Economic policies and management (Topic 4 Economics)

• Macroeconomic policy is the use of government policies to reduce large fluctuations and stabilise economic activity, in order to achieve economic goals. Due to the nature of macroeconomic policy minimising fluctuations, it often has short-term effects (rather than long-term impacts) on the economy, supporting AD and economic growth by stabilising the business cycle. Hence, the effectiveness of macroeconomic policy benefits from the multiplier effect of spending on the economy.
• The rationale for economic stabilisation policies is to achieve both internal and external balance across the whole economy, while sustaining economic growth. Internal balance refers to economic issues affecting the internals of an economy, including low unemployment, low inflation and stable economic growth, whereas external balance concerns an economy’s objective in relation to the world, including financing import and export expenditure, stability of exchange rate, level of net foreign liabilities, and debt as percentages of GDP.
• The policy mix refers to the combination of macroeconomic and microeconomic policies used in an economy.
• Fiscal policy involves the government using spending, taxation and the budget outcome to influence resource allocation, redistribute income and reduce fluctuations in economic activity
• The Budget is a tool that plans an economy's government expenditure and revenue for the next financial year. Budget outcomes refer to the overall outcome of the Budget (different to the budget stance!). The budget outcomes include: • Deficit: expenditure greater than revenue • Surplus: revenue greater than expenditure • Balanced: revenue equal to expenditure
• Budget stances refer to the spending pattern of the government, and includes: • Expansionary budget: a net increase in government spending (increase in government expenditure or decrease in revenue collected). This is often used in downturns or recessions, as it increases AD, supporting economic growth. • Contractionary budget: a net decrease in government spending (increase in revenue collected or decrease in government spending). This is often used in periods of economic growth to contain AD and promote sustainable economic growth and price stability.
• Automatic stabilisers are instruments inherent in the government budget that counterbalance economic activity (e.g. progressive tax system and transfer payments). For example, when an economy improves, tax revenue increases. This is because people’s income increase, into higher tax brackets (called bracket creeping), causing higher tax collection and a lower demand for welfare. This occurs in times of economic growth, to help contain inflation and excessive growth. Conversely, as tax revenue falls and welfare increases in contractionary periods, AD is supported to maintain spending.
• The cyclical component (non-discretionary changes) of fiscal policy are caused by changes in the level of economic activity (e.g. automatic stabilisers in the budget). On the other hand, the structural component (discretionary changes) of fiscal policy are the deliberate changes to the budget (e.g. the 2019 tax cuts to lower-income and middle-income earners)
• Methods of financing deficits: Borrow from the private sector, Borrow from the RBA, Borrow from overseas.
• Borrow from the private sector: Debt financing is the selling of Treasury bonds to raise funds. It is the main form of deficit financing where investors lend money through bond purchasing and the government pays back the money, with interest. This is advantageous as there is no change in the money supply, since the government is borrowing within the domestic economy, so there is no increase in net foreign debt. The government may need to offer higher interest rates, and the private sector (banks) may then need to borrow from overseas, which would add to CAD.
• Borrow from the RBA: Quantitative easing/monetary financing increases supply through the government’s selling of securities to the RBA, which increases their cash flow. This method increases the quantity (supply) of money in the economy and is usually used only when the cash rate is nearing 0, as interest rate cuts become ineffective. The advantages to this are that there is no change to the interest rate, no accumulation of public debt, and no increase in net foreign debt. Governments rarely use this, though it was seen in the US during the GFC, which devalued their currency.
• Borrow from overseas The RBA sells government securities to foreign investors, then the RBA credits the Australian dollar equivalent of the loan to the government’s account. If the government budget is ‘irreparable’ it could borrow from the IMF, but currently Australia is not in such a position. Exchange rate fluctuations can also be volatile and may affect the servicing costs of the debt (valuation effect).
• Use of a surplus • Pay off retiring public debt: will reduce future debt obligations, as interest repayments become lower, minimising future expenditure • Reduced foreign debt: will reduce interest payable and the size of NPY deficit, hence reducing the CAD and overall foreign debt levels • Government owned investment funds: surplus government revenue can be invested into government funds used for future expenditure (e.g. the Future Fund helps cover superannuation liabilities
• Monetary policy involves the setting of interest rates administered by the RBA, on behalf of the government. The aim is to smooth the effects of economic fluctuations and maintain low inflation.
• If AD is growing too fast and consumer confidence is too high, the RBA may increase the cash rate. This is because an increased cash rate causes interest rates to increase, incentivising saving and raising the costs of borrowing. If AD is slowing down and consumer confidence is low, the RBA may decrease the cash rate. This is because a lower cash rate causes interest rates to decrease, incentivising spending.
• The transmission mechanism refers to how changes in the stance of monetary policy influence economic objectives, such as inflation and economic growth. The intertemporal substitution channel of monetary policy refers to the phenomena where interest rates are low and savings are discouraged, causing consumption and other forms of investment to increase, until rates increase again
• The wealth effect refers to when lower interest rates makes borrowing cheaper, which encouraging spending and increasing demand e.g. housing, making homeowners feel wealthier and more likely to spend.
• High domestic interest rates increase demand for the AUD, as savings rates are more attractive for investors. This can cause an appreciation of the dollar, whereas low domestic interest rates may increase supply for the AUD, as savings rates are less attractive for investors, and money may be invested internationally. This interest rate differential determines whether investment, and hence demand for the dollar, increases or decreases. However, the impact on the exchange rate is a secondary function of monetary policy, with the RBA focusing on stabilising inflation as a priority
• Microeconomic policies aim to increase Aggregate Supply (AS) by improving the efficiency and productivity of producers. These policies are aimed at individual industries or markets, for example the labour market. Microeconomic policy may involve deregulation, privatisation (selling of government enterprises), or reformation of the competition policy.
• Rationale for microeconomic policies: Firms can be ‘forced’ to improve their own performance by exposing them to greater competition from foreign firms, for example through the removal of protectionist policies. Competitive pressures encourage efficient operation of markets, for example an increased investment in new technology. This increases productivity, and improve flexibility and responsiveness to change
• The Australian economy has experienced major reforms to overall economic output since the 1980s. The economy experienced a shift from manufacturing production to focus on primary commodity markets (highlighted by the significance of the mining boom), to an increased focus on services.
• There are three types of efficiency gains from successful microeconomic policies, including: • Technical/productive efficiency: where firms are able to produce more output with lower opportunity cost. This is represented by the point of technical optimum for firms. • Allocative efficiency: where the prices charged reflect the marginal cost of production. Hence, resources are allocated to reflect consumer preferences • Dynamic efficiency: where firms are increasingly able to adapt to changing circumstances (e.g. the use of new technologies and consumer preferences)
• A product reform occurs in a specific industry. A factor reform involves the form of a factor of production. For example, reforms made to the labour market are factor reforms. Because labour is utilised in every industry, an increase in productivity in the labour market will increase overall productivity and benefit overall economic output. Capital deepening refers to the use of more machines per worker. This improves productivity; for instance, from 2001 to 2018, capital deepening productivity grew 1%.
• Deregulation refers to the removal of rules that constrain the operation of market forces in the aim to improve the efficiency of industries. The government, firms and industries are all responsible for implementing change.
• The National Competition Policy is an agreement between Australia’s Federal and State Governments, made in 1995 to encourage microeconomic reform throughout the economy. Competition policy is monitored by the ACCC under the Competition and Consumer Act 2010, which promotes competition, fair trading and consumer protection, as well as monitors unfair market practices (such as collusion and price-discrimination). The penalties that can be applied for breaches of the Competition and Consumer Act are up to $10 million for companies and $500,000 for individuals.
• The industrial relations system is used to determine wages and conditions in Australia. This system was centralised (i.e. controlled by government) in the 1990s, but is now decentralised, whereby the free market determines wage prices with the government only setting floor prices and conditions.
• The National System (Fair Work Act 2009) The National (minimum) Employment Standards are ten minimum employment standards and are often called the ‘safety net’ to which all employees are entitled. For example, standard 1 specifies a maximum of 38 hours of work per week.
• An industrial dispute occurs when employers or employees take action to disrupt the production process, to highlight a disagreement e.g. unfair dismissal. Unfair dismissal refers to a harsh, unjust or unreasonable dismissal of a worker. The industrial relations system aims to solve disputes efficiently to minimise the impact on productivity, output, and profits.
• Dispute resolution may involve: • Collective bargaining: a form of negotiation between employers and groups of employees or unions • Conciliation: where Fair Work Australia or a third-party act as a mediator and suggest solutions to resolve a dispute • Arbitration: where an industrial tribunal sets a legally binding decision on the dispute – this is usually a last resort and can involve further court judgements if escalated
• A centralised wage system is where there is a single national wage case for all employees, or multiple award wages set on an industry or occupation basis. A decentralised wage system involves individual contracts or enterprise bargaining, with less involvement from the government.
• The Kyoto Protocol and Paris Accord promote environmental sustainability within the global community. To deliver on Australia’s 2030 (Kyoto agreement) target to reduce emissions by 26–28% below 2005 levels, the government is investing $3.5 billion in a Climate Solutions package. The aim of this package is to reduce emissions while lowering energy prices for Australians, through the use of subsidisation rather than taxation, as taxation often increases the cost of production and price levels.
• Limitations on economic policies: Time lags - Policy lag refers to the length of time that elapses between a change in the stance of economic policy and its effects on real economic activity and behaviour. Implementation lag refers to the time it takes for the government to make, change, or introduce new economic policies. Impact lag refers to the time it takes time for a new policy or policy change to have an impact on the economy (e.g. for prices or consumption to adjust accordingly).
• Fiscal policy has a medium-term implementation lag, as the budget is decided annually, and has a shortterm impact lag, as spending multiplies AD at a fast rate. Monetary policy has a short-term implementation lag, as the cash rate is reviewed monthly; however, it has a medium-term impact lag as spending adjusts to the changing price of borrowing. Change can be implemented quickly, as it has immediate effect on the cash rate. Microeconomic reform as a long-term implementation lag, as policies are often researched before they are implemented due to their potential for large impacts
• Expansionary macroeconomic policy will boost AD due to the multiplier effect of additional expenditure. Microeconomic policy causes increases in AS, which require reform to increase productivity, economic output and growth. Australia has continued to sustain moderate growth mainly due to a combination of successful macroeconomic policy stimulus and microeconomic reform.
• Price stability response in dealing with economic objectives: Contractionary macroeconomic policy is used to lower inflation, as it limits AD and spending. Microeconomic reforms that that cause productivity to be greater and goods/services to be cheaper in the longer term will also assist with price stability. The RBA has a framework of 2–3% inflation. When this target was introduced, inflation fell from 8% in the 1980s to a stable 2.5% average since the introduction of inflation targeting.
• External stability: Contractionary macroeconomic policy will decrease spending, including spending on imports, improving the BOGS and lowering the CAD. Furthermore, a fiscal policy surplus can lower public foreign debt. Microeconomic policy causes increased competitiveness, for example protection reforms, which will increase exports, improving the BOGS and lowering the CAD.
• Distribution of income: Macroeconomic policies such as discretionary changes to the budget, including the progressive income tax which details a tax-free threshold of $18,200, with high income earners paying up to 47% of income, and automatic stabilisers, exist to protect lower income earners in economic downturns. Microeconomic policies regarding labour market reforms, for example the introduction of 10 minimum standards, protect lower wage recipients and can minimise income inequality
• Environmental sustainability: In terms of macroeconomic policies, fiscal policy can implement policies to regulate environmental degradation that occurs due to the free market. Microeconomic reform can increase the use of sustainable behaviours, for example the implementation of new technologies.
• Monetary policy refers to central bank activities that are directed toward influencing the quantity of money and credit in an economy. By contrast, fiscal policy refers to the government's decisions about taxation and spending. Both monetary and fiscal policies are used to regulate economic activity over time.