How Macroeconomic Policy in Australia Has Changed with Time - Example

How Macroeconomic Policy in Australia has changed with Time Introduction In general, governments use official macroeconomic policies as a means of achieving any of the four common objectives: low unemployment, a stable balance of payments, low inflation and high and sustainable rates of economic growth. The situation Australia has not been different, for several years, the government has adopted a macroeconomic policy that has primarily sought to control the rate of inflation in the country. This has been seen as a prerequisite for attaining sustainable rates of growth as well as general macroeconomic stability in the country. However, following the global financial crisis, the emphasis on macroeconomic policy has shifted from attempting to control inflation to seeking to avoid the effects of recession on the economy. This essay contrasts these two phases of macro economic policy in Australia in terms of the objectives, targets and instruments used. The essay is divided into three distinct sections. The first section outlines the experience of the Australian economy in the last 10 to 15 years. In the second section, the applicability of the concept of instruments and targets is analysed in light of the current policy framework in Australia. The third section relates the economic theory to the current macroeconomic policy in Australia. Trends in the economy of Australia The experience of the Australian economy over the last 10 – 15 years has been characterised by shifting objectives in the official macroeconomic policy. This has been necessitated by the need to realign the economic fundamentals of the country’s economy with the prevailing macroeconomic conditions not only within the country but at the regional and global level as well. However, despite the shifts in targets and policy objectives, the need to control inflation can be seen in the macroeconomic policy of Australia in the last fifteen or so years. According to Pitchford (2009, p. 23), this overriding objective has been informed by the fact that controlling the rate of inflation is associated with overall economic stability and sustainable growth. The need to maintain the rate of inflation within a modest level had its roots in the late 1990s (Weber 2012, p. 7). During this period, the Reserve Bank of Australia (RBA), through its budget statements, indicated various shifts in macroeconomic policy targets for the country. For instance, during the financial periods of 1990 and 1991, the RBA was primarily concerned with the need to contain the rising inflationary pressures on the economy. With rising demand pressures, a runaway rate of inflation and worsening of the current account deficit, the macroeconomic policy of the country was primarily concerned with developing a sustainable mechanism of reducing the high rate of inflation (Weber 2012, p. 13). During the period between 1993 and 1995, the economic climate was dominated by the following conditions: the need to reduce high rates of unemployment, the need to lift national savings and corresponding investments and lastly, the overall need to boost the recovery process following the recession of the mid-1990s (Bowen 2013, p. 34). With the turn of the 21st century, the economy of Australia has been showing solid prospects of growth, declining unemployment rates and a significant increase in the level of resource investments (Dwivedi 2005, p. 66). These trends are reflected in changes in the following economic indicators: the rate of GDP growth, consumer price index, the rate of unemployment and current account deficit. a) Current account balance Figure 1: Changes in the current account balance between 1994 and 2012 Source: Bowen (2013, p. 16=) b) Consumer Price Index and the rate of inflation Figure 2: Changes in CPI Inflation and cash rate target in Australia between 2005 and 2011 Source: Bowen (2013, p. 13) c) The rate of unemployment Figure 3: Changes in the rate of unemployment in Australia between 1994 and 2012. Source: Weber (2012, p. 29) There are several challenges facing policy makers both now and in the near future. These challenges arise from the need to address the changes resulting from the impact of the global financial crisis. For instance, there is need for the government to take the lead in stabilising the overall macroeconomic environment in the country. According to Veale (2008, p. 56), this task was left to the financial markets and the central banks. However, following the failure of financial markets during the global financial crisis, there is a need to develop measures that would ensure that the government plays a leading role in stabilising the overall macroeconomic environment in the country. In doing this, there is need for policy makers to develop policies that incorporate the use of both traditional instruments of fiscal policy and new instruments that take into account the realities in the current global economic environment. Apart from this, there is need for the RBA to institute measures that curb the effect of a possible recession, following the global financial crisis. According to Brischetto and Voos (2010, p. 27), high signs of recession in the leading economies in Europe act as a strong indicator for the RBA to revise its growth forecasts for the next few years. As such, there is need to implement policies that address the impact of a recession on the economy. Lastly, the policy thinking in Australia is faced with the need to make sufficient allocations for the expanding public sector allocations in the national budget. With the current situation dominated by the need to handle the possible effects of a recession, policy makers in Australia need to make 3% to 5% allocations of the national budget for public expenditure (Brischetto & Voos 2010, p. 30). Instruments and targets in macroeconomic policy in Australia The concept of targets and instruments in macroeconomic policy arises from the fact that macroeconomic policies cannot be used entirely as a means of achieving economic reforms in a country (Gregory & Sheehan 2011, p. 76). As much as macroeconomic policies seek to influence the demand side of the economy, there is need for these policies to be used in conjunction with special instruments that are based of the supply side of the economy in order to have sufficient influence over the economy (Dwivedi 2005, p. 167). In general, there are two types of instruments which are used in effecting macroeconomic policies: fiscal and monetary instruments. According to Alfonso and Sousa (2009, p. 14), fiscal policies entail the use of budgets to influence broad economic objectives. By varying the amount of expenditure and revenue, governments are able to alter the level of economic activity within a country – which corresponds to the conditions of deficits, surpluses or balanced budgets. In addition to this, governments influence the outcome of their budgets by use of either automatic stabilisers, which adjust to the state of the economy, or structural components, where discretionary changes by the government influence the outcome of the budget which in turn bears a strong influence upon the overall macroeconomic policy (Afonso & Sousa 2009, p. 21). As such, governments seek to shape their fiscal policies by using discretionary measures which seek to not only to stimulate growth, but also cause a multiplied increase in consumption and investment. Apart from using fiscal instruments, governments may use monetary instruments as a means of influencing the macroeconomic policies in the prevailing economic conditions in a country. Essentially, using monetary instruments seeks to influence the cost and availability of money and credit within the economy of a country (Beggs 2010, p. 13). As such, governments use domestic market operations such as trading in government bonds and correcting surpluses as a means of achieving internal balance in the economy. For instance, when there is a lot of pressure on the rates of interest in the economy, the government my resort to buying financial bonds in the markets (Beggs 2010, P. 15). This will have the effect of increasing the level of consumer and investment spending, thus helping in achieving the set target for unemployment rates in the economy. In essence, there are many ways in which the concepts of instruments and targets can be applied in the current macroeconomic policy context in Australia. For instance, although the government has generally abandoned the use of fiscal instruments as a means of achieving external stability, there is need for the government to maintain the use of such instruments not only as a back up for the monetary policies in current use but also as a way of maximising sustainable growth in the economy (Bodman et al. 2009, p. 55). Also, there is need for the RBA to maintain its use of monetary instruments as a means of reducing the effects of business cycles. By setting specific targets for different monetary instruments, the RBA can maintain sustainable growth and keep the rates of unemployment within acceptable levels. Current macroeconomic policy in Australia The current macroeconomic policy in Australia is complex. The theory of fiscal and monetary policy can be used to explain the current state of macroeconomic policy in the country in terms of different factors. These include the countercyclical fiscal policy; taxation and expenditure; the monetary policy; financial regulation; and lastly, the macroeconomic models of the future (Garnett & Lewis 2009, p. 100). For instance, many central banks around the world still target the rate of inflation as a means of ensuring both short-term and long-term stability in the economy (Garnett & Lewis 2009, p. 105). Although this is a universal method, there are subtle differences in the way the rate of inflation is used as a method of attaining economic stability. For instance, in countries such as the United States, the rate of inflation is not a practical method. This is because of the rates of interest in such countries being close to zero, thus making it impossible to use the conventional method of targeting inflation, which is based on small adjustments to the prevailing rates of interest. On the other hand, the RBA still retains the use of monetary policy as a primary means of influencing the economy. This is because the economy experiences small but positive rates of interest, which makes it practical for the RBA to target the rate of inflation as part of its monetary policy initiatives (Otto 2007, p. 219). Also, the primary concern of the government is attaining and maintaining equilibrium in its budget. In maintaining a balance between deficits and surpluses over the long-term, the government is faced with the question of how much allocation to be made for the public sector and how the allocated government revenue shall be distributed among different services within the economy (Gordon & Valentine 2009, p. 87). In practice, the government share of national income has remained between 20 and 25% in the last several decades. This situation has been necessitated by two key trends. In the first place, there has been a relative growth in the importance of sectors such as health and education (Gordon & Valentine 2009, p. 96). Since these are sectors that the government is best suited to handle, their growth has underscored the corresponding growth in the government’s share in national income. The second reason has been associated with the need to introduce for profit infrastructure projects through public private partnership initiatives (Veale 2008, p. 156). With losses on the side of private investors, the role of the government in funding public projects and services remains relevant in the current macroeconomic policy in Australia. Lastly, the current macroeconomic policy in Australia can be understood with reference to the Keynesian fiscal theory, which provides the necessary requirements for managing the effects of business cycles on the macroeconomic indicators in an economy (Weber 2012, p. 33). Theoretically, this model requires that the budgets of governments satisfy the following fiscal conditions: (1) the need to maintain deficits during slumps and surpluses during booms and (2) the need for sustainability over the course of the economic cycles (Jain & Majhi 2008, p. 122). In practice, these conditions are satisfied through a series of actions that are undertaken by the government. For instance, increasing the purchase of goods and services by the government or reducing taxes is a direct method of stimulating demand and, by extension, general economic activity. Conclusion In conclusion, there has been a fundamental shift in the focus of macroeconomic policy in Australia over the last decade. Prior to the global financial crisis, the overriding objective of the macroeconomic policy was to maintain the rate of inflation within moderate levels. As such, it was observed that controlling inflation was a prerequisite to reducing the rate of unemployment and stimulating overall economic growth in the country. The global financial crisis marked a period of fundamental shift in financial policy. In one way, there was a shift in policy objectives as the primary concern of the RBA has been to avoid a recession. This has been reflected in overall changes in policy objectives as well as in the theory that informs the official macroeconomic policies in the country. References Afonso, A & Sousa, R M 2009, ‘The macroeconomic effects of fiscal policy’, European Central Bank Working Paper no. 991, Available at: (Accessed 29 October 2013). Beggs, M 2010, ‘Inflation and the making of macroeconomic policy in Australia: 1945 – 85’, PhD thesis, Faculty of Economics and Business, University of Australia, Available at: (Accessed 29 October 2013). 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