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Economics 3/4 > 4.1 - Aggregate Demand Policies and Domestic Economic Stability > Flashcards

4.1 - Aggregate Demand Policies and Domestic Economic Stability Flashcards

1
Q

Budgetary (Fiscal) Policy

A
  • The manipulation of the level and composition of Federal Government revenues and expenses, in order assist in the achievement of economic and social goals
  • Main aggregate demand management instrument
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2
Q

Government Revenue

A
  • Incoming money that pays for budget outlays
  • Includes direct taxes, indirect taxes, revenue from government businesses and the sale of assets
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3
Q

Progressive Tax

A
  • Collects proportionally more from higher income earners compared to lower income earners
  • For example - income tax
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4
Q

Proportional Tax

A
  • Collects proportionally identical the same amount from all income earners
  • For example - Medicare Levy, company tax
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5
Q

Regressive Tax

A
  • Collects proportionally more from lower incomes earners compared to higher income earners
  • For example - Goods and Services Tax
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6
Q

Direct Taxes

A
  • Taxes paid directly to the government and usually paid on income
  • Examples: income tax, capital gains tax, Medicare levy, witholding tax, company tax
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7
Q

Indirect Taxes

A
  • Usually taxes on expenditure or consumption
  • Examples: excise duty on coal, petrol, tobacco and alcohol; Goods and Services Tax; Customs tariffs
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8
Q

Non Tax Revenue

A
  • Sale of Government assets – for example, Medibank Private in 2014
  • Profits from Government businesses – for example, Australia Post
  • HECS repayments
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9
Q

Main Government Expenses

A
  • Social security and welfare = 35%
  • Health = 17%
  • Education = 7%
  • Defence = 6%
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10
Q

Government Expenditure (G)

A
  • Government Consumption Expenditure (G1)
    o Goods and services that are consumed in the current budget period, and have no ongoing benefits
    o For example, wages and supplies for schools and hospitals
  • Government Investment Expenditure (G2)
    o Government capital expenditure designed to increase the productive capacity of the economy
    o Includes infrastructure projects
  • Unemployment benefits are not included in government expenditure as they are transfer payments, and will eventually be included in C or I
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11
Q

Budget Outcomes

A
  • Balanced budget – when revenue = expenditure
  • Budget deficit – when revenue < expenditure
  • Budget surplus – when revenue > expenditure
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12
Q

Headline Cash Balance

A

Total cash received by the Government minus total cash paid

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13
Q

Underlying Cash Balance

A
  • Excludes cash flows that do not hare a direct or immediate impact on the economy
  • For instance, future fund earnings and proceeds from asset sales are excluded
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14
Q

Underlying Cash Balance as a Proportion of GDP

A

Shows how expansionary or contractionary the budget is, in comparison to GDP

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15
Q

Fiscal Outcome

A

Total cash received by the Government minus total cash paid only over the relevant budget period

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16
Q

Actual vs Estimate Budget Figures

A
  • Actual budget figures are for the previous financial year
  • Estimate budget figures are predictions for future financial years
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17
Q

Contractionary Budgetary Stance

A
  • Occurs when the budget is in surplus
  • Reduced government expenditure (G) → lower aggregate demand
  • Reduced transfer payments → reduced C + I → lower aggregate demand
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18
Q

Expansionary Budgetary Stance

A
  • Occurs when the budget is in deficit
  • Increased government expenditure (G) → higher aggregate demand
  • Increased transfer payments → increased C + I → higher aggregate demand
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19
Q

Bonds

A
  • Issued by the Federal Government with a promise to pay periodic interest and repay the principle on the maturity date
  • Sell bonds to - RBA, overseas investors, domestic investors
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20
Q

Selling Bonds to RBA

A
  • Involves the RBA purchasing bonds using assets in their vault or by printing money
  • This is the most expansionary and inflationary source of funding
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21
Q

Selling Bonds to Overseas Investors

A
  • Will result in higher net foreign debt and a higher Current Account Deficit due to interest repayments
  • Will also appreciate the AUD due to higher demand for it
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22
Q

Selling Bonds to Australian Investors

A
  • Will result in higher interest rates due to higher demand for money
  • Will ‘crowd out’ the private sector, as there will be less funds available for consumption or investment expenditure
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23
Q

Consequences of a Budget Deficit

A
  • Cost of repaying bonds – may need higher tax and lower government spending to service
  • ‘Crowding out’ of domestic markets
  • Impact on credit rating
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24
Q

Implications of a Budget Surplus

A
  • Able to invest into financial markets
  • Able to repay debt
  • Increases credit ratings
  • Able to place into funds – such as the Future Fund → can act as a buffer against future economic decline
  • Reduces interest rates so increases private consumption and investment spending
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25
Q

Discretionary Stabilisers
+ Their Operation

A
  • Deliberate changes to the composition or volume of receipts/payments
  • Represents the structural component of the budget
  • Includes changes to tax rates and infrastructure projects
    o Decrease in growth → increased discretionary measures → increased growth and net debt
    o Increase in growth → decreased discretionary measures → decreased growth and net debt
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26
Q

Automatic Stabilisers

A
  • Automatic changes to the level of economic activity – government does not have to announce or implement changes to the budget for automatic stabilisers to work
  • Operate counter-cyclically
  • Represents the cyclical component of the budget
  • Includes tax receipts and welfare benefits
    o Decrease in growth → decreased tax receipts and increased welfare benefits → increased net debt and increased growth
    o Increase in growth → increased tax receipts and decreased welfare benefits → decreased net debt and decreased growth
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27
Q

2023/24 Budet Policy:
Instant Asset Write-Off

A
  • Allows businesses to claim up to a $20k deduction from their tax liability when they purchase new assets, equipment or machinery
  • → increased willingness and ability for businesses to purchase → increased private investment expenditure → increased aggregate demand →
  • Impact on SSEG: increased production → increased economic activity
  • Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
  • Impact on Low Inflation: increase demand inflationary pressures → increased inflation
28
Q

2023/24 Budet Policy:
Child Care Subsidy

A
  • Subsidises childcare for families earning up to $530k p.a.
  • Increases disposable income → increased willingness and ability to purchase goods and services → increased private consumption expenditure → increased aggregate demand →
  • Impact on SSEG: increased production → increased economic activity
  • Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
  • Impact on Low Inflation: increase demand inflationary pressures → increased inflation
29
Q

2023/24 Budet Policy:
Infrastructure Pipeline

A
  • $120bn in spending on infrastructure over the next 10 years
  • Increases government investment expenditure (G2) → increased aggregate demand →
  • Impact on SSEG: increased production → increased economic activity
  • Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
  • Impact on Low Inflation: increase demand inflationary pressures → increased inflation
30
Q

2022/23 Budet Policy:
Low and Middle Income Tax Offset

A
  • Reduces the amount of tax payable for low and middle income earners by an additional $420 p.a. to a total of $1500
  • Increases disposable income → increased willingness and ability to purchase goods and services → increased private consumption expenditure → increased aggregate demand →
  • Impact on SSEG: increased production → increased economic activity
  • Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
  • Impact on Low Inflation: increase demand inflationary pressures → increased inflation
31
Q

2022/23 Budet Policy:
Fuel Excise Reduction

A
  • Reduces the fuel excise by 50%
  • Increases disposable income → increased willingness and ability to purchase goods and services → increased private consumption expenditure → increased aggregate demand →
  • Impact on SSEG: increased production → increased economic activity
  • Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
  • Impact on Low Inflation: increase demand inflationary pressures → increased inflation
32
Q

2022/23 Budet Policy:
Cost of Living Payment

A
  • $250 cash payment for eligible pensioners and welfare recipients to assist with cost of living pressures
  • Increases disposable income → increased willingness and ability to purchase goods and services → increased private consumption expenditure → increased aggregate demand →
  • Impact on SSEG: increased production → increased economic activity
  • Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
  • Impact on Low Inflation: increase demand inflationary pressures → increased inflation
33
Q

Strengths of Budgetary Policy

A
  • Able to target specific sectors – increase growth in low growth sectors while not causing excessive growth in other sectors
  • Short time lag for automatic stabilisers to act
  • Short impact lag for policies to have an effect on the economy
  • Able to stimulate aggregate demand directly by increasing C, I and G
  • Checks and balances prevent poorly designed policies from being implemented
  • Public scrutiny increases transparency and accountability so prevents poorly designed policies from being implemented
34
Q

Weaknesses of Budgetary Policy

A
  • Financial restrictions – government can only introduce so many policies as they wish to prevent increasing debt or taxes
  • Can undermine monetary policy
  • Some discretionary stabilisers have long time lags, such as infrastructure projects
  • Lack flexibility as the budget is only delivered once a year
  • Implementation lag as bills take time to pass both houses of parliament and may require cooperation with state governments
  • Less effective at restricting aggregate demand during a boom – government is less able to restrict disposable income of consumers
  • Political hurdles – bills can be blocked by the Senate
  • Political bias – policies may bander to voters or lobby groups
35
Q

Implementation of Monetary Policy

A
  • Target cash rate set by RBA at board meetings
  • RBA manipulation of cash rate allows it to indirectly affect all other interest rates
36
Q

Overnight Money Market

A

o A market in which financial institutions borrow from and lend to each other
o RBA controls the supply of cash (liquidity) in the overnight money market

37
Q

Conventional Monetary Policy

A
  • RBA manipulates the supply of cash in the overnight money market by buying and selling Commonwealth Government Securities
  • Increase interest rates: RBA will sell securities to banks, taking cash out of circulation and reducing the supply of cash (reducing liquidity) → upward pressure on interest rates
  • Decrease interest rates: RBA will buy securities from banks, putting cash into circulation and increasing the supply of cash (increasing liquidity) → downward pressure on interest rates
38
Q

Loosening of Monetary Policy

A

RBA announcing a lower target cash rate → increasing liquidity

39
Q

Tightening of Monetary Policy

A

RBA announcing a higher target cash rate → decreasing liquidity

40
Q

Unconventional Monetary Policy - Foward Guidance

A
  • RBA signals its expectations for monetary policy into the future
  • Expected reduced/stable cash rates → increased willingness to borrow
  • Expected increased cash rates → decreased willingness to borrow
  • For example – 2020, the RBA suggested that the cash rate would not increase for at least 3 years
41
Q

Expansionary/Accommodative Stance

A

Achieved through reducing the cash rate (loosening monetary policy) = <3.5%

42
Q

More Expansionary/Accommodative Stance

A

Growth is able to continue to increase without a change to interest rates as the rates are low enough already to stimulate growth

43
Q

Contractionary/Restrictive Stance

A

Achieved through increasing the cash rate (tightening monetary policy) = >3.5%

44
Q

More Contractionary/Restrictive Stance

A

Growth is able to continue to decrease without a change to interest rates as the rates are high enough already to slow growth

45
Q

Neutral Stance

A

When the cash rate is neither working to stimulate nor contract the economy = 3.5%

46
Q

Transmission Mechanism 1:
Savings and Investment

A
  • Interest rates change the incentives for savings and investment
  • Increase in the cash rate:
    o Consumers are more likely to save → reduced C → decreased AD
    o Consumers and businesses are less likely to borrow → reduced C + I → decreased AD
  • Decrease in the cash rate:
    o Consumers are less likely to save → increased C → increased AD
    o Consumers and businesses are more likely to borrow → increased C + I → increased AD
47
Q

Transmission Mechanism 2:
Cash Flow

A
  • Cash flow: cash available for purpose other than paying interest on loans
  • Increase in the cash rate → increased proportion of income to pay interest → decreased cash flow → decreased C + I → decreased AD
  • Decrease in the cash rate → decreased proportion of income to pay interest → increased cash flow → increased C + I → increased AD
48
Q

Transmission Mechanism 3:
Exchange Rate

A
  • Higher cash rate → foreign investors more willing to save in Australia due to higher returns → increased demand for AUD → appreciation of AUD → decreased international competitiveness → decreased net exports → decreased AD
  • Lower cash rate → foreign investors less willing to save in Australia due to lower returns → decreased demand for AUD → depreciation of AUD → increased international competitiveness → increased net exports → increased AD
49
Q

Transmission Mechanism 4:
Asset Prices

A
  • Higher interest rates → lower demand for assets due to reduced willingness to borrow → decreased value of assets → asset owners become less confident to spend → decreased C → decreased AD
  • Lower interest rates → higher demand for assets due to increased willingness to borrow → increased value of assets → asset owners become more confident to spend → increased C → increased AD
50
Q

Goals of RBA

A
  • Stability of the currency
  • Maintenance of full employment
  • Economic prosperity and welfare
51
Q

Role of RBA

A
  • RBA is responsible for monetary policy
  • Set the cash rate, which influences other interest rates, to control economic activity, employment and inflation
  • Uses underlying inflation as the key statistic to forecast future inflation
52
Q

Implementation of Monetary Policy

A
  • Target cash rate set by RBA at board meetings
  • RBA manipulation of cash rate allows it to indirectly affect all other interest rates
53
Q

Conventional Monetary Policy

A
  • Overnight money market:
    o A market in which financial institutions borrow from and lend to each other
    o RBA controls the supply of cash (liquidity) in the overnight money market
  • RBA manipulates the supply of cash in the overnight money market by buying and selling Commonwealth Government Securities
  • Increase interest rates: RBA will sell securities to financial institutions, taking cash out of circulation and reducing the supply of cash (reducing liquidity) → upward pressure on interest rates
  • Decrease interest rates: RBA will buy securities from financial institutions, putting cash into circulation and increasing the supply of cash (increasing liquidity) → downward pressure on interest rates
54
Q

Loosening of Monetary Policy

A

RBA announcing a lower target cash rate → increasing liquidity

55
Q

Tightening of Monetary Policy

A

RBA announcing a higher target cash rate → decreasing liquidity

56
Q

Unconventional Monetary Policy - Forward Guidance

A
  • RBA signals its expectations for monetary policy into the future
  • Expected reduced/stable cash rates → increased willingness to borrow
  • Expected increased cash rates → decreased willingness to borrow
  • For example – 2020, the RBA suggested that the cash rate would not increase for at least 3 years
57
Q

Stance of Monetary Policy

A
  • Expansionary/accommodative: achieved through reducing the cash rate (loosening monetary policy) = <3.5%
    o More accommodative: growth is able to continue to increase without a change to interest rates as the rates are low enough already to stimulate growth
  • Contractionary/restrictive: achieved through increasing the cash rate (tightening monetary policy) = >3.5%
    o More contractionary: growth is able to continue to decrease without a change to interest rates as the rates are high enough already to slow growth
  • Neutral: when the cash rate is neither working to stimulate nor contract the economy = 3.5%
58
Q

Transmission Mechanism 1:
Savings and Investment Channel

A
  • Interest rates change the incentives for savings and investment
  • Increase in the cash rate:
    o Consumers are more likely to save → reduced C → decreased AD
    o Consumers and businesses are less likely to borrow → reduced C + I → decreased AD
  • Decrease in the cash rate:
    o Consumers are less likely to save → increased C → increased AD
    o Consumers and businesses are more likely to borrow → increased C + I → increased AD
59
Q

Transmission Mechanism 2:
Cash Flow

A
  • Cash flow: cash available for purpose other than paying interest on loans
  • Increase in the cash rate → increased proportion of income to pay interest → decreased cash flow → decreased C + I → decreased AD
  • Decrease in the cash rate → decreased proportion of income to pay interest → increased cash flow → increased C + I → increased AD
60
Q

Transmission Mechanism 3:
Exchange Rates

A
  • Higher cash rate → foreign investors more willing to save in Australia due to higher returns → increased demand for AUD → appreciation of AUD → decreased international competitiveness → decreased net exports → decreased AD
  • Lower cash rate → foreign investors less willing to save in Australia due to lower returns → decreased demand for AUD → depreciation of AUD → increased international competitiveness → increased net exports → increased AD
61
Q

Transmission Mechanism 4:
Asset Prices

A
  • Higher interest rates → lower demand for assets due to reduced willingness to borrow → decreased value of assets → asset owners become less confident to spend → decreased C → decreased AD
  • Lower interest rates → higher demand for assets due to increased willingness to borrow → increased value of assets → asset owners become more confident to spend → increased C → increased AD
62
Q

‘Factors’ Influencing Monetary Policy

A
  • Trends in inflation
  • Levels of national spending and confidence
  • Labour market conditions
  • Budgetary policy stance
  • International developments
63
Q

Strengths of Monetary Policy

A
  • RBA independent from political bias or considerations
  • Short implementation lag due to monthly board meetings
  • Influences expectations of consumers, investors etc
  • Effective at controlling inflation through aggregate demand
64
Q

Weaknesses of Monetary Policy

A
  • Imprecise/blunt instrument – cannot target certain sectors of the economy
  • Long time lag – up to 2 years for impact to take full effect
  • No direct control over interest rates – up to banks to determine whether to implement changes to cash rate
  • Less effective at increasing AD as consumers/businesses may prefer to reduce debts than increase consumption/investment
  • Cannot reduce cost inflation
  • Ageing population → increased reliance on interest rates on savings to spend → decrease in interest rates to stimulate spending may have opposite effect
65
Q

Budget Outcome and Public Debt

A
  • Budget deficit → sell bonds → increase public debt
  • Budget surplus → able to repay existing debt → decrease public debt

Economics 3/4 (6 decks)

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