Economic Policy Objectives Flashcards
What are the four major economic roles of the government?
- Provision of goods and services.
- Provision of welfare services.
- Regulation of business enterprises.
- Macroeconomic management.
What was the objective of the 1945 ‘White Paper’?
“Stimulate spending on goods and services to the extent necessary to maintain full employment.”
What are the three main macroeconomic objectives of the government?
- Price stability (inflation between 2 and 3 per cent).
- Economic growth (target rate is between 3 and 4 per cent).
- Full employment (target rate of 5% unemployment).
Define economic growth.
Economic growth is defined as the increasing capacity of the economy to satisfy the material needs and wants of its members.
Why are high rates of economic growth unsustainable?
High rates of economic growth are unsustainable in a mature economy because it places pressure on the factor market (e.g. labour and raw materials) and risks driving up their prices (demand inflation).
What were the economic policy goals of the 1965 Vernon Report?
- High rate of growth.
- High rate of population growth.
- Full employment below 1-1.5% of the workforce.
- External viability.
- Stability of costs/prices
- Increasing productivity
- Rising living standards.
How and why might the Vernon Report no longer apply to government policy?
- Rapid economic growth is regarded as unsustainable from an environmental point of view.
- External viability is no longer valid. We now have a floating exchange rate (1983).
- Population growth is no longer relevant, as it was in the 50’s and 60’s when it was required to support infrastructure and resource projects needed to support the growth of a manufacturing economy. Knowledge and skills are more important today.
What happens when economic growth is too slow.
When economic growth is too slow, there is insufficient demand to employ those resources.
What does the extent to which growth helps achieve higher employment depend on?
The extent to which growth helps to achieve higher employment depends on whether the growth rate exceeds the rate of growth of the population and workforce. The extent of the growth-employment link is also determined by improvements in productivity, and structural changes.
What are the main benefits of economic growth?
- Delivers higher real incomes.
- Enables people to consume more goods and services.
- Creates more demand for productive resources, including labour.
What are the main costs of economic growth?
-Possibly unsustainable, pressure is placed on factor markets and risks driving up their prices (demand inflation).
Define price stability. What is the appropriate target?
Price stability occurs when there is little change in the general price level- that is, there are low rates of inflation.
The appropriate target for the inflation rate is 2-3 per cent.
What are the negative economic impacts of high inflation?
The negative economic impacts of high inflation are that high inflation reduces the buying power of households and firms, puts upward pressure on interest rates, erodes international competitiveness, widens the distribution of wealth and distorts the allocation of resources.
How does inflation erode the purchasing power of incomes?
Inflation erodes the purchasing power of household incomes (real incomes). Consumers are able to buy a smaller quantity of goods and services than they previously could, unless of course their income increases at the same rate as general prices.
Why must interest rates increase when prices rise?
When prices rise, interest rates must follow otherwise lenders are paid in inflated dollars which do not provide a positive rate of return. The real interest rate is more important than the nominal interest rate.
What is the effect of an increase in price on international competitiveness?
International competitiveness is eroded by price increases. For example, if inflation in Australia is higher compared to in New Zealand, the Australian product becomes relatively more expensive. Therefore, Australian products are less competitive.
This means there will be less exports, and so an increase in the CAD.
Similarly, imports become more competitive in the domestic market as their prices fall relative to those charged by domestic firms.
What is the relationship between inflation and the exchange rate?
The relationship between inflation and the exchange rate is a double-edged sword.
If our inflation rate was higher than that experienced overseas, we would predict a currency depreciation because demand for our exports would fall.
But, a depreciation means exports become more competitive, and imports become more expensive. The price of imports rise, which is inflationary.
Overall, the effect of a depreciation on inflation depends on the elasticity of imports and exports.
What is the effect of persistent inflation on confidence and investment decisions?
Persistent inflation erodes the confidence people have in money as a store of value, so they seek ‘hedges’ against expected price rises.
They purchase assets that are likely to appreciate in value e.g. property, antiques, or precious metals.
This speculation has a negative impact on the potential output of the economy.
Investment decisions are more risky in an inflationary environment because rising costs and prices make it more difficult to determine a rate of return on investment.
Give two examples of how sustained inflation may help to bring about structural changes in the economy?
e. g. Capital-for-labour substitution occurs if wages (the price of labour) rise faster than productivity, in which case labour ‘prices itself out of a job’, and employers replace labout with machines.
e. g. The rising oil prices that led to cost push inflation in the 1970s provided an incentive for companies to focus on energy efficiency and reducing fuel consumption.
How can households benefit from price increases?
Households that are able to anticipate inflation may be able to arrange their financial affairs to benefit from expected price increases, e.g. buy property.
How can sustained inflation effect taxation and government revenue?
Sustained inflation also effects taxation and government revenue. ‘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.
When does full employment occur?
Full employment occurs when everyone in the workforce who is willing and able to work can find a job.
Explain some issues hidden by the official unemployment rate.
- ABS data understates 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.
- The average duration of unemployment has increased.
- Unemployment among young people is consistently higher than adult unemployment.
What will happen to low income earners during periods of high inflation?
The living standards of low income earners and recipients of transfer payments (e.g. pensions) will fall during periods of inflation unless these payments are indexed to compensate for price rises.
What is the effect of high inflation on sectors of the economy with market power?
Sectors of the economy with market power (perhaps business owners who can pass on price increases to their customers, or aggressive trade unions who can achieve wage increase for their members) seem more capable of maintaining their real incomes.
What is the opportunity cost of unemployment?
Unemployment has an opportunity cost- the benefits that could have been obtained has the lost taxation and welfare payments been spent on infrastructure, health or education.
Is it possible to achieve zero unemployment?
Given the dynamic structure of developed economies, it is impossible to achieve a zero rate of unemployment due to the existence of frictional unemployment and structural change.
What are two other possible economic objectives for the government?
- A more equitable distribution of income and welfare.
- Efficient resource allocation.
Describe what is meant by compatible economic objectives.
Some economic objectives are compatible, in the sense that the policies applied to achieve one objective also help to achieve other objectives at the same time.
They can be achieved simultaneously, because the policies used to achieve them are complementary.
Give four examples of compatible economic objectives.
- Economic growth and full employment.
- Full employment and equitable income distribution.
- Price stability and economic growth.
- Efficient resource allocation, productivity and economic growth.
Explain how economic growth and full employment are compatible policy objectives.
Economic growth increases demand for goods and services, so as a result, resources used to produce these goods and services are also in greater demand (e.g. labour). Policies to achieve lower unemployment also promote growth.
Explain how full employment ad equitable income distribution are compatible.
Policies designed to lower unemployment should lead to a more equitable income distribution because the proportion of the population who depend on welfare payments will fall.
Explain how price stability and economic growth are compatible.
Keeping inflation low is an important prerequisite for promoting sustainable growth. Low inflation reduces uncertainty and encourages investment in productive activities.
Explain how efficient resource allocation, productivity and economic growth are compatible.
Microeconomic reform promotes efficiency and improved productivity which are the diving force in increasing long run aggregate supply. More efficient resource use also lowers the cost of supply and helps to reduce inflationary pressures.
What is meant by conflicting policy objectives?
Some macroeconomic objectives are difficult to achieve at the same time, as illustrated by the following examples.
What are four examples of conflicting objective?
- Price stability and full employment.
- Economic growth and price stability.
- Economic growth and structural unemployment.
- Economic growth and equitable income distribution.
Explain how price stability and full employment are conflicting.
Policies to reduce demand pull inflation generally aim to reduce the level of economic activity. Lower consumption and investment, however, mean less demand for labour. One the other hand, reducing unemployment by expanding economic activity puts pressure on available resources and prices. This suggests a trade-off between high employment and stable price levels.
Explain how economic growth and price stability are conflicting objectives.
A booming economy places demand pressure on resource, especially if there is little excess capacity- this may be inflationary because competition for resources pushes up their prices.
Explain how economic growth and structural unemployment are conflicting.
Economic growth is associated with structural change. Despite growth, demand for outdated skills will fall, bringing about an increase in structural unemployment.
Explain how economic growth and equitable income distribution are conflicting.
While economic growth increases the size of the economic pie, not everyone may benefit equally from the growth in income. This is especially the case in the short run, People employed in the expanding sectors and owners of the appreciating assets such as property and shares tend to gain more than the disadvantaged groups in society.
What are the three types of government economic policy?
Fiscal policy- the use of government revenue raising and spending powers to influence the level of economic activity.
Monetary policy- the use of the ‘cash rate’ to influence other interest rates.
Competition and industry policy- measures taken to improve the efficiency of resource use and the productivity of labout.
What are fiscal and monetary policy concerned with?
Fiscal and monetary policy are concerned with aggregate demand and management in the short term i.e. stabilizing the business cycle.
What is competition and industry policy concerned with?
Competition and industry policy directs itself more towards long term growth- what we call the ‘supply side’ of the economy.
Describe fiscal policy and who is responsible for it.
Fiscal policy is developed in the government budget- a statement of expected revenue and expenditure issued each May. The Federal Treasurer’s announcements on Budget night estimate government revenue (such as income and company tax) and expenditure in the coming year. The institution mainly responsibly for constructing the Budget is a government department (the Treasury).
Describe monetary policy and who is responsible for it.
The Reserve Bank Board’s obligations with respect to monetary policy are laid out in the Bank’s ‘character’. The nine-member Board holds its monetary policy meeting on the first Tuesday of each month.
Monetary policy is currently regarded as the most important type of stabilization policy. The institution responsible for monetary policy is the Reserve Bank of Australia (RBA). The RBA is not a government department, but a statutory authority established by an Act of Parliament. It has two specific obligations- the conduct of monetary policy and the maintenance of the financial payments system.
What is the role of the Productivity Commission?
At the national level, the Productivity Commission plays a dominant role in competition and productivity policy. The Commission has a wide ranging scope but only has advisory status in recommending policy to government.
The Council of Australian Governments (COAG) was established in 1992 to initiate and monitor the implementation of policy reforms that are of national significance and require cooperative action by Australian governments (for example, productivity, National Competition Policy, and transport, power and water reform).
Describe the three time lags associated with policy effectiveness.
Recognition lag
The period of time it takes to recognize what is happening in the economy (at macroeconomic level).
Decision lag
Occurs because it then takes policy makers some time to decide what policy changes should be made in the light of the economic data.
Impact lag
It can take some time for policy decisions to have an effect on household and business behavior.
