Macroeconomic Policy, inflation, Unemployment, and Growth - Literature review Example

Macroeconomic Policy, inflation, Unemployment and growth Name Grade course Institution Tutor Date Introduction Inflation refers to a general increase of prices in the economy. Increase in prices leads to reduction in the purchasing power of the currency. To control inflation, monetary and fiscal policies are needed to achieve macroeconomic objectives and stability. According to Haslag and Hein (1992) monetary policies are employed to control inflation and interest rates while fiscal policies are used to improve the aggregate output of the economy. Combining both tools appropriately creates economic stability. For close to a decade, Australian government has used these tools to control the rate of inflation which in turn would help attain economic stability while at the same time avoiding the recession. This paper will analyze the economic experience of Australia in the last decade while highlighting the challenges policy makers had to endure. It will also look at instruments and targets in macroeconomic policies. Macroeconomic policies will be discussed using various economic theories in relation to Australia’s economy. Experience of the Australian economy over the last 10-15 years, in relation to major macroeconomic aggregates According to Love and Payne (2008) economic stability entails; low unemployment or full employment, price stability, economic growth and external balance. Over the past decade, Australia has tried to achieve the above by mainly controlling their inflation which in turn controls unemployment and promotes economic growth. Employment Unemployment rate show the comparison between those that are employed and those that are not. Over a decade before the global recession, employment in Australia grew every year by about 2.3%. Availability of full time employment grew by 1.9% and that of part-time by 3.5%. After the recession in September 2008, growth in employment stalled and unemployment rose to 5.9% in 2009. In the following years, the economy saw great improvements with employment growing by about 3.3% in 2010 and unemployment falling to 4.9% and participation rate being recorded at 65.8%. In March 2012 unemployment had settled at 5.2%. This has been according to Australia bureau of statistics. Growth in employment has been limited by the financial market volatility and global uncertainty which have affected businesses which in turn has affected their hiring rates. The graph below is a representation of how the employment rates have been changing over time. This level of growth to the labor market has been due to various factors. According to Sullivan, and Steven (2003), the key to this success is shifting of the economy from production to manufacturing which has seen so many jobs been created. Also technological advances, increase in international trade, economic reforms and workplace relations, increasing labor force participation and change of consumer preferences. Inflation trend in Australia Inflation rate is the percentage increase in the price index or consumer price index over time which is mostly one year. According to Allen and Wood (2006), inflation rate can also be described as the general rise in prices measured against a standard level of purchasing power. These standards include the GDP deflator and the consumer price index and they measure the whole domestic economy. In the 1980s, inflation rate in Australia was at 10% and by early 90s it fell substantially to below 8% and now averages at 2% as indicated in the graph below. This was partly because the reserve bank of Australia set a target of 2-3% inflation rate and employed policies to attain the target. The Reserve bank of Australia main aim is to maintain inflation at these rates because the economy is perceived to be at full employment at these levels (Hubbard et al 2010). The reserve bank has been able to maintain this kind of inflation by controlling the money supply in the economy. This reduces inflation as increase of money supply which leads to increase in prices. It has also provided guidelines to concerning pricing and its subsequent changes. Economic growth trends Australia’s economy has experienced growth in real GDP per capita for over a decade now. According to the Australian Bureau of Statistics (2008), since early 90s to 2005, real GDP per capita has gone up by 36% (Gertler & Karadi 2011). This has been cultivated by improvements in business investment, increase in net export and moderate growth in household consumption. Unemployment has reduced from over 10% in the mid 90s to less than 6% today showing a great improvement in the economy. The economy shifted from reliance on agriculture to manufacturing and service provision. Agriculture currently constitutes 3% of the GDP down from 68% in the 80s and early 90s. Inflation has reduced from 21% in the 80s to less than 105 in the 90s to about 2-3% nowadays. All these improvements in the economy has been due to vigorous changes in their monetary policies and diversification of the economy to exploit the country resources such minerals and its features that have greatly attracted tourists (Thompson, Murray & Jomini 2007) Challenges encountered by policy markers An inflation rate of 2-3% provides for a full employment in Australia. This has been a great challenge for the policy makers as maintaining the same levels at all time has been difficult like in the mid 90s when the inflation was so high and the levels of unemployment went so high. The other problem was and is still is that further growth of the economy would cause an increase in the inflation and this drastically affects employment and businesses in the economy (Thompson et al 2007). ‘Instruments and Targets’ In Macroeconomic Policy Macroeconomic policies in Australia like many other countries, seeks to ensure that its citizen are employed, there is economic growth, limited or no foreign debt and low levels of inflation (Huizinga 2002). In order to achieve this, the Australian government has employed several instruments. The reserve bank of Australia set a target of 2-3% inflation in the early 90s and they need to implement instruments to attain this target. To attain the above set target, the RBA had to use proper monetary policies to control the money supply. In the late 90s and early 2000 when inflation was high, money supply had to reduce in order to counter the high rates therefore contracting monetary policies had to be engaged to counter the high supply. When the inflation rates came down, appropriate measures where interchanged to ensure they remain the same either contracting or expanding (Sullivan & Steven 2003). According to Haslag and Hein (1992) the government spending is key factor in economic growth. The more the government spends the more the jobs available and more opportunities for business to getting contracts. Although key to growth, the government should device policies to ensure that it does not overspend and hence need to borrow externally. The other instrument that Australia has used to create growth in the economy is shifting from producing to manufacturing. This improves the net export as more is exported than imported. This has been motivated by the government through proper monetary policies improving the value of the currency hence attracting more investors to build facilities to produce products for export. This has greatly improved the balance of trade. Taxes are part of people’s lives and cannot be avoided. Through proper fiscal policies, the Australian government has devised means to make taxes that are friendly to investors and tourists and hence the level of production and tourist visiting the country rises (Love & Payne 2008). Tourism contributes a big part of the economic development plus mining and service delivery. This has only been possible because of the friendly taxes the government has established. The government has limited its spending to tax collection so that it does not need to increase taxes or introduce more. These fiscal policies ensure that taxes do not cause inflation to go up hence distorting the economy Economic Theories and current macroeconomic policies According to Phillips curve, some certain level of inflation has to be for an economy to be at full employment (Love & Payne 2008). This is up to a certain point and beyond this more of inflation leads to less employment opportunities. For Australia, it is between two and three percent. In the 90s when the inflation was above 10%, unemployment was high with it being over 10% but when inflation came down to less than 3% unemployment went down to less than 6%. Gordon and Valentine (2009) explain how monetary policies are used to control supply and demand for money. When there is excess supply of money it means that its value goes down and hence the prices go up causing inflation. When this happens like in the 80s and the 90s, the RBA implemented contraction monetary policies so as to reduce the supply of money in order to mitigate the inflation. Employment means that households have income. Income means that they are going to spend and hence this creates demand. According to Sullivan and Steven (2003), different people have different preferences and this will affect demand and spending habits. Depending on need, they will create demand and hence this creates need for supply and this is a business opportunity which in turn attracts investors. This in turn translates to economic growth. Inflation can either be caused when demand exceeds supply. This is known to be demand pull inflation or it can be caused by high cost of production which leads to rise in prices or cost push inflation. Both of this inflation can be avoided through proper fiscal policies. According to Love and Payne (2008), reduction in taxes or having tax breaks ensures that the cost of producing is kept low and hence avoiding the cost push inflation. Proper government spending policies means that taxes are not increased. Also, these fiscal policies play a great role in attracting investors. If they favor investment ensures that there is consistent supply and hence avoiding demand pull inflation (Allen & Wood 2006). Conclusion This paper has analyzed the inflation, unemployment, economic growth and how they are related in the case of Australia. Some level of inflation cannot be avoided if unemployment is to be reduced and for Australia it is between 2-3%. Money supply has to be controlled through proper monetary policies in order to avoid inflation; the RBA has done well in this area. Unemployment in Australia has drastically reduced and economic growth has been ensured through shift in economy to manufacturing and service provision rather than production and over reliance on agriculture. In short, Australia has achieved it macroeconomic targets. References Allen, W. & Wood, G. 2006, ‘Defining and achieving financial stability’, Journal of Financial Stability Vol.2, No.2, pp 152–172. Gertler, M. & Karadi, P. 2011, ‘A model of unconventional monetary policy’, Journal of Monetary Economics, Vol.58, No.1, pp 17–34. Gordon, C. & Valentine, T. 2009, ‘Economics in Focus: The Global Financial Crisis, Pearson Education, NSW. Haslag, J. & Hein, S 1992, ‘Macroeconomic Activity and Monetary Policy Actions: Some Preliminary Evidence’, Journal of Money, Credit & Banking, Vol 24, No.4, pp 431-446. Hubbard, G., Garnett, A., Lewis, P. & O’Brien, A. 2010, ‘Essentials of Economics’, Pearson Education, NSW. Huizinga, H. 2002, ‘A European VAT on financial services? Economic Policy, Vol, 7, No. 35, pp 498–534. Love, R., & Payne, R 2008, ‘Macroeconomic News, Order Flows, and Exchange Rates’, Journal of Financial & Quantitative Analysis, Vol 43, No.2, pp 467-488. Otto, G 2007, ‘Central Bank Operating Procedures: How the RBA Achieves Its Target for the Cash Rate’, Australian Economic Review, Vol. 40, No. 2, pp 216-224. Sullivan, M. & Steven, M 2003, ‘Economics: Principles in action’, New Jersey: Pearson Prentice Hall. Thompson, G., Murray, T. & Jomini, P. 2007, ‘Trade, Employment and Structural Change: The Australian Experience’, Pearson Educational, NSW Read More