Economic Policy Objectives

Question 1

Macroeconomic Policy

Objectives (Government)

Answer 1

Australian Government Macroeconomic Objectives:

1. Sustainable Economic Growth
2. Price Stability
3. Full Employment
4. Productivity and Efficient Allocation of Resources
5. Equitable Redistribution of Income

Question 2

Sustainable Economic Growth

Answer 2

• Economic Growth Defn: The increasing capacity of an economy to satisfy it’s needs and wants over time.
• Growth signifies an expansion of a nations productive
  capacity.
• Economic growth is measured via changes in Real GDP, which accounts for distortions resulting from inflation and population change.
• Target range for economic growth is between 3-4% per annum.
• Average growth rate over past 30 years is 3.3%
• Economic growth is generally compatible with the macroeconomic objective of full employment
• > Other things being equal, growth creates the demand for productive resources including labour
• > Extent of the growth – employment link is also determined by improvements in productivity and structural change
• > Growth is necessary to provide opportunities for future employment (especially if population is also growing)
• > Higher employment and growth are directly related because more is produced and aggregate levels of expenditure rise, other things remaining the same
• > The task is to suggest an appropriate rate of growth in recognition of the fact that growth has benefits and costs

Question 3

Economic Growth Costs and Benefits

Answer 3

• Over time, growth increases economic welfare throughout the society
• Growth brings benefits such as increasing levels of real income, and consumption of more - goods and services
• Economic growth may bring costs such as structural unemployment and inflation
• Environmental problems have been associated with high rates of growth
  -> Growth is usually measured in terms of the increasing value of output
  -> GDP doesn’t account for economic ‘bads’
  • E.g. pollution, resource depletion, social problems, etc

Question 4

Price Stability

Answer 4

• Price stability occurs when there is little increase in the general price level that is, low rates of inflation
• Appropriate target for inflation rate is 2-3 per cent
• As price increases,
• > Puts upward pressure on interest rates
• > Reduce buying power of households and firms
• > Erode international competitiveness
• > Widen the distribution of wealth
• > Distort the allocation of resources

Question 5

• Inflation Defn:

Answer 5

• The persistent and appreciable rise in the level of prices

- Some inflation is a sign of increasing demand and a growing economy.

Question 6

Costs and Benefits of Inflation

Answer 6

• Uncontrolled inflation has a number of costs
• > Price rises reduce purchasing power if incomes do not rise in line with price rises.
• > Real income falls
• Low inflation helps maintain low real interest rates
• > Important influence on decisions concerning investment and consumer durables
• > Real interest rate is the nominal interest rate minus the inflation rate
• Inflation discourages both savings and investment
• > Persistent inflation erodes the confidence people have in money as a store of value, so they seek ‘hedges’ against expected price rises
• A way of hedging inflation is purchasing assets which are likely to appreciate in value
• > e.g. Property, Antiques, Precious Metals
• > This speculative activity has a negative impact on the potential output of the economy if it is seen as an easier way to create wealth than production of goods and services
• Investment decisions are more risky in inflationary environment because rising costs and prices may reduce the rate of return they expect from investment projects
• Other things being equal, international competitiveness is eroded by price increases
• > E.g.
• > US could buy a product from either New Zealand or Australia
• > If inflation is higher in Australia than NZ, US will buy from NZ
• > Imports become more competitive in the domestic market as their prices fall relative to those charged by domestic firms

Question 7

Cost of Inflation part 2

Answer 7

• Sustained inflation has impacts the structure of the economy
• > Capital for labour substitution occurs if wages rise faster than productivity, in which case labour ‘prices itself out of a job’ and employers replace labour with machines
• Burden of inflation doesn’t fall evenly on all sectors of economy
• > Households who anticipate inflation may be able to arrange financial affairs to benefit from expected price rises
• Living standards of low income earners and recipients of transfer income will fall during periods of inflation unless these payments are indexed to compensate for price rises
• > Sectors of economy with market power seem more capable of maintaining their real incomes
• Pay as you go taxpayers suffer bracket creep as inflation gradually causes their income levels to rise to levels where they are liable for higher marginal rates of taxation
• > Government revenue increases as a result

Question 8

Full employment

Answer 8

• Occurs when everyone in the workforce who is willing to work can find a job
• Official unemployment data understate the true extent of joblessness in the workforce
• > Many people holding part time or casual jobs would prefer to work longer hours, and are thus underemployed
• Over the long term, persistent unemployment reduces economic growth because the capacity of the economy to satisfy future wants is reduced
• Impossible to achieve zero rate of unemployment due to frictional unemployment and structural change
• > Job search (uncertain matching of demand and supply across the labour market) is responsible for some joblessness
• > Structural unemployment occurs when there is a mismatch of available and required skills in the economy
• > Together, these constitute what economics call the ‘natural rate of unemployment’
• > Lowest rate of unemployment which can be achieved without inflationary pressure developing

Question 9

GDP and Unemployment

Answer 9

• Unemployment represents a GDP ‘gap’ in that actual levels of production and income lie inside those that could be achieved at the PPF
• Gap represents two costs to the economy
• > A direct monetary cost arises because unemployment results in lower levels of aggregate consumption, investment and business confidence and increases the welfare payments paid to the unemployed from employed taxpayer’s pockets
• > Unemployment also has an opportunity cost
• > > > Benefits that could have been obtained had the lost taxation and welfare payments been spent on infrastructure, health or education

Question 10

Australian institutions and economic policy objectives

Answer 10

Three types of government (G) policy:

• Fiscal policy
• > Use of G revenue raising and spending powers to influence the level of economic activity
• Monetary policy
• > Use of interest rates
• Microeconomic reform policy
• > Measures taken to improve the efficiency of the economy
• First two policies concerned with AD management in the short term
• > E.g. stabilising the business cycle
• Microeconomic reform directs itself more towards medium term growth
• > Supply side of economy

Question 11

• Fiscal policy

Answer 11

• Fiscal policy is developed in the G budget – a statement of expected revenue and expenditure issued each May
• Institution mainly responsible for constructing the Budget is a government department (The Treasury) which is responsible to the Treasurer
• Treasury focuses on following economic policy outcomes
• > Economic management
• > G spending and taxation arrangements
• > Taxation and retirement income arrangements
• > Removing impediments to competition in product and services markets

Question 12

• Monetary Policy

Answer 12

• Monetary policy is regarded as most important type of stabilisation policy
• Institution responsible for monetary policy is the RBA (reserve bank of Australia)
• > Two specific obligations
• > Conduct of monetary policy and the maintenance of the financial repayments system
• RBA will do its best for…
• > The stability of the currency of Australia
• > The maintenance of full employment in Australia
• > The economic prosperity and welfare of the people of Australia
• > Price stability is a crucial precondition for sustained growth in economic activity and employment

Question 13

• Compatible policy objectives

Answer 13

• (objectives that can be achieved simultaneously)
• Economic growth and full employment
• > Economic growth creates demand for more goods and services
• > As a result, the resources used to produce these goods and services are also in greater demand (the demand for resources including labour is a derived demand)
• > Economic growth also improves material welfare, so demand will rise, providing further stimulus to the expansion of output and employment
• Full employment and equitable distribution of income
• > Policies designed to lower unemployment should lead to a more equitable income distribution because the proportion of the population who live on welfare payments will fall
• Price stability and economic growth
• > Keeping inflation low is an important prerequisite for promoting long term sustainable growth
• > Low inflation reduces uncertainty and encourages investment in productive activities
• Efficient resource allocation, productivity and economic growth
• > Microeconomic reform promotes efficiency and improved productivity which are the driving force in increasing LRAS

Question 14

• Conflicting objectives

Answer 14

• Price stability and full employment
• > Policies to reduce inflation do so by reducing the level of economic activity
• > Lower consumption and investment means less demand for labour
• > Trying to reduce unemployment by expanding economic activity puts pressure on available resources and prices
• Economic growth and price stability
• > Pursuit of economic growth places pressure on resources if the economy has little excess capacity
• > This may be inflationary in the short run because competition for resources pushes up prices
• Economic growth and structural unemployment
• > Economic growth can be associated with rapid structural change
• > Demand for outdated skills will fall leading to an increase in structural unemployment
• Economic growth and income distribution
• > Not everyone may benefit equally from growth in income
• > People employed in the expanding sectors and owners of appreciating assets such as property shares may gain more than the disadvantaged groups in society