Economics_Essay

The use of monetary and fiscal policy by the Australian government is a tool in achieving its main economic objectives. These include sustained economic growth, price stability, external stability, equal income distribution and full employment (at the natural rate which excludes cyclical unemployment). Monetary policy is a macroeconomic tool which involves the Reserve Bank of Australia selling and buying Commonwealth securities in the short term money market. This is known as Domestic Market operations which aims to influence the cash rate which is the rate charged on overnight loans and therefore the general level of interest rates. Fiscal policy is another macroeconomic policy which involves the government reducing or increasing spending, taxation and the overall budget outcome to influence resource allocation, redistribute income and minimize the functions of the business cycle. An overview of the history of monetary and fiscal policy in past decade reveals that it has achieved some of its objective such as an average inflation rate of 2-3 p.a %, sustainable economic growth at 3-4% p.a and a stable Gini coefficient of 0.304-0.32 at some periods while at the same time not achieving other objectives e.g. external stability. Economic growth is the increase in real GDP over a period of time usually one year. Although economic growth is beneficial it must be kept at a sustainable level of 3-4% to avoid a CAD blowout or high inflation. Therefore the RBA through its use of DMO will buy government securities and force the cash rate down, this reduces interest rates and increases economic activity and vice versa. The RBA’s focus in the last decade has been accelerate growth, therefore the interest rate have been relatively stable with movements roughly within the 4-7% band. With the onset of the global financial crises, the RBA has reduced the cash rate over the past few months from over 7% down to the current 3.0%. In regards to fiscal policy, monetary policy is more effective as it is more flexible board members meet every month as opposed to every year in the budget. The government exercises its fiscal policy to keep economic growth at a sustainable level i.e. avoid high inflation and a CAD blowout. If economic growth is too high, the government will use a contractionary fiscal policy stance, reducing spending and maybe even increasing taxation and vice versa if economic growth is too low. Over the past decade the budget has moved from a deficit of $4.2 bn in 1997-98 to a surplus of $23.3 bn in the 2008-09 financial year. This reflects successful achievement of economic growth as the budget is set be contractionary over the majority of the decade. However, with the outbreak of the global economic crises the Rudd government was forced to run a huge budget deficit of around 50$bn responding to slow economic growth of 0.4%. Maintaining price stability is one of the main objectives of the RBA. Price stability refers to keeping inflation at a sustainable rate i.e. 2-3%. Aside from the introduction of the GST which pushed inflation up to 6%, the RBA has generally been successful in controlling the level of inflation. The inflation rate has average around 2.6 % since 1996 which demonstrates the RBA’s success in keeping inflation in the target range. However, recent events e.g. high oil prices, 17 consecutive years of economic growth has pushed the inflation rate prompting the RBA to be cautious in promoting economic growth. External stability has become an objective of fiscal and monetary policy with the expanding role of globalization. A budget deficit decreases national savings through the crowding out effect which is linked with the twin deficit theory. This suggests that if the government runs a budget deficit then it will increase the CAD therefore the government should avoid running a budget deficit unless deemed necessary, such as in a recessionary period. External stability is not one of the important objective of the RBA, only in rare cases may the RBA sacrifice domestic factors and force the interest rate up to encourage capital inflow into the country. Australia has sustained a relatively high CAD ranging from 52.3 -62.5 % of GDP for many years and a heavily traded exchange rate compared to the Australia’s contribution to GWP. Monetary policy can also be used to influence the level of unemployment. By using expansionary monetary policy, and reducing interest rates, this will lead to an increase in aggregate demand. As demand increases so too will ‘derived demand’ for labour. A tightening of monetary policy will have the opposite effect. The cash rate is currently at 3.0% to encourage consumer spending and thus reduce our unemployment which is at 5.8%. By implementing macroeconomic policies to reduce unemployment this can lead to higher levels of demand-pull inflation. Thus, using only macroeconomic policies the government is not able to simultaneously achieve all its economic objectives. This must be done through the use of structural change and microeconomic reform. Fiscal policy changes can influence the level of unemployment level in an economy directly or indirectly. Fiscal policy may improve unemployment level directly through government spending in particular area of the economy, such as the development of infrastructure. This should create demand for additional labor. Over the last decade from 99-07, our budget surplus has gradually reduced, reflecting expansionary fiscal policy. This has been effective as it has led to a 3% decrease in the unemployment rate between 2001 and 2007. The indirect influence of fiscal policy covers tax and spending decisions that make it more attractive for labour to be employed. Monetary policy can also be used to achieve an equal distribution of income, however this falls outside the primary objectives of the RBA. As high income earners have a high marginal propensity to save and low income earners have a high marginal propensity to consume, a decrease in interest rates would result in less money accumulated in interest for high income earners and cheaper funds available to borrow for low income earners. This phenomenon results in money being redistributed from the higher quintiles (in the form of lost interest) to the lower quintiles (in the form of money saved on loans) and therefore should lower the Gini coefficient. In the last decade the use of fiscal policy to influence income distribution has been effective. The government can achieve a more equal distribution of income through progressive taxation. This takes away money from the wealthy and gives it to the lower quintiles in the form of welfare payments. In 2004, before government intervention, the lowest 20% of the population were earning 0.8% of total income whereas the highest 20% were earning 47.6% of total income. As a result of taxation, the share of final income received by the lowest quintile was increased to 14%. However, the implementation of the goods and services tax in 2000 which is a regressive tax meaning the more you earn the less tax you pay, along with reduced tax rates for higher income earners in John Howard’s time in office has led to greater income inequality. This is due to low income earners, not receiving the benefits of the tax break, but still having to pay the extra 10% on goods and services. The government’s economic objectives cannot be achieved through the use of only macroeconomic policies. Microeconomic policies and structural change are required to allocate resources effectively, achieve world’s best practice, improve efficiency amongst firms and result in a more stable and structurally safe economy in the long term. Microeconomic policies are supply side policies which aim to achieve certain objectives that macro cannot fulfill. The Australian government’s main economic objectives of external stability, price stability, full employment, equitable income distribution and sustainable economic growth have achieved successfully in the last decade through its use of a mix of both fiscal and monetary policies as well structural change and microeconomic reform. The RBA achieves this through its use of Domestic Market Operations to increase or decrease interest rate to influence economic outcomes. The government can use the budget and as well as taxation to influence economic outcomes. After comparing planned outcomes with actual outcomes, it can be said that Australia’s use of fiscal and monetary policy in the past decade has been effective in achieving most economic objectives while at some points in the decade not achieving other objectives.