external stability

Topics: Inflation, Unemployment, Macroeconomics Pages: 9 (4245 words) Published: June 4, 2014
Analyse the use of macroeconomic policies in achieving
the Australian government’s economic objectives

Macroeconomic policies are those policies used by the Australian government to influence the level of aggregate demand in the economy, where AD = C + I + G + (X-M). They are used in the short term in order to smooth out fluctuations in the business cycle. Combined with an extensive microreform (MER) agenda, the government uses macroeconomic policies (fiscal and monetary policy) in order to achieve its five economic objectives. These are: strong economic growth (3-4% pa), price stability (2-3% across the cycle), full employment (at NAIRU), equitable distribution of income and ecologically sustainable development. It is important to note that although external balance is no longer a policy objective of the Australian government, the need to have a sustainable CAD, sustainable foreign liabilities and a stable exchange rate still plays a significant role in influencing policy making decisions.

Monetary policy is the main macroeconomic policy used to achieve the government’s economic objectives, operating as the ‘swing arm’ of policy making. Monetary policy involves the RBA influencing the cost and availability of money in Australia via the interest rate level. The chief objective of monetary policy is to maintain price stability, and in 1992 the RBA set a target inflation rate of 2-3% across was the cycle. Inflation may be defined as a general and sustained increase in the level of prices over a period of time. The most widely used measure of inflation is the Consumer Price Index (CPI), a basket of goods and services reflecting average household spending patterns (a regimen). The RBA uses these CPI figures in order to determine its monetary policy stance. The other two objectives of monetary policy are to reduce the level of unemployment and achieve a sustained level of economic growth. Unemployment refers to the underutilisation of resources in an economy (though essentially it is focused on labour resources), while economic growth (2.5% for 2005-06) may be defined as an increase in a country’s productive capacity (GDP) over time. However, the fast changing nature of economic conditions means it is not always possible to achieve all of these objectives in the short to medium term, and so goals may conflict.

There are two main instruments for conducting monetary policy. Monetary targeting, whereby the RBA controls the growth in the money supply through its control over the money base, was used extensively in Australia from the mid-1970s but was abandoned in the mid-1980s. Today, monetary policy is implemented via Domestic Market Operations (DMO’s), which involves influencing the interest rate level in the economy through the setting of the cash rate in the short term money market. The RBA can either tighten or loosen monetary policy by selling or buying government securities. This influences the liquidity of funds, which in turn impacts on the marginal return on capital. The cash rate will then either rise or fall, influencing the cost of borrowing and translating into either higher or lower interest rates. The current cash rate of 6%, the highest since 2000, is a clear indicator of the steady tightening of monetary policy over the last six years to combat rising inflation.

There are four channels through which monetary policy achieves its economic objectives. The first of these is the inter-temporal substitution effect. Higher interest rates dampen consumer spending and business investment in the economy (dropping the C and I components of aggregate demand). This results in a decline in economic growth and removes pressure from prices, leading to a corresponding drop in demand-pull inflation. As the demand for labour is a derived demand, job opportunities will decrease as less goods and services are being produced, means an increase in the level of unemployment and automatically widening inequality. This...
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