The Australian Output - Case Study Example

Econimices Name Course Tutor Date The economy of Australia has always been regarded as one of the strongest and among the fastest growing around the world. Over the past two decades the Australian economy has had a decline in unemployment and economic growth. With the economy getting involved in thorough policy and structural reforms the economy has become very strong, flexible and very nicely integrated with markets all round the world (Garnett, 2010). Fiscal policy refers to an action by the Australian government to spend money or to collect money in the form of taxes with the aim of influencing the level of economic activity. These policies influence the amount of government purchases and taxes thereby controlling the economy (Bhattacharya & Mukherjee, 2013). Fiscal policy therefore involves a component of public debt management. The Australian economy is not performing well; there is a moderate decrease in Australian output in the short run because of the decrease in foreign demand for the output especially by the Chinese market. The Australian output can be stimulated either by adopting a fiscal policy or by adopting an expansionary monetary policy combined with tax increase and spending cuts by government seeking to reduce its budget deficit. There are many merits for stimulating Australian output via fiscal policies. The Australian government may use fiscal policy to intervene in the economy in the following three crucial ways; firstly, by spending more money and financing this expenditure through borrowing, by collecting more in taxes without increasing expenditure and finally by collecting more in taxes with the aim of increasing spending (Galí & Perotti, 2003). Fiscal policy is one of the instruments of demand management used by the Australian government. Changes in the level of government expenditure and taxation could be used to eliminate an inflationary or deflationary gap in the economy. Additional government spending should create a multiplier effect on national income, although such public sector spending may have the effect of ‘crowding out’ private sector investment owing to increase in interest rates (Gruen & Sayegh, 2005). If the government follows the above measures then there is a like hood of the output to be stimulated and eventually lead to economic prosperity. This can be illustrated in the figure below In the figure above, an increase in taxation by T without any matching increase in government expenditure would lead to a reduction in the aggregate expenditure in the economy as shown by the shift in the aggregate demand curve from AD1 to AD2. When the government expenditure exceeds the government revenue it causes a budget deficit. According to the Keynesian perspective, a budget deficit may not in itself be a problem. During the times of unemployment and recession, a government may deliberately create or allow a budget deficit to develop with the intention of stimulating the economy as it is being done by the Australian government (Kulish & Elias, 2013).This can be illustrated in the below diagram whereby G represents the government expenditure and T is taxes. In the above diagram the national income of the Australian government is in equilibrium at a level Ye where withdrawals are equal to injections. This level of income falls short of the full employment level Yf and according to Keynesian view point, if the government increases its spending to (G*) to exceed its income (T) then through the multiplier effect, national income will be increased towards Yf. The model demonstrates that a new equilibrium at Yf is achieved with withdrawal =injection (W=J) but with G>T and with adjustment to other pairs, for example, M+X. In this context, the budget deficit G>T is viewed as a positive measure for taking the economy out of recession (Kulish & Elias, 2013). An increase in spending by the Australian government will cause an increase in the aggregate demand for output in both the short run and long run. Aggregate supply must also increase in order to tackle the increase in aggregate demand. Output will as well increase because the demand for goods and services in the economy has increased and therefore aggregate output must increase to meet aggregate demand. If the Australian government increases spending, it will cause an increase in demand for all values of income which eventually cause a shift to the right of the aggregate demand curve and in the long run the economy will be stimulated. The diagram below shows an outward shift of the demand curve which is most likely caused by an increase in consumers’ wealth (Paradiso, Kumar & Rao, 2013). The Australian economy can also be stimulated by collecting more in taxes without increasing expenditure. When taxation is used as a fiscal policy to stimulate the economy it always has a significant impact on the national income causing an immediate effect on the economy. An increase in taxes will likely lead to a decrease in consumption of demerit goods, while a decrease in tax on public goods will lead to an increase in consumption and if the government cuts taxes on wages will encourage people to work very hard causing the aggregate supply curve to shift to the right. The fact that people earn more wages and are taxed less allows them to have much more to use is purchase of goods and services and therefore allowing the economy to flourish (Paradiso, Kumar & Rao, 2013). The Australian output can also be stimulated by collecting more in taxes with the aim of increasing spending. When the Australian government increases tax on a certain activity it tends to discourage that activity, furthermore a very high marginal tax rate on peoples income will reduce people incentive to earn any income. The government will always collect more income from taxes and will increase on spending therefore increasing output in the economy (Jaffe, 2007). Stimulating the Australian economy that is experiencing a decrease in foreign demand for her output using the expansionary monetary policy combined with tax increase and spending cuts by the government seeking to reduce its budget is not the best way as compared to stimulating the output via fiscal policy (Whitehead, 2010). Expansionary monetary policy refers to a situation whereby a policy is used to increase the supply of money in an economy. The Reserve bank of Australia plays this role of increasing money supply i.e. increasing the quantity of money in circulation and reducing interest rates in order to stimulate the economy. This is purely done with an intention of addressing the core problem affecting the economy of unemployment (Paradiso, Kumar & Rao, 2013). When there is a combination of extra money circulating in the economy and low interest rate, the economy will be stimulated by inducing additional expenditure on aggregate output and therefore more resources will be used, more people will be employed leading to reduced cases of unemployment. This method of stimulating the economy using an expansionary monetary policy has only a short term implication in the output of an economy, in the long run it tends to drive up inflation in the economy as well as increase debt making it very hard for the economy to expand. The economy will not expand because the cost of money exceeds the value of the investment that can be made using that money. The Australian economy will most probably suffer if the government decides to adopt an expansionary monetary policy (Perotti, 2005). Australian economy is a large modern economy and among the fast growing ones. Expansionary monetary policy if used in a large economy usually takes time to work its way through the economy (Meredith, 1999). In most times the expansionary monetary policy action that can really affect output is estimated to take approximately 3 months to 2 year for their real effect to be felt by the people. These policies affect in one way or the other the current account in the short run though their effect on the real exchange rate. In most case the expansionary monetary policy will cause an increase in income as well depreciation of the currency (Lipsey, 1995). The Australian output has really decreased in recent years especially due to a slowdown in the growth of the Chinese economy because many Chinese are not importing from Australia. In order for the Australian output to be stimulated I will recommend that the government adopts a fiscal policy (Jaffe, 2007). An expansionary fiscal policy has an effect on the country’s currency and the economic output. It causes a real appreciation of the currency and causes an increase in output and eventually affecting the current of account in a negative manner causing the current of account to decrease. A currency appreciation especially when the Australian economy is in a boom will help in the reduction of the inflationary pressures. Therefore in a situation whereby the current account is affected policy makers should be concerned especially when choosing which course to follow (Gordon, 2009). References Bhattacharya, R., & Mukherjee, S. 2013. Non-Keynesian effects of fiscal policy in OECD economies: an empirical study. Applied Economics, 45(29), 4122-4136. Galí, J., & Perotti, R. 2003. Fiscal policy and monetary integration in Europe. Economic Policy, 18(37), 533-572. Garnett, A. P. 2010. The economy. Sydney: New South Wales University Press. Gordon C, 2009. Economics in focus: the global financial crisis. New York: Pearson Gruen, D., & Sayegh, A. 2005. The evolution of fiscal policy in Australia. Oxford Review of Economic Policy, 21(4), 618-635. Jaffe, A.B, 2007. Innovation, policy and the economy and citizen since 1960; Cambridge. Cambridge University press. Kulish, M., & Elias, S. 2013. Direct effects of money on aggregate demand: another look at the evidence. Applied Economics, 45(27), 3801-3809. Lipsey, G.R. 1995. An Introduction to Positive Economics. Vancouver. Oxford University press. Meredith, D.U. 1999. Australian in the global economy: continuity and change. Sydney: Cambridge university press. Paradiso, A., Kumar, S., & Rao, B. B. 2013. A New Keynesian IS curve for Australia: is it forward looking or backward looking?. Applied Economics, 45(26), 3691-3700. Perotti, R. 2005. Estimating the effects of fiscal policy in OECD countries. Whitehead, G.P. 2010. Economics. New York. The Beaver. Read More