Economics External Exam Unit 4 Flashcards
What are the 6 macroeconomic objectives?
- sustainable economic growth
- internal stability
- external stability
- improved standard of living
- equitable distribution of income and wealth
- sustainable development via efficiency in resource allocation.
Identify and describe the demand-side policies?
- Fiscal and monetary are the demand-side (AD) policies because they will influence C, I, G and NX in the AD formula.
- Together, these two measures are used to help to stabilise the growth of AD to ensure it is economically sustainable and does not exceed the growth in the economy’s productive capacity or aggregate supply.
What is the supply-side policy
- Microeconomics is the supply-side policy which focuses on firms which produce
What is the target rate/percentage that inflation should increase at?
2 - 3% growth
Identify the two demand side polices?
Fiscal and Monetary policy
What are examples of leading indicators?
- Consumer confidence, managers purchasing index, bond yields, money supply, housing permits and starts factory overtime, dwelling approvals and money supply.
Explain how factory overtime is a leading indicator?
Because it is a precursor to employers hiring more workers
Provide examples of coincident indciators?
- retail sales, new car registrations, factory production and job vacancies, GDP
Provide examples of lagging indicators?
- CPI, unemployment and investment expenditure
What are the impacts of the budget in the fiscal policy?
- Changes in the levels of government revenue (receipts) and expenses (outlays) can have a powerful overall effect on total expenditure
What are the two tools for fiscal policy?
- Revenue (taxes)
- Expenditure
What are the three tyoes of government income?
- Direct taxes on individuals (income tax and Medicare levy) and businesses (company profits)
- Indirect taxes (the goods and services tax, customs duty and excise duty)
- Other revenues (dividends from gov business enterprises and sale of gov assets)
What the main government expenditures?
- social security and welfare (also called transfer payments)
- public administration
- health
- education
- defence
Identify the three budget outcomes?
- A deficit (when the value of receipts is less than outlays),
- A surplus (when receipts are greater than outlays)
- A balance (when receipts are equal to outlays).
What are receipts and outlays?
- The receipts equals the revenue
- The outlays equals the spending
What are Adam Smith’s four principls of taxation?
- Equity: the rich should pay more tax than the poor.
- Economy in collection: cost involved in collecting the tax should be kept as low as possible.
- Quality of certainty: know when the tax must be paid, how much must be paid, and how the tax rate is calculated
- Quality of convenience: the entity who pays should be inconvenienced as little as possible. (used in Aus to combine the GST into all prices - do you think this is a good idea or bad idea?)
What is the modern take of Adam Smith’s taxation principles?
1.Equity
2.Efficiency
3.Simplicity
What are the three methods of taxation?
- Proportional Tax - goes up with income proportionally
- Progressive Tax - *A progressive tax takes an increasing proportion of the taxpayer’s wage as their wage rises.
- Regressive Tax - A regressive tax takes a decreasing proportion of the taxpayer’s wage as their wage rises
What is bracket creep and the two main reasons why they occur?
- Bracket creep occurs when rising incomes cause individuals to pay an increasing proportion of their income in tax, even though there may not have been changes to tax rates and thresholds.
- There are two reasons why bracket creep occurs in Australia: we have a progressive personal income tax system - where the proportion of income paid in tax gets higher as incomes get higher - and we have an economy where average incomes are usually increasing.
Explain Fiscal drag?
- Bracket creep causes tax receipts to grow faster than the economy, which is sometimes known as ‘fiscal drag’.
What is the Laffer Curve?
- The laffer curve shows the relationship between the size of the tax and tax revenue. Works on the principle that higher tax rates reduces incentive to work but higher tax rates give more revenue.
What are six direct taxes?
- income tax
- company tax - mostly regressive
- super annuation tax - regressive
- Petroleum Resources Rent Tax
- Capital Gains Tax (CGT)
- Medicare Levy
What are indirect taxes?
- GST - regressive
- customs
- excise
Examples of non-tax revenue?
- The profits gained from the operation of government business enterprises that sell goods and services (such as Australia Post).
- Receipts from asset sales when government business enterprises (GBEs) are privatised, such as Medibank Private in 2014 (however, these will only be included in the headline budget outcome and not th
- Interest (e.g. earned by the Future Fund), petroleum royalties, the repayment of loans by state and local governments, HECS loan repayments by students, GST administration costs and property rentals.eunderlying outcome)
Explain Tax Mix?
- The tax mix refers to the balance between direct and indirect taxes as sources of revenue.
Explain Tax Base?
- total value of all of the assets, income, and economic activity that can be taxed.
Explain Tax Burden?
- The tax burden relates to the rates of direct or indirect tax applied.
What are the three categories of gov spending?
- government current spending (G1)
- Government capital spending (G2)
- transfer payments
Explain and provide examples of G1 spending?
- government current spending
- payment of wages and salaries for federal government employees (around $30 billion) in the public sector including health, education, defence, housing, transport and welfare, along with the day-to-day operating expenses of departments. This also includes the resources bought from the private sectors for the public sector.
Explain and provide examples of G2 spending?
- Government capital (or investment) spending (abbreviated as G2) involves budget outlays on national social and economic infrastructure including the building of schools and universities, roads and highways, airports, reservoirs and water supply, the national broadband network system (NBN), pipelines and the purchase of capital equipment for hospitals, schools, universities and railways.
What is transfer payments?
- These mainly involve budget outlays on welfare benefits, along with grants and industry assistance
- That transfer payments are not regarded as government spending (G1 or G2) because it is the recipient of transfer payments who actually spends the money.
What are the 3 things gov can do with budget surplus?
1.Reduce Debt
2.Save with RBA
3.Invest
What are the four advantages of a surplus?
- Can offset deficits and avoid debt.
- Save for a rainy day
- Protect Australia’s credit rating. A budget surplus helps to protect our international AAA credit rating.
- This rating allows credit to be borrowed more cheaply in the future, freeing financial and other resources for use elsewhere in areas such as infrastructure.
- Generates confidence
Three ways to finance deficit?
- borrow from overseas - The government or Treasury can borrow from overseas
- selling Australian government bonds.
- Borrow from government
Disadvantages of Budget Deficit?
- The loss of a nation’s good credit rating. which might later make it more expensive to borrow due to higher interest rates
- Interest payments take money from providing community services.This involves an opportunity cost. It diverts money and resources away from more productive uses like the provision of adequate education, welfare and health.
- Reduce our capacity to increase borrowing and lower the government’s cash reserves available in a ‘fighting fund’.
How are budget outcomes measured?
- Fiscal balance: subtract total government expenditure and net capital investments from total Commonwealth revenue. Accrual method. Better long term measure.
- Underlying cash balance: better reflects the impact of fiscal policy on economic activity during the budget year. Calculated using cash accounting. (Coincident/ cash method). most common
What is the Accural Method?
- Accrual accounting records income when it is earned, and records costs when they are incurred, regardless of when the related cash is received or paid.
What is cash accounting?
- Cash accounting records income when cash is received, and records costs when cas
Explain the terms, ‘expansionary’ vs ‘contractionary’ Fiscal Policy?
- An expansionary fiscal policy stance is indicated by an increase in the cyclically adjusted deficit or decrease in the cyclically adjusted surplus
- A contractionary fiscal policy stance is indicated by a decrease in the cyclically adjusted deficit or increase in the cyclically adjusted surplus.
Describe discretionary fiscal policy and prove two examples?
- Discretionary fiscal policy: deliberate changes to fiscal policy instruments to influence the level of aggregate demand. (Also referred to as ‘structural components of the budget’)
- Changing government expenditure or changing tax
Describe automatic stabilisers and prove two examples?
- Automatic stabilisers: those elements of non-discretionary fiscal policy that operate without the need for government action
- Income Tax, and Unemployment and Welfare Benefits.
How does Fiscal policy work in a structure/design
- It works counter cyclically
What are the five trade offs when meeting some economic objectives?
- economic growth and improved environmental quality/sustainable economic development
- rapid economic growth and external stability - as growth is often underpinned by imported capital and technology, and usually generates increased demand for imports of consumer goods
- policies to improve the equity of income distribution that can result in a reduction in incentives to work or invest
- incentives for technological innovation that can create structural unemployment
- improvements to the current account through debt reduction that may improve external viability, but divert revenue from other priorities such as increased spending on economically vulnerable sections of the population
What is the inflationary gap?
- When aggregate output is above potential output
- so you just keep the long term supply where it is and then short term one shifts to right. or AD pushes to left.
What is the deflationary gap?
- When aggregate output is below potential output
What are the negatives of a deflationary gap?
- The general concept here is that this leaves stock unbought, and this will put downwards pressure on prices as stores try to clear surpluses
What is the RBA?
- Reserve Bank of Australia
- The RBA is our country’s independent central bank and is accountable to (but not controlled by) the parliament.
What are the three main goals of the RBA?
- The stability of the currency of Australia;
- the maintenance of full employment in Australia; and
- the economic prosperity and welfare of the people of Australia.
What is monetary policy?
- Monetary Policy: measures implemented through the RBA to bring about changes in aggregate demand by influencing money supply and interest rates
What is the top/main goal of the RBA?
The RBA sees the goal of low inflation as its number one priority.
What does loosening monetary policy mean?
- Lowering the cash rate
Why is supply curve of money vertical?
- Because the quantity of reserves is determined by Central Bank policy
What is exchange settlement accounts?
- These are the funds held by banks with the Reserve Bank of Australia (RBA) in order to settle payment with other banks and the RBA
What are government bonds?
- The written pledge of a government or a municipality to repay a specified sum of money, along with interest
What is the overnight money market?
- A market for overnight lending and borrowing of reserves among banks; the interbank market for reserves
Explain the short term/overnight money market, open marker operation?
- The cash rate is the interest rate that applies to a specialised market called the overnight or short-term money market.
- This rate depends on the overall supply of cash (deposits) in the overnight money market which, in turn, is controlled by the RBA through its open market operations (OMO).
How does the entire open market operation work?
So you got a short term money market, RBA sets a cash rate and put 0.25 basis points above that as their borrowing rate, and 0.25 basis points lower as the deposit rate. When banks want to borrow for example they wouldn’t want go anymore above what the RBA is lending at so they’ll go to other banks, hence this pushes cash rate towards the middle. If banks want to deposit in the RBA they don’t want to go lower so this again pushes it towards the cash rate target. The RBA changes the supply of the money in this market by buying and selling bonds. So they change the supply of money to create incentive for banks to lend or save. When the RBA buys bonds, it injects money into the banking system. This increases the reserves of banks, making it easier for them to lend to each other at lower rates. As a result, the cash rate decreases, which can stimulate economic activity.
Selling Bonds (Decreasing Money Supply): When the RBA sells bonds, it withdraws money from the banking system. This reduces the reserves of banks, making it harder for them to lend to each other, leading to higher cash rates. This can help cool down an overheating economy.
Provide 3 tools for open market operations?
- Outright Government Bond Purchases
- Reverse repurchase agreements (repos)
- Forex swaps
How does for example selling bonds mean cash rate goes up?
- So sell bond banks buy it reducing money supply. To meet yk their minimum requirements they’ll need some funds still in their ESA, so they gotta borrow. Other banks know this so they push up their interest rate when the other banks borrow, this naturally drives up the cash rate towards the target.
What are the two stages of the transmission mechanims?
1.Changes to the cash rate flow through to other interest rates in the economy.
- Changes to these interest rates affect economic activity and inflation.
What are the four channels of monetary policy?
1.The savings and investments channel
2.The cash-flow channel
3.The asset prices and wealth channel
4.The exchange-rate channel
2 other names for the savings and investment channel?
- interest rates channel
- Intertemporal substitution channel
Explain the saving and investment channel?
- Lower interest rates will encourage spending and borrowing, but discourage saving; the effect on the level of economic growth, employment and inflation is likely to be expansionary, especially in the short-term.
- Higher interest rates will encourage saving, but discourage spending and borrowing; this is likely to have a contractionary effect on the level of economic growth, employment and inflation, especially in the short-term
Explain the cash flow channel?
- Lower interest rates will increase the cash flows of households, businesses and governments as the cost of servicing debts is reduced; this will encourage spending and borrowing and have an expansionary effect on the level of economic growth, employment and inflation.
- Higher interest rates will decrease the cash flows of households, businesses and governments as the cost of servicing debts is increased; this will discourage spending and borrowing and have a contractionary effect on the level of economic growth, employment and inflation.
Which is effect is more prominent in the cash flow channel?
- Borrowing; Because there’s way more money borrowed generally than in peoples bank accounts
Explain Asset Prices and Wealth Channel?
- Lower interest rates will encourage the purchase of assets such as houses, property, shares and bonds; this will increase borrowing and inflate asset prices; there will be an expansionary effect on economic growth, employment and inflation.
- Higher interest rates will discourage the purchase of such assets, decreasing borrowing and deflating asset prices; there will be a contractionary effect on economic growth, employment and inflation.
- Then wealth effect also occurs if the value of their assets go up they think they are richer and hence are more incline spend more
Explain the exchange rate channel
- Lower interest rates reduce the returns investors earn from assets in Australia (relative to other countries). Lower returns reduce demand for assets in Australia (as well as for Australian dollars) with investors shifting their funds to foreign assets (and currencies) instead.
- A reduction in interest rates (compared with the rest of the world) typically results in a lower exchange rate, making foreign goods and services more expensive compared with those produced in Australia. This leads to an increase in exports and domestic activity. A lower exchange rate also adds to inflation because imports become more expensive in Australian dollars.
- When the AUD depreciates, Australian goods and services become cheaper for foreign buyers because they need less of their own currency to buy the same amount of AUD. This can make Australian exports more competitive on the global market, potentially increasing export volumes.
What is microeconomics?
- Microeconomics: the study of economic behaviour at the level of the individual units of an economy; it focusses on the factors affecting the decisions made by individuals, firms and governments about the allocation of resources and the prices of goods and services
What is crowding out?
- This approach could cause upward pressure on domestic interest rates because the government is also competing against the private sector for access to limited savings.
- In turn, higher interest rates may crowd out and depress private sector borrowing, investment spending and economic activity at a time when policy needs to boost AD and economic activity.
- There is criticism of using the domestic market to raise funds, because if entities lend to the government, that money is not available to lend to productive enterprise.
- When the government competes against private business for assets (any of the 4FOP) it’s described as the government “crowding out” private business.
Explain structual change?
- Structural change: industry-wide changes in the pattern of production that result in certain products, production processes and even industries disappearing while new ones emerge
Explain the microeconomic policy?
- Government policies that aim to increase the amount of supply by increasing the efficiency, productivity and international competitiveness of individual businesses and Australia’s industries.
- They promote long-term structural change and growth in the economy.
Identify the nine supply-side polices?
- Investment in Infrastructure
- Investment in Education and Training
- Research and Development
- Deregulation and Competition Policy
- Tax and Welfare Reform
- Privatising of Government Business Enterprises
- Labour Market Reform
- Floating exchange rate
- Trade liberalisation
Explain investment in infrastructure?
- Infrastructure is the basic physical and organisational structures and facilities needed for people to conduct their daily lives, and for producers to access supplies of productive resources and intermediate goods, produce goods and services, and market and distribute the finished products.
Explain investment in education and training?
- Investment in education and training is essential to deliver a productive workforce that provides a supply of the specialist/skilled workers needed for existing and emerging production processes and industries
Explain research and development?
- R&D and innovation are vital for firms to maintain or increase their competitiveness by developing new products and more efficient production processes and adjusting to structural changes in local and global markets
Explain deregulation and competition policy?
- Deregulation and competition policy refer to two related strands of microeconomic policy seeking to increase competition in Australian markets. Deregulation is the removal of government regulations or restrictions, especially in a particular industry, and is often characterised as ‘cutting red tape’.
- Unnecessary regulatory burden, or red tape, impedes business competitiveness and affects economic productivity.
Explain Privatising GBEs?
GBE = Government Business Enterprise
Privatisation is a part of the general deregulation of government services, in order to achieve better growth, efficiency and productivity through greater accountability to the share-holders
Explain Taxation reforms?
- Reform that makes the taxation system more equitable and efficient should strengthen the incentive to participate in the workforce (increasing the available supply of labour) and work longer hours. relates to laffer curve
Explain labour market reform?
- Labour market reform has the potential to increase productivity and improve the competitiveness of Australian producers. The labour market is a key factor market for almost all productive activity, and outcomes in this market are directly related to the costs and efficiency of production.
Explain trade liberilisation?
- These trade reforms have opened up access to overseas markets, and exposed domestic markets to increased competition, forcing domestic producers to become more efficient
What is monetary liquidity?
- liquidity” refers to the money held by commercial banks
How do forex swaps help in open market operations?
- Purpose in OMOs: Forex swaps are used primarily to manage the liquidity of the Australian dollar in the domestic financial system. By conducting forex swaps, the RBA can inject or withdraw liquidity from the banking system, depending on the needs of the market.
- Injecting Liquidity: When the RBA buys AUD and sells foreign currency (e.g., USD) in the spot market, it injects AUD into the financial system, increasing liquidity.
How to repurchase agreement help in open market operations?
- What They Are: A reverse purchase agreement, or repo, is a short-term agreement where the RBA purchases securities with an agreement to sell them back at a later date. In this transaction, the RBA temporarily provides cash to the financial system in exchange for securities, with the expectation that the cash will be returned when the securities are sold back.
- Purpose in OMOs: Repos are a key tool in daily liquidity management. They allow the RBA to provide short-term funding to financial institutions, ensuring that there is sufficient liquidity in the system to maintain the cash rate at its target level.
- Injecting Liquidity: When the RBA conducts a repo, it injects liquidity into the system because banks receive cash in exchange for their securities.
