EPO, MONETARY AND FISCAL POLICY

Question 1

What are the Australian Government’s 5 economic policy objectives?

Answer 1

1. Price Stability - target is 2-3% long term average CPI
2. Sustainable Economic Growth - target is 3-4% real GDP growth rate
3. Full employment - target is 4.5% - 5% unemployment
4. Equitable Distribution of Income
5. Efficient Resource Allocation

Question 2

Define “economic growth”

Answer 2

Increasing the capacity of the economy to satisfy the material needs and wants of its members

Question 3

Importance of steady economic growth

Answer 3

higher material living standards
employment opportunities
confidence

Question 4

Importance of price stability

Answer 4

redistribution of income
loss of international competitiveness
business and consumer confidence
decrease in efficiency

Question 5

Fiscal Policy

Answer 5

Use of government revenue and expenditure to influence a country’s economy

Question 6

What is Structural Balance

Answer 6

Fiscal decisions which are deliberate (discretionary fiscal policy) such as tax rates, infrastructure spending, education etc

Question 7

Structural deficit and issues

Answer 7

Structural deficits occur due to structure of Australia’s economy and long term tax & spending habits
Structural issues: rising health spending and structural unemployment

Question 8

Recent fiscal policy

Answer 8

Australia had budget deficit every year since 2009

Gov. strategy to reduce deficit due to concerns of debt

Question 9

Strengths and Weaknesses Fiscal

Answer 9

Strengths - Direct (short outside lag), spending tap that sets off multiplier effect, complements effects of automatic stabilisers
Weaknesses - Recognition and decision lag, inflexible and non-effective in boom, political constraints

Question 10

Funding budget deficit - Selling government bonds

Answer 10

Financial investment which raises funds for its issuer in return for rate of interest payable to the buyer (sold in trough with expansionary budget)
Crowding out - Government needing borrowed funds to pay for expansionary policies creates a shortage of funds for borrowing

Question 11

Funding budget deficit - Borrowing from RBA

Answer 11

Achieves expansionary effect but causes inflation
(if growth in money supply > growth in real output)
can cause inflation

Question 12

Funding budget deficit - Borrowing from overseas

Answer 12

Appreciated AUS will make Australian exports less competitiveness and imports more attractive (reduces AE) - doesn’t help Australia out of trough

Question 13

Strengths and Weaknesses of Monetary Policy

Answer 13

Strengths - Flexible (does not require parliament approval and meets regularly), political neutrality (impacts all sectors of economy), effective during boom periods (direct impact on AD via transmission mechanism) and very effective under floating exchange exchange rate
Weaknesses - Less effective during trough (liquidity trap), timelags (effect) and blunt instrument (can’t target specific sectors)

Question 14

Market for loanable funds definition

Answer 14

Market where savers supply access funds, and borrowers demand these funds for investment

Question 15

Factors affecting market for loanable funds

Answer 15

Credit creation process (saving, loan and requirement)
Government budget outcome (methods of financing)
Business cycle (level of economic activity positively correlated with demand for credit)
Overseas economic events (investor confidence)
RBA’s market operations

Question 16

Define monetary policy

Answer 16

Actions taken by country’s central bank to influence price and availability of credit in the economy (implemented by manipulating level of liquidity)
Cash rate above 4% contractionary

Question 17

Transmission Mechanism - lower CR / IR

Answer 17

Cost of Borrowing - Price of borrowing (mortgage and business loan) lower, rate of return on savings drops due to lower interest rate
Cash Flow - Price of servicing exisiting loan decreases which has a positive impact on remaining costs and cash available for consumption spending
Asset Prices + Wealth - Lower interest rates make shares a more attractive option compared to bonds (higher return from shares). Increased demand and price for shares. Wealth effect for shareholders
Exchange Rate - Lower interest rates affect demand for AUD (relative interest rate), resulting in decreased FI and AUD decreases. Decreased imports (more expensive for domestic buyers), increased exports (cheaper for foreign buyers)

Question 18

How transmission effect impacts C, I and NX

Answer 18

timeshift effect (people bring forward consumption), exchange rate effect, cash flow effect, wealth effect and expectation effect
Impacts confidence and future expectations

Question 19

Contractionary gap - Exchange settlement market

Answer 19

Supply shifts right after RBA buys securities which increases liquidity in the market, decreasing the cash rate. The monetary policy stance has loosened. Increase in quantity and decrease in CR

Question 20

Contractionary gap - Loanable funds market

Answer 20

Supply shifts right as there is more money available to the market. Cash rate decreases

Question 21

Automatic stabilisers

Answer 21

Act to dampen fluctuations in business cycle and uncontrollable by government
Welfare and Tax Revenue

Question 22

Discretionary Fiscal Policy

Answer 22

Changes to expenditure and revenue that government makes in budget to stabilise the economy
G2 spending and Tax

Question 23

KEY INDICATOR STATISTICS

Answer 23

CPI - 2-3%
GDPr - 3-4%
Unemployment - 4.5-5%