Chapter 17 - Policy relationships and the current policy mix Flashcards
What is the recent policy mix to fight inflation?
As previously discussed, restrictive MP is primarily used to fight inflation, however it can be supported by both BP and AS policies. Restrictive (contractionary) AD policies to reduce inflation, (e.g. via the delivery of tighter MP and budget surpluses) will be supported by AS policies (such as MRPs) that increase efficiency, reduce costs and boost productive capacity. These AS policies will typically alleviate the (capacity) constraints that resulted in excessive growth in AD and inflationary pressure. Accordingly, the right combination of policies can achieve a reduction in inflation without impacting negatively on the rate of economic and employment growth. This is depicted in the diagram below.
What is the recent policy mix to promote strong and sustainable growth?
Expansionary AD policies that are designed to achieve stronger economic growth will be compatible with AS policies that boost efficiency and productive capacity. The policies will combine to provide both a demand and supply stimulus to the economy, boosting the growth rate of real GDP without creating excessive pressure on inflation. The expansionary AD policies to stimulate growth will tend to add to inflationary pressure in the economy, whilst AS policies reduce inflationary pressure. It is this seeming incompatibility that makes them powerful weapons when combined in the policy mix. The implementation of AS policies actually allows the government to undertake more expansionary AD policies. The AS policies work to boost productive capacity (or aggregate supply), alleviating capacity constraints, and allowing higher real GDP levels to occur without inflationary pressure. In short, AS policies allow expansionary AD policies to stimulate AD and generate sustainable, non-inflationary, economic growth. This is summarised in the diagram below.
What is the recent policy mix to promote Full Employment?
As with strong and sustainable economic growth, all policies have combined to achieve a long term improvement in employment, reductions in unemployment and achievement of the government’s full employment goal. Monetary policy has (and will) focus on reducing unemployment in the shorter term if low inflation is achieved, but it primarily focuses on reducing unemployment over the longer term via the achievement of low inflation. At amacroeconomic level, budgetary policy is sometimes used stimulate economic growth during economic downturns. For example, the downturn experienced in Australia during 2008 resulted in large stimulus programs including cash bonuses and tax reductions in order to contain cyclical unemployment.
However, given monetary policy’s relatively ‘blunt’ nature, and the strength of budgetary policy to have a more microeconomic focus, lower interest rates have been supported by budgetary policy supply side initiatives that seek to increase productive capacity and employment in the long run. A further strength of budgetary policy is its ability to target particular types of unemployment, such as structural or hard-core unemployment,something that cannot be achieved by monetary policy. In addition, the continued implementation of AS side policies, such as the continued roll-out of the NBN, also remain a key component of the policy mix that is also designed to maintain jobs growth and reduce unemployment over the longer term. But most AS policies are unsuited to achieving reductions in unemployment in the short term. On the contrary, AS policies will often create job losses in the short term which then requires supporting budgetary or monetary policies.
What is the recent policy mix to promote external stability?
With respect to external stability, the policy mix used to achieve this goal has changed. It was once the case (e.g. in the late 1980s) that monetary policy was an important part of the policy mix. However, the RBA discovered that tight monetary policy (to reduce the CAD and NFD via a containment of national spending or GNE) was having conflicting impacts on the external sector. On the one hand, the higher interest rates would tend to reduce import spending (or GNE) and help to contain pressure on the CAD. On the other hand, higher interest rates tended to appreciate the AUD and reduce the international competitiveness of Australia’s tradables sector (thereby reducing net exports and increasing the CAD). Monetary policy’s role is now limited to assisting with the achievement of external stability in the longer term via the achievement of low inflation (and its impact on international competitiveness). In addition, it has a key role to play in ensuring that the value of the AUD does not become too volatile (or diverges too far from its fundamental value).
Today, the role of achieving a more externally stable economy is left to the combination of budgetary policy and/or supply side policies, including the benefits of MRPs over time. These policies are used to either:
- increase national savings or
- increase Australia’s share of world income.
National savings can be lifted via the medium term budgetary policy strategy to achieve budget surpluses on average over the course of the economic cycle, as well as other specific measures that will help to raise national savings. This includes superannuation tax concessions and tax breaks on savings more generally.
Increasing Australia’s share of world income can occur via the improvement in international competitiveness that comes from various MRPs, or specific export promotion, such as export market development grants.
What is the recent policy mix to achieve equity in the distribution of income?
While the operation of all expansionary policies can help to improve equity via better long term employment outcomes, the government uses budgetary policy as the primary weapon to achieve greater equity in the distribution of income. This occurs primarily via its control over the progressive tax system, the provision of welfare and the multitude of indirect benefits that provide a benefit to lower income earners (see BP and the distribution of income).
This has been particularly evident over recent budgets, where the Government has introduced a number of initiatives that have been designed with equity in mind, such means testing of family payments and tax cuts that benefit lower to middle income earners. In addition, budgetary policy supply side initiatives, such tax and welfare reform, continue to have an important role to play. While monetary policy and other aggregate supply policies (such as MRPs) can contribute to better equity outcomes in the longer term, they are not designed to target equity as a goal of policy. Indeed, they can actually contribute to negative outcomes for equity in the short term.
What is the recent policy mix to increase living standards?
With respect to living standards, the implementation of any policy action is designed to improve the nation’s overall living standards. This is because all policies (should) seek to ensure that the nation’s resources are used in the best way possible such that living standards are maximised. From this point of view, all policies should be compatible in the longer term. However, there will clearly be occasions when policy combinations are employed that are seemingly at odds with some of the government’s other economic goals. This takes place because policies involve trade-offs or costs which are the outcome of any cost-benefit analysis that is undertaken when policies are formulated. This means that primacy will often be given to the achievement of one goal over another. For example, the government’s very expansionary budgetary and monetary policy measures over 2008-9 helped to maintain stronger growth and employment. However, they added to inflationary and external pressures. Similarly, over 2012-3 the government introduced the Clean Energy legislation (with the carbon tax as the centerpiece and due for repeal in 2014) which was designed to protect our long term prosperity and welfare. However, by increasing production costs across the economy, it conflicts with government efforts to achieve its goals of strong growth, full employment and low inflation in the short to medium term.
On balance, policy makers believed that both the stimulus measures from 2008-9 and the Clean Energy legislation (and a whole host of other policy initiatives) were the best policies to employ in order promote Australia’s economic prosperity or living standards. That is, the benefits of pursuing expansionary budgetary and monetary policies outweighed the costs; and the costs of taking no action to protect against excessive C02 pollution were too high relative to the benefits gained from early intervention via the Clean Energy legislation.
However, it is important to keep in mind a point mentioned earlier in relation tobudgetary policy weaknesses. That is, the political cycle tends to result in some policy actions that are indeed not in the nation’s long term interests, but instead are designed to attract votes and maintain power. Arguably, the eventual decision to repeal the carbon tax in 2014 is an example.
