Macroeconomic Policy in Australia - Case Study Example

Macroeconomic Policy Student’s Name Institution Date Macroeconomic Policy The macroeconomic policy of any country is determined by the inflation rate, unemployment and economic growth rate. The percentage of inflation in the developed world ranges from 2.5% to 3%, following a recession in 1991. Whereas in other major countries they have a low rate of inflation of 2% or less per annum, Norway whose rate is 2.5% per annum is an exemption. For the past ten years, both core inflation and unemployment rates have gone slightly above the target of 3% per annum. It can be viewed as if they have opted to have a high rate of inflation target thus being saddled with high average inflation rate. The investors seem to have given into to this rate which is interesting. Australia ranges among the highest with 3% inflation rate per annum over the last 5-10 years. Consumer inflation is usually way above 3.5% though slightly. Inflation over the last 5 years has not been good nor has it worked well for the Australian economy (Lewis, et al, 2010). It had nothing to do with monetary policy or fiscal policy prior to the financial crisis and also not withstanding a multiple of media claims. Australia has had a slow development of its securitization markets and banking system that was 10-15 years behind US and 5 years behind the UK. Australia’s trading mix and exposure to Asia, strong population growth, extraordinary resources and luck associated with housing cycle was running 3-4 years ahead of their peers. Inflation thus has been lower than expected making it much more stable although subdued in range industrialized economies. For example, those economies which do not have explicit inflation targets, it is suggested that the fundamental change has occurred in the inflation process. The type of shocks that influenced inflation previously seems to have less influence. Currency depreciation generated increase in inflation in Australia since it has a small open economy (Garnett & Lewis, 2010). In 1990’s, despite a high depreciation of Australian dollar, rising import prices, growth in retail import prices remained high hence little effect on consumer price inflation. For the past two decades, increase in domestic competition, a shift from centralized wage setting to a decentralized enterprise system and a rise in trend productivity growth have had an effect on inflation (Hubbard, et al, 2013). These developments are conducive to achieve low and stable inflation to at least short to medium run and reinforced effects of reduced exchange rates. Inflation can be gleaned by close checking the speed at which inflation responds to disequilibrium between prices and costs in the long run relationship. Error connection of inflation equation is necessary because it features speed of adjustment parameters. Low inflation environment of 1990’s in the inflation process was accompanied by increase in inertia. Unemployment is usually a major setback in a country’s economic growth. For Australia, unemployment increased from 0.2% to 5.6 percent in March as it was announced by Australian Bureau of Statistics. Number of employed decreased by 36,000 to 11,592 as also full time and part time employment decreased. As a result, the unemployed people increased from 25,900 people to 686,900 in March. Citizens of 15 years of age and above are classified unemployed if they satisfy this criterion: they are unemployed, ready and available to start working and are searching for a job. The measures of unemployment are mainly two; unemployment rate and the number of people employed. In the 1990’s, the unemployment level was high, but in 1992 unemployment peaked to 11% in October, and then falling to 4.1% in March 2008. After that, unemployment rate gained a steady increase to 5.8% in 2009 in the month of July then followed by a steady decrease or downfall of up to 4.9% in 2011 in the month of March. Unemployed people face various difficulties in finding work whether male or female. The main issues were that many applicants were from the two genders, unsuitable working hours for females and also difficulties with children and family. The male complained of no job in their line of work, transport problems and disabilities. Labor underutilization is not reflected by long term unemployment rate and the unemployment rate. It is characterized by the number of hours underutilized of the available labor and the worker’s labor that is underutilized. It is expected that the unemployed rate will remain at 5.5%. Other than unemployment and inflation being macroeconomics policies, economic growth plays an equally important role as the rest. Australia’s economy is at its twentieth year of economic growth with a remarkable performance (Lewis, et al, 2010). Since in 1990 there was a recession, the economy began to grow in September 1991. Irrespective of its ups and downs in growth trends, there was no time that the economy was negative. Though the growth remained positive, there was a rise in unemployment that was noticeable. The period in which the economic growth was noticeable was in the year 2009 at 0.7% and 1.4% between 2000 and 2001. Australia’s economic growth is a result of adopting disciplined and prudent economic policies that were derived from a long process. Macroeconomic policy instruments refer to macroeconomic quantities that can be directly controlled by an economic policy maker. Instruments can be divided into two subdivisions namely, the monetary and the fiscal policy instruments (Garnett & Lewis, 2008). Monetary policy is conducted by the central bank of a country while the fiscal policy is conducted by the Executive and Legislative Branches of Government and deals mainly with managing the budget of a nation. The policy goals of macroeconomic policy vary from country to country and according to the political priorities of various governments. Monetary policy instruments consist in managing short term rates and changing reserve requirements for commercial banks. Monetary policy can either be expansive for the economy meaning that short term rates are low relative to the inflation rate or restrictive for the economy whereby short term rates are high relative to the inflation rate. Fiscal policy consists in managing the national budget and its financing so as to impact on the economic activity. This consists of the expansion or contraction of government spending related to specific programs offered by the government such as building of roads or infrastructure, military expenditures and social welfare programs. Fiscal policy also entails the raising of taxes to finance government spending and the raising of debt to bridge the gap between revenues and expenditures related to the implementation of government programs (Gordon & Valentine, 2009). The raising of taxes and the reducing of the budget deficit is deemed to be a restrictive fiscal policy as it would reduce aggregate demand and slow down GDP growth. Lowering of taxes and increasing the Budget Deficit is considered an expansive fiscal policy that would increase aggregate demand and enhance economic growth. Instruments and targets refer to macroeconomic policies. Institutions are the ones that are liable for making policies. Examples would include the Reserve Bank of Australia and the Treasury. These institutions set policy TARGETS. An example of such a target would be an annual inflation rate of no more than 3%. Policymakers then use policy INSTRUMENTS to meet the targets. Typical instruments include the RBA cash rate or government expenditure. By applying the concept of instruments and targets to the current policy framework in Australia, the RBA would buy bonds in order to create excess liquidity, putting downward pressures on interest rates, allowing boosted consumer and investment spending and eventually lower unemployment. Macroeconomic policies have in the past been effective in influencing the short- term demand economy, and over the last decades, fiscal policy has played a major function in the policy mix where the government has used this aim of policy to improve Australia’s national savings and to control public debt in order to keep external factors under control and maintain external stability, providing opportunities for economic growth. The government has abandoned its use of fiscal policy as a current policy objective to achieve external stability. The government ensures that it makes no contribution through the private sector borrowing and the public sector debt to the CAD. The RBA’s pre-emptive approach of targeting monetary policy to raise the cash rate from 4.75% to 5% would ensure inflation would not spill over its target range. The RBA uses short term interest rate as its operating instrument for implementing monetary policy. The Reserve Bank of Australia sets target level for its cash rate. It can target a certain level of bank reserves and accept the resulting outcome for short term interest rates. It can also seek to attain a certain target point for short term and supply whatever quantity of services is demanded at the target rate. The RBA pays interest on reserves which is linked to the cash rate. The systematic changes to the stance of monetary policy need to be implemented by changing the supply of bank reserves. The RBA can change the stock of bank reserves by undertaking open market operations either directly with the banking system or with the non-bank public. The tax systems must be fiscally sustainable across the economic cycle and the short –run liquidity effects of fiscal policy must be put into consideration since monetary policy is the main macroeconomic management tool. In order to understand how the RBA achieves its target for the cash rate it is essential to consider the payment system operations in Australia and the overnight cash market. The fiscal and monetary policy tools are the main controls adopted by the Australian government to smooth the short run fluctuations in the economy such as inflation, unemployment and external trade (Lewis, et al, 2010). These economic theories can be used to explain current macroeconomic policy with their manipulation by the Australian government. When it comes to fiscal policy, the government can manipulate its spending and taxes so at to control inflation, output and the rate of interest. On the other hand, the government can manipulate monetary policy so as to control variables such as inflation, unemployment and economic growth. The aim of using monetary policy is to maintain low inflation and unemployment levels and the stability of the Australian currency. The RBA implements the monetary policy through its control of the cash rate. The cash rate is the rate the RBA charges banks for loans within the RBA reserves system. It is the base interest rate for the economy and all other interest rates are derived from it. The profitability of investment projects depends on the nominal rates of interest. The higher the investment spending, the less will be the interest rates and the more profitable will be the investment projects. The RBA controls the cash rate upon which the interest rates depend and so the RBA can shift the aggregate demand curve since it controls investment which is one of its components. The monetary policy can stabilize the economy by affecting the level of interest rates from the short term to medium term. The policy also aims to stabilize demand and inflation in the medium term as well as attaining government objectives of sustainable growth with minimal inflation of 2 to 3%. The macroeconomic performance of any one nation is affected by the events, policies and shocks in other countries. No economy in the world is immune to what is happening in the financial and economic global system (Gordon & Valentine, 2009). The causes of inflation and its effects, its link with unemployment and the level of interest rates should be a key concern for the government in carrying out of fiscal policy. Macroeconomic policy has a major role in providing a stable economic environment conducive to sound investment decisions by business and to encourage workers to invest in enhancing their skills to take advantage of the new employment opportunities. Macroeconomic policy in Australia has been primarily been directed at controlling inflation to maintain economic stability and growth. References Hubbard, G., Garnett, A., Lewis, P. and O’Brien, A. (2013), Essentials of Economics 2nd Edition. Pearson Education, NSW. (Hubbard) Lewis, P., Garnett, A., Treadgold, M. and Hawtrey, K. (2010) The Australian Economy:Your Guide, Pearson Educational, NSW. (Lewis) Garnett, A. And Lewis, P.(2010), ‘The Economy’, in Aulich, C. and Evans, M. (eds), The Rudd Government, ANU E Press , Canberra. Garnett, A. and Lewis, P.(2008), ‘The Economy’, in Aulich, C. and Wettenhall R. (eds), Howard’s Fourth Term, New South Wales, University Press, Sydney. Gordon, C. and Valentine, T. (2009), Economics in Focus: The Global Financial Crisis, Pearson Education, NSW Read More