; and

Analyse alternative ways to nance a budget decit.

ECONOMIC SKILLS

Explain how governments are restricted in their ability to simultaneously achieve economicobjectives;

Use simple multiplier analysis to explain how governments can solve economic problems;

Identify limitations of the effectiveness of economic policies;

Explain the impact of key economic policies on the economy;

Propose and evaluate alternative policies to address an economic problem in hypotheticaland the contemporary Australian contexts;

Explain, using economic theory, the general effects of macroeconomic and microeconomicpolicies on an economy; and

Select an appropriate policy mix to address a specic economic problem.

TOPIC FOCUS This topic focuses on the aims and operation of economic policies in the Australian economy

and hypothetical situations.

Students should learn to examine the following economic issues and apply the following economic

skills in Topic 4 of the HSC course:

ECONOMIC

POLICIES ANDMANAGEMENT

TOPICFOUR

4

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Year 12 Economics 2014 Tim Riley Publications Pty Ltd

Chapter 13: Economic Objectives and Policies 277

Economic Growth, Full Employment, Price Stability and External Stability 277

Environmental Sustainability and an Equitable Distribution of Income 279

Potential Conicts among Economic Objectives 280 Macroeconomic Policies and the Stabilisation of Aggregate Demand 280

Chapter 14: Fiscal Policy 287

e Federal Government Budget 287

Possible Budget Outcomes 288

e Economic Eects of the Budget 292

Recent Trends in Fiscal Policy 301

Chapter 15: Monetary Policy 311

e Goals or Objectives of Monetary Policy 311

e Implementation of Monetary Policy 313

e Economic Impact of Changes in Interest Rates 316

Recent Trends in Monetary Policy 318

Transparency, Accountability and Eectiveness of Monetary Policy 322

Chapter 16: Microeconomic Policy 329

e Rationale for Microeconomic Policies 329

Structural Change and Microeconomic Policies 332 Reforms in Product Markets 333

Reforms in Factor Markets 335

Regulation, Deregulation and Competition Policy 337

e Costs and Benets of Microeconomic Reform 346

Chapter 17: Labour Market Policy 351

e Role of the National and State Industrial Relations Systems 351

Evolution of the National Industrial Relations System 352

e Role of Institutions in the Current Industrial Relations System 364 Evaluation of the Fair Work Act 2009 367

Evaluation of the Current Industrial Relations System 369

Chapter 18: Australias Recent Economic Performance 377

e Limitations of Economic Policies 377

Australias Recent Economic Performance 380

Glossary and Index 392 Glossary of Terms 392

Index 402

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Tim Riley Publications Pty Ltd Chapter 13: Economic Objectives and Policies 277

Chapter 13

A major rationale for government macroeconomic intervention is to stabilise uctuations in the businesscycle. is is called the conduct of counter cyclical or stabilisation policy. Fluctuations in the businesscycle occur when economic activity (or real output as measured by changes in real GDP) deviates fromits long run trend, causing excessive levels of ination in booms, or excessive levels of unemploymentin recessions. e government uses macroeconomic and microeconomic policies to target long termeconomic growth which can lead to the achievement of rising living standards and economic prosperityfor Australian residents over time. e three major objectives of government economic policy are:

1. Economic growthwhich is sustainable in terms of delivering rising real incomes whilst minimisinginationary pressures and the current account decit as a percentage of GDP;

2. Internal balance, which refers to the achievement of full employment of resources (includinglabour) and price stability where the ination rate is at or near zero; and

3. External balance, which involves nancing import expenditure with export income, stability of theexchange rate, and the levels of net foreign liabilities and net foreign debt as percentages of GDP.

Other objectives of economic policy include ensuring that the benets of economic growth are sharedby the majority of the population in terms of a fair or equitable distribution of income and wealth, andthat economic growth is ecologically sustainable in terms of environmental quality being maintained forcurrent as well as future generations (i.e. intergenerational equity).

ECONOMIC GROWTH AND THE QUALITY OF LIFE

Economic growth involves increasing the economys production of goods and services over time and ismeasured by changes in real GDP, which is nominal GDP (or GDP at current prices) adjusted for therate of ination. Sustaining economic growth is important for a number of reasons:

Increases in the rate of economic growth lead to rising real per capita incomes, employment creationand higher standards of living for the Australian people.

Economic growth is accompanied by an expansion in the economys productive capacity, andthe creation of employment opportunities to accommodate increases in the size of the potential

workforce. is helps to reduce existing levels of unemployment and the rate of unemployment.

Economic growth is consistent with more opportunities for investment in private infrastructure(such as new plant and equipment), and public infrastructure (such as transport, health andeducation), as well as advances in the rate of technological progress, which can all add to the

economys productive capacity and improve the quality of life over time. Economic growth leads to more opportunities to realise the gains from international trade and

investment through the specialisation of production according to comparative advantage. Higherrates of economic growth should be accompanied by increased exports and imports and moreopportunities for employment in export industries.

After the release of the Mortimer Report on industry policy (Investing for Growth) in late 1997, theAustralian government committed itself to going for growth by setting a target of 4% real GDP growthper annum for the Australian economy. is target represented a higher growth outcome than thehistorical average of the 3% annual growth rate achieved by Australia between the 1960s and 1980s.Economic growth averaged 3% to 4% per annum between 1996 and mid 2008. is contributed to asignicant reduction in the unemployment rate from 7% in 1996 to 4.2% by mid 2008. However theGlobal Financial Crisis in 2008-09 led to lower growth and a rise in the unemployment rate to 5.8%.

Economic Objectives and Policies

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Chapter 13: Economic Objectives and Policies Tim Riley Publications Pty Ltd278


FULL EMPLOYMENT

Full employment refers to the achievement of the objective of full employment of the economysresources of land, labour, capital and enterprise. In policy terms, full employment is taken to meanthe full employment of the labour force. If the labour force is fully employed, it is assumed that the

other factors of production will also be fully employed. Full employment is dened as that level ofemployment where the demand for labour is equal to the supply of labour. However this does notmean that unemployment will be zero in the labour market as some unemployment will still exist dueto frictional and structural unemployment. is is known as the natural rate of unemployment.

e non accelerating inflation rate of unemployment(NAIRU) is the rate of unemployment that isconsistent with a constant or non accelerating ination rate. e NAIRU is estimated at 5% to 6% ofthe workforce in Australia. is means that if ination is not increasing (i.e. not accelerating), structuraland frictional factors in the economy would still lead to an unemployment rate of around 5% to 6%.e government attempts to keep unemployment at the NAIRU by containing ination and usingreforms in the labour market (such as enterprise bargaining) to reduce the natural rate of unemploymentover time by increasing the exibility of the labour market and the eciency and productivity of labour.

e important relationship that exists between economic growth and the rate of unemployment isknown as Okuns Law(developed by the American economist Arthur Okun). Okuns Law states thatthe rate of economic growth (e.g. 4%) must exceed the sum of productivity growth (e.g. 2%) and thegrowth in the workforce (e.g. 1%), for the unemployment rate to fall (e.g. by -1%) i.e.

Economic Growth > Productivity Growth + Labour force Growth(e.g. 4%) (e.g. 2%) (e.g. 1%)

Okuns Law provides the theoretical basis for the Australian government wanting to achieve a growth rateof around 4% in real GDP in order to reduce the rate of unemployment. If economic growth exceedsproductivity growth plus labour force growth, there should be a fall in the rate of unemployment.

e main benets of reducing the rate of unemployment include increasing the economys productivecapacity and living standards, and minimising the economic and social costs of unemployment. Forexample, during the Global Financial Crisis in 2008-09 the Australian government used expansionarymacroeconomic policies to support economic growth and minimise the rise in the unemployment rate.

PRICE STABILITY

Price stability or low ination is a major objective of government economic policy because rising inationreduces real incomes and living standards. Rising ination can also cause distortions in the economysuch as a misallocation of resources and a loss in international competitiveness. Rising ination canalso lead to higher inationary expectations (i.e. excessive wage and price demands), which can cause a

wage-price spiral to develop in the economy, leading to an acceleration in the rate of ination.

In the rst Statement on the Conduct of Monetary Policysigned by the former Reserve Bank governor IanMacfarlane and Treasurer Peter Costello in 1996, a target was set for underlying ination of 2% to 3%over the economic cycle. is was formalised as a key operating objective for the conduct of Australiasmonetary policy. e underlying rate of ination is a calculation of ination that removes one o,seasonal or volatile factors from the headline or CPI calculation of ination. However in 1998 changesto the method used to calculate the CPI by the ABS improved its reliability as a measure of ination andthe Reserve Bank adopted the CPI measure as its formal target for ination.

Between 1996 and 2008 ination was contained by the Reserve Bank and averaged about 2.6% perannum. Ian Macfarlane was reappointed governor of the Reserve Bank for a further three years in July2003, and this was contained in the second Statement on the Conduct of Monetary Policyon July 29th

2003 which rearmed the Reserve Banks independence in conducting monetary policy and the use ofan ination targeting regime for the conduct of monetary policy.

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e third Statement on the Conduct of Monetary Policywas released in 2006 by the former Treasurer, PeterCostello. Glenn Stevens was appointed as the new governor of the Reserve Bank for a term of sevenyears. Inationary pressures rose between 2006 and 2008 as the economy reached full employment andcapacity constraints emerged, prompting a tightening in monetary policy. However in 2008-09 lowerdemand and cost pressures due to the Global Financial Crisis (GFC) led to lower ination and an easing

in the stance of monetary policy. With economic recovery in the second half of 2009 and early 2010inationary pressures rose and the Reserve Bank tightened monetary policy to reduce ination.

e fourth Statement on the Conduct of Monetary Policy (30th September 2010) rearmed the ReserveBanks use of ination targeting to conduct monetary policy in a transparent and accountable manner.

A new section was added to the Statement, outlining the Reserve Banks role in using its powers whereappropriate to promote the stability of the Australian nancial system, after the turmoil in nancialmarkets during the GFC. is role was endorsed by Glenn Stevens and the Treasurer, Wayne Swan.

EXTERNAL STABILITY

External stability refers to the goal of Australia meeting its short term and long term nancial obligations

with the rest of the world. External stability has three main dimensions or elements:

1. Ensuring that the current account in the balance of payments is in equilibrium. is means thatthe income received from exports of goods and services, Australias assets abroad, and transfers,nances expenditure on imports of goods and services, Australias external liabilities, and transfers.

2. Maintaining stability of the exchange rate in currency markets through international condence inthe Australian economys performance and the conduct of the governments economic policy.

3. Ensuring that the levels of net foreign liabilities and net external debt are sustainable as percentagesof GDP. e sustainability condition for the current account decit is that it should be kept tounder -5% of GDP to stabilise net external liabilities and the level of net foreign debt over time.

ENVIRONMENTAL SUSTAINABILITYEnvironmental sustainability as an objective of government policy means that current levels of economicgrowth and development should meet the needs of the present generation without compromising theability of future generations to meet their own needs. is reects ecologically sustainable development(ESD) principles by maintaining environmental quality such as clean air and water, and access to otherenvironmental resources. is can be achieved by meeting environmental standards and preservingand conserving both renewable and non renewable natural resources. It also commits the Australiangovernment to meeting its obligations under the Montreal Protocol to reduce CFC emissions; theKyoto Protocol to reduce greenhouse gas emissions; various UN environmental treaties (such as the

Antarctic Treaty and the Law of the Sea Treaty), and the World Heritage, Climate Change, Protectionof the Ozone Layer and Biological Diversity global conventions to preserve natural environments.

EQUITABLE DISTRIBUTION OF INCOME

ere is not perfect equality in the distribution of income in market economies like Australia becauseof dierences in the quality and quantity of resources and their factor income returns. However thegovernment has a social responsibility to redistribute income from high to low income earners tomake the distribution of income more equitable, and to alleviate absolute and relative poverty. egovernments policy objective of achieving a more equitable distribution of income is supported by:

Providing transfer payments to disadvantaged social groups unable to earn market income;

Making the taxation system progressive to redistribute income from high to low income earners;

Using a proportion of taxation revenue to nance spending on elements of the social wage such as

public education, health, transport, housing and community services; and Reducing the incidence of poverty traps through the selective targeting of welfare assistance.

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POTENTIAL CONFLICTS AMONG ECONOMIC OBJECTIVES

In seeking to achieve its economic objectives simultaneously, the Australian government may experienceconicts or tradeos between the main goals of economic policy in both the short and long runs:

Price stability and full employment may conict with each other in the short run because if thegovernment pursues policies to promote economic growth and full employment (such as budgetdecits or cuts in interest rates), economic growth may become unsustainable and lead to inationarypressures and a lack of price stability. Alternatively, government policies (e.g. budget surpluses orrises in interest rates) designed to reduce the rate of economic growth and ination, may lead torising unemployment and the governments inability to achieve the objective of full employment.

Economic growth and full employment may conict with external balance in the short run if anunsustainable rate of economic growth leads to rising import spending (because of excess aggregatedemand) and a deterioration in the current account of the balance of payments. An unsustainablecurrent account decit imposes an external constraint on domestic economic growth and may alsolead to a depreciation in the exchange rate which can raise ination through higher import prices.

e pursuit of microeconomic eciency to raise domestic economic growth may conict in thelong term with full employment as some structural unemployment will result from the structuralchanges induced by various microeconomic reform measures. ese measures may also conict

with achieving a more equal distribution of income if displaced workers suer a loss of income.

Economic growth may conict with environmental quality in the long run if economic growth isecologically unsustainable. is may lead to a depletion of renewable and non renewable resources,increasing levels of pollution, rising rates of land degradation and a reduction in biodiversity.

MACROECONOMIC POLICIES AND THE STABILISATION OFAGGREGATE DEMAND

Macroeconomic policies refer to policies directed at stabilising the aggregate level of economic activity

or aggregate demand. e two main tools or instruments of macroeconomic management are scalpolicy and monetary policy. Fiscal policyrefers to the governments use of the federal budget to aectthe level of economic activity, income distribution and resource allocation in the economy. esescal objectives can be achieved through the governments control of the two budgetary instrumentsof taxation and government spending. Monetary policyon the otherhand refers to the governmentsability, through its monetary authority, the Reserve Bank of Australia, to aect the level of interest ratesin the economy. Changes in interest rates will indirectly aect the growth and cost of credit, therebyinuencing spending, output, prices and employment in the economy. Monetary policy is generallyused for counter cyclical stabilisation in the economy as it is quicker to implement than scal policy.

Macroeconomic policies operate on the demand side of the economysince changes in the settings orstances of scal and monetary policies will impact on the growth of aggregate demand. Changes inthe growth of aggregate demand will then impact on the growth of output (real GDP), employmentand prices. e Australian government may change the settings of macroeconomic policies if theeconomys equilibrium level of income does not coincide with the full employment level of income inthe following situations:

If aggregate demand is less than aggregate supply at the full employment level of income, adeationary gap may occur in the economy and result in a rise in the rate of unemployment.

If aggregate demand exceeds aggregate supply at the full employment level of income, an inationarygap may emerge in the economy and result in a rising price level and ination.

Both of these situations are illustrated in Figure 13.1. e full employment level of national incomeis Yf, where all of the economys resources including labour are fully employed. If the economys

equilibrium level of income is Ye1, aggregate demand (AD1) would be less than the level of spending oraggregate demand (AD) necessary to achieve the full employment level of income at Yf.

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281

A deationary or unemployment gap of abwould arise causing unemployment to increase. e sizeof the deflationary gapis measured by the shortfall in aggregate spending between AD1and AD. is

could occur if there was a recession such as the Global Financial Crisis in the business cycle in 2008-09.e government could try to close the deationary gap of abby easing the stances of monetary and scalpolicies to encourage more spending. is would increase aggregate demand from AD

1to AD in Figure

13.1and could be achieved by using more expansionary settings of monetary and/or scal policies:

e government could ease the stance of monetary policy by cutting interest rates in the economyto encourage consumption and investment spending and the growth in aggregate demand to closethe deationary gap. Lower interest rates would encourage more borrowing and spending.

e government could adopt a more expansionary stance of scal policy (e.g. through a largerbudget decit or a smaller budget surplus) by cutting taxes and/or increasing government spendingto stimulate aggregate demand. If for example, the economys equilibrium level of income at Ye

1

was $1,000m and the full employment level of income at Yfwas $1,200m, the government couldincrease its level of spending by $100m to close the deationary gap. Any change in autonomousgovernment spending (G) will have a multiplier eect (k) on national income (Y). If we assumea scal multiplier of k = 2 then an increase in autonomous government spending (G) of $100m

will lead to an increase in national income (Y) of $200m:

G x k = Y

$100m (G) x 2 (k) = $200m (Y)

Alternatively if the economys equilibrium level of income was Ye2, aggregate demand (AD

2) would

exceed the level of spending (AD) necessary to achieve the full employment level of income of Yf. An

inationary gap of cd would arise causing ination to increase. e size of the inflationary gap ismeasured by the excess of spending between AD

2 and AD. is situation could arise if there was a

boom in the business cycle (such as the resources boom between 2006 and 2008) which caused over fullemployment and ination. e government could try to close the inationary gap of cdby tighteningthe settings of monetary and scal policies to discourage spending and growth. is would lead to adecrease in aggregate demand from AD

2to AD in Figure 13.1and could be achieved by using more

contractionary settings or stances of monetary and/or scal policies:

e government could raise interest rates in the economy, to discourage consumption and investmentspending and the growth in aggregate demand, to close the inationary gap.

e government could adopt a more contractionary stance of scal policy by raising taxes and/or

decreasing government spending to reduce the growth of aggregate demand. is may result in alarger budget surplus (i.e. G < T) or a reduction in the size of an existing budget decit (i.e. G > T).

Figure 13.1: Macroeconomic Stabilisation of Aggregate Demand

Expenditure

National Income

AD

AS

AD1

AD2

YfYe1 Ye20

ab

cd

450

inflationary gap

deflationary gap

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ECONOMIC POLICY INSTRUMENTS AND OBJECTIVES

Macroeconomic theory suggests that a government should have at least as many policy instruments asthe number of objectives it is trying to achieve. is is known as the targets and instruments approachto policy design. If this is the case the government has greater policy exibility and does not need to

achieve more policy objectives than it has policy instruments. Furthermore, for each instrument thereshould be a short term policy target so that the medium or long term objective can be achieved.

Figure 13.2: Economic Policy Instruments and Objectives

Australian Government

Internal Balance Economic Growth External Balance

Economic Policy Instruments

Monetary Policy Fiscal Policy Microeconomic Policy Industrial Relations Policy

Economic Policy Objectives

e Australian government uses a combination of two macroeconomic policy instruments (monetary andscal policies) in the medium term, and one microeconomic policy instrument (in the longer term) toachieve its three main policy objectives as illustrated in Figure13.2. ese objectives include economicgrowth, internal balance and external balance. e Australian government therefore attempts to achievethree policy objectives with three policy instruments. e next step is to assign each policy instrumentto an objective the government is trying to achieve. is is known as policy assignment. e Howardgovernment, the Rudd government and the Gillard government used the following policy assignment:

1. Monetary policy is assigned the role of counter cyclical stabilisation through the use of an ination

target for the conduct of monetary policy by the Reserve Bank. e ination target is explicitlystated as 2% to 3% consumer price ination on average over the economic cycle. e achievementof the ination target set by the Reserve Bank and the Treasurer (i.e. in the Statement on the Conductof Monetary Policy 2010) is a pre-condition for achieving the other two objectives of economicgrowth and full employment.

2. Fiscal policy is largely assigned the role of achieving external balance by ensuring that the budget iskept in balance over the medium term and that higher public saving (through accumulated scalsurpluses) can be used to reduce Australias call on foreign saving. e key relationship is thatthe dierence between domestic saving and investment is equal to the size of the current accountdecit. Aside from balancing the budget over the medium term, the main scal policy target iskeeping the current account decit to under -5% of GDP over time.

Despite scal policy having a more medium term focus in achieving external balance, it can also beused for counter cyclical stabilisation if economic conditions change. is would involve a morecontractionary scal stance if inationary pressures arose in the economy as they did between 2006and 2008 due to the resources boom and capacity constraints. Conversely a more expansionaryscal stance would be adopted if the rate of economic growth fell and the rate of unemploymentrose as occurred in 2008-09 because of the impact of the Global Financial Crisis and recession.

3. Microeconomic policies have a longer term focus by changing the allocation of resources in theeconomy. Microeconomic policies are more eective in promoting structural change or reform inproduct and factor markets to make markets more competitive, ecient and productive. Examplesinclude major reforms in factor markets such as labour market reform and nancial deregulation;

and reforms in product markets, such as the reform of taris and quotas, and the use of the nationalcompetition policy to maintain competitive conduct by businesses in Australian markets.

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ECONOMIC OBJECTIVES AND POLICIES

1. Why does the government use macroeconomic policies to intervene in the economy?

2. Explain the difference between the economic objectives of internal and external balance.

3. Why does the government pursue economic growth as an objective of economic policy?

4. What is meant by full employment? Why does the government pursue the objective of fullemployment?

5. What does Okuns Law suggest about the relationship between the rate of economic growthand the rate of unemployment? What implications does Okuns Law have for the conduct ofAustralian economic policy?

6. How and why does the Australian government pursue the objective of price stability?

7. Which three elements are involved in the Australian government achieving external stability?

8. Briey explain the economic objectives of an equitable distribution of income and ecologicallysustainable development.

9. Discuss the conicts or tradeoffs that may arise in the short and long runs in the simultaneousachievement of the Australian governments main economic objectives.

10. Explain how deationary and inationary gaps may arise in the economy.

11. How can changes in the settings of macroeconomic policies be used to close deationary andinationary gaps by shifting aggregate demand? Refer to Figure 13.1 in your answer.

12. Discuss the targets and instruments approach to economic policy design in Australia.

13. How are macroeconomic and microeconomic policies assigned to objectives by the Australiangovernment?

14. Define the following terms and add them to a glossary:

REVIEW QUESTIONS

aggregate demandaggregate supplydeationary gapecologically sustainable developmenteconomic growtheconomic objectiveseconomic policiesefficiencyequitable distribution of incomeexternal balancefiscal policyfull employment

inationary gapinternal balancemacroeconomic policiesmicroeconomic policiesmonetary policynatural rate of unemploymentnon accelerating ination rate of unemploymentOkuns Lawprice stabilityproductivityresource allocationstabilisation policy

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Year Real GDP CPI Inflation Unemployment Rate Current Account(%r) (%r) (% of workforce) Deficit (% of GDP)

1 3.5 2.0 5.0 -4.5

2 4.2 3.5 4.0 -6.0

3 2.5 2.0 6.0 -4.0

4 2.1 1.8 6.5 -3.5

5 1.5 1.6 7.0 -2.8

Refer to the table above of selected economic indicators for a hypothetical economyand answer the questions below. Marks

1. What stage of the business cycle did this economy experience in Year 2? (1)

2. Explain TWO examples of evidence from the table that suggest Year 5 was a period oflow economic activity in this economy. (2)

3. Describe and account for the relationship between ination and unemployment betweenYears 2 and 5. (3)

4. Explain how the government of this economy could use a combination of macroeconomic

and microeconomic policies to increase economic activity in Year 5. (4)

[CHAPTER 13: SHORT ANSWER QUESTIONS

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[CHAPTER FOCUS ON ECONOMIC OBJECTIVES AND POLICIES

The maintenance of stable economic conditions in Australia has proven to be a challengingtask, with the emergence of unwanted ination and external current account pressures. Policyaction to address these and other pressures has frequently contributed to a short term downturnand inevitably constrained the sustainable pace of economic growth. The source of the problemhowever is the policy failure which permitted these pressures to emerge in the first place.

Source: Commonwealth of Australia (1997), Budget Strategy and Outlook 1997-98.

Explain how conicts or tradeoffs can arise in the Australian governments attempts to achieve itseconomic objectives simultaneously.

The Objectives, Targets and Instruments of Australian Economic Policy

Objective Target Instruments

Price Stability 2% to 3% CPI ination Monetary and scal policies

over the economic cycle

Full Employment NAIRU of 5% to 6% Monetary and scal policies

of the workforce

Economic Growth Sustainable growth of Monetary and scal policies

3% to 4% in real GDP

External Balance Sustainable current account Monetary and scal policies

decit of less than -5% of GDP

[CHAPTER 13: EXTENDED RESPONSE QUESTION

Discuss the main economic objectives of the Australian government and explain how it can usemacroeconomic and microeconomic policies to achieve these objectives.

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ECONOMIC OBJECTIVES AND POLICIES

1. The major rationale for the use of government counter cyclical or stabilisation policies is tocounteract adverse uctuations in the business cycle such as higher ination during booms andhigher unemployment during recessions.

2. The major objectives of Australian government economic policy are to:

Achieve a sustainable rate of economic growth to raise living standards and the quality of life;

Achieve internal balance by securing price stability and full employment of resources; and

Achieve external balance by ensuring export income nances import expenditure, and thereis stability in the level of net foreign liabilities, net foreign debt and the exchange rate.

3. Achieving sustainable economic growth means increasing Australias productive capacity without

adding to inationary pressures or the current account decit as a percentage of GDP.

4. Achieving full employment involves minimising the unemployment rate to the NAIRU which isestimated at between 5% and 6% of the labour force in Australia.

5. Achieving price stability involves the Reserve Bank of Australia meeting its ination target of 2% to3% average CPI ination over the economic cycle.

6. Achieving external balance involves the current account being in equilibrium in the balance ofpayments; ensuring that the levels of net foreign liabilities and net foreign debt are sustainable asa percentage of GDP; and the exchange rate is also stable over time.

7. Other economic objectives of the Australian government include achieving an equitable distribution

of income and environmental sustainability.

8. Conicts can arise between the simultaneous achievement of the Australian governments economicobjectives. For example, the achievement of sustainable economic growth and full employmentmay be compatible in the short run, but could conict with achieving price stability and externalbalance in the long run.

9. Macroeconomic policies such as monetary and fiscal policies are directed at stabilising the growthof aggregate demand. For example, if an inationary gap arises in the economy, it can be closedby the government using a tighter stance of monetary policy to raise interest rates, and fiscal policyto raise taxes and reduce government spending, to reduce the growth of aggregate demand.

Conversely, if a deationary gap arises in the economy, it can be closed by the government using

a more expansionary stance of monetary policy to reduce interest rates, and fiscal policy to reducetaxes and increase government spending, to increase the level of aggregate demand.

10. Microeconomic policies such as tariff reform, the national competition policy and labour marketreform are used by the government to raise productivity, efficiency and international competitivenessin the economy. Microeconomic policies are directed at the supply side of the economy and havea long term focus on improving resource allocation and productivity in markets.

11. The use of microeconomic policies complements the use of macroeconomic policies by improvingcompetition and efficiency, thereby helping the government to achieve its macroeconomic objectivesof sustainable economic growth, price stability, full employment and external balance.

12. A major problem that emerged in the Australian economy between 2005 and 2008 was higher

ination, whereas in 2008-09 the GFC led to lower economic growth and higher unemployment.



CHAPTER SUMMARY

2014 y12 chapter 13_cd

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