Macroeconomic Policy-Inflation, Unemployment and Growth in Australia - Case Study Example

Macroeconomic policy-Inflation, Unemployment and Growth Name: Institution: The Global Financial Crisis affected the economic growth of all developed and developing countries. In fact, it almost led to the collapse of the economy of some influential developed countries. Australia was not left out. As the analysis in this paper will show, Australia had to change its macroeconomic policy from that which focused on controlling inflation to that which focused on trying to avoid recession. As analysis will also show, these two macroeconomic policy approaches seem to contrast in terms of objectives, instruments and targets. Therefore, through outlining the experience of the Australian economy over the last 10-15 years while putting into consideration the major microeconomic aggregates, this paper aims at discussing the contrast between these two policy approaches and their impacts to the Australian economy. In addition, it discusses and assesses how instruments and targets of the macroeconomic policy can be applicable in the current Australian policy framework. The paper will then lastly look at the application of economic theories in understanding economic policy in Australia. Experiences of Australian economy Source: Taylor, Bradley, Dobbs, Thompson & Clifton (2012) An overview of the past performance of the Australian economy can be looked at through different perspectives. In terms of how the country has been, performing based on GDP per capita Australia ranks in the sixth position from its sixteenth position in the early 1990s amongst OECD countries. An interesting fact to note about Australian economy is that since 2005, the country’s economy driving force has been the temporary boom factors, which accounted for the 58% of the income growth (Taylor, et al, 2012). During this period, Australia has also realized a 99% drop in productivity capital, leaving the country’s income growth to be driven by resources, which accounted for 35% of the income. In addition, between 2005 and 2011, the country’s economy experienced a decline of 0.7% annual productivity, compared to that between 1993 and 1999, which was an increase of 2.4%. What these overview data projects to the future of this country’s economy is that the decline in productivity alongside the slow pace of boom is likely to drop the income growth by 0.5%. Source: Taylor, Bradley, Dobbs, Thompson & Clifton (2012) However, the need to continue with stability of economy is likely to lead to an increase in investment in resources sector by over 50%. This would lead to an increase in national income up to A$90 billion by 2017 (Taylor, et al, 2012). However, this is only possible if the country’s economic productivity averages on restored in the long term. However, the strength of in investment could see the national income rise above what is indicated above. Before the global financial crisis, productivity controlled almost half of Australian economy growth income. However, since 2005, it was noted that both labour and capital productivity fell dramatically (Garnett & Lewis, 2008). Australian economy depended on resource prices increase as favourable terms of trade in driving its economy. Therefore, before the global financial crisis, the capital investment alongside terms of trade played a critical role in defining Australian economic growth. This meant that the country concentrated on balancing the ratio of exports to its imports. This was basically powered by the rise of the Chinese economy due to the demand for ore and coal. The high demand for ore and coal increased the price of exporting them while at the same time, the ease and cheap steady flow of goods manufactured by Chinese factories into Australia led to the less spending on imports (Taylor, et al, 2012). This played an essential role in stabilizing the economy of this country and preventing inflation at all cost. However, up to 2011, it was evident that capital productivity played an insignificant role in growing the economy. In fact, it dragged the Australian economic growth by close to A$43 billion. Economic growth brought with it the focus on resource boom, which currently drives a junk part of the country’s economy. This has been an advantage to the Australian economy especially because of the pace of stability experienced in Asian countries trading with Australia, among which include China (The Australian Industry Group, 2013). Source: The Australian Industry Group. (2013) As evident, China did not suffer global economic crisis. In fact, it became the most powerful economy in 2009. Therefore, it played a critical role in defining the pace of stability of the Australian economy. However, as it is indicated, this pace of stability is based on temporary boom from resources. This means that the economy is on the balance and policy makers try as much as possible to avoid recession (Lim, Chua, Claus & Tsiaplias, 2010). Therefore, lack of demand from customers was noted to be a major concern to policy makers, as evident from the graph. They are not expecting the Australian economy to remain stable just on temporary booms. This is because lack of demand is likely to dampen the growth of the manufacturing industry. Targets and instruments in macroeconomic policy Microeconomic policy instruments can be defined as the macroeconomic quantities that are under the direct control of policy makers. Therefore, instruments can be categorised into Fiscal policy or monetary policy instruments. For clarity it is essential to note that the Federal Reserve conduct, formulate and control monetary policy while the legislative or executive branches of government are expected to conduct and control fiscal policy (Jacobs & Rayner, 2012). This is because it concerns management and determination of the government’s financial budgets. On the other hand, ‘targets’ in macroeconomic policy simply refers to the laid down goals that policy makers strive to achieve in a macroeconomic level. Therefore, as it is with any government or organization, targets can be either being long term or short term (Dungey & Pagan, 2009). The adoption of either short term or long-term targets is always to ensure a systematic approach and understanding of goals. In reference to the Australian economy, it is essential to note that some of the important goals of this country’s economic policy are to ensure reduction in inflation, as evident in the durations before global financial crisis, increase in the country’s economic growth, avoiding recession and more importantly, is the need to reduce foreign obligations (Lim, Chua, Claus & Tsiaplias, 2012). The Australian macroeconomic policies are designed to cater for all these issues through encouraging increase in economic growth rate, solving unemployment, lowering inflation rates and at the same time, ensuring a balance of payment that is favourable to the economy. In order to achieve all these, the policy makers came up with targets, which included the need to reduction of inflation rate to 2 to 3%, stability and growth of the country’s GDP, lowering of unemployment level, and increasing productivity. In order to achieve these, the Australian government must focus on the ‘instruments’ (Gordon & Valentine, 2009). According to the policy stipulated in the Reserve bank Act 1959, especially in section 10(2), it is clear that this country’s economy must focus on stability of currency, attaining a full level of unemployment, and attaining a stable economic progress to avoid both inflation and recession (Otto, 2007). Therefore, the policy should introduce an influence on levels of interest rates and circulation of money through utilization of open markets. Policy makers, on the other hand, should use fiscal policy, in order to ensure that the government is in control of the influence level of aggregate demand and supply (Fenna, 2013). This is essential in attaining the set targets. In order to balance taxation and government spending, Australian policy makers must ensure the policy adopted reduces taxation alongside reducing taxation as a methodology of contraction policy. Economic theories and their applications Some of the essential aspects that the government of Australia is putting much focus on are improving their economic growth, lowering the level of unemployment and fighting recession. As it is clear, the Australian temporary economic boom resulted from exporting of ore and coal to mainly China and India during the global financial crisis (Lewis, 2010). In fact, this enabled Australia to stand the test of the crisis. However, in order to avoid recession, the government has a different approach to handling inflation, quite different from its focus before the financial crisis (Gordon & Valentine, 2009). This is because of decrease in the resources demanded by both China and India. Therefore, analytically through theories of causes of inflation alongside those of trying to explain the methodology of using fiscal policy and monetary policy in achieving objectives, it is interesting to look at the trend of the Australian economy. One understandable fact with inflation is that it can be either due to demand-pull or due to cost-push. In the Australian situation, inflation increase is based on demand-pull as mentioned. It is expected that when demand rises, there is a relative increase in prices. If this demand is based on major industrial activities such as mining and manufacturing, it is expected that the wages of workers also shoot up (Connolly & Lewis, 2010). Important to note is the fact that the demand-pull inflation type has its main causes to be a stagnant output level that might currently not be able to meet the aggregate demand or simply an increase in aggregate demand. Considering that the two situations apply to the Australian economy, there are inevitable problems that the RBA must put into consideration (Fenna, 2013). This is because of the possibility of increase in prices of affordable commodities in Australia, as the policy makers try to balance the decrease in demand level of exports while at the same time try to balance the stability of economy, reduction in unemployment rate and the need to avoid recession. However, policy makers understand that for economic growth to increase, there is need to lower the inflation rate and stabilize the prices of commodities in order to ensure maximization of the welfare of both parties involved in building and stabilizing the Australian economy. In terms of monetary policy, inflation or high circulation of money, the policy makers must employ the use and adoption of contraction monetary policy theories. This has been a critical aspect used by the Reserve Bank of Australia. RBA has been able to regulate the circulation of money in the Australian economy to stabilize and reduce the rate at which inflation is on the increase (Gordon & Valentine, 2009). Through this mechanism, Australian economy has observed increased interest rates, market operation and minimized requirements of the bank. This mechanism is evidently likely to divert money into the banks thereby controlling the rate at which money is released by the banks. This has been a vital step in trying to balance the flow of money into the Australian domestic market. On the other hand, the employment of fiscal policy always arises when a country experiences high inflation rate (Jacobs & Rayner, 2012). Though the country has not reached this far parse, in case this level is reached, it will be required that policy makers increase tax levels and, at the same time, reduce government expenditures. This should be done in order to ensure increase in draining excess resources available in the economy (Fenna, 2013). Since the country is striving towards avoiding recessions at all costs, it is expected that Australian economy does not reach the level where it is forced to use an expansionary policy. This will require pumping of additional resources into the market through reduction of taxation and increasing the government expenditures. In conclusion, therefore, it is evident that thought before the Global Financial Crisis, the Australian economy concentrated on dealing with inflation, the crisis brought with it an economic stability based on the boom of temporary resources. However, the stability of the economy through this boom is temporary and with reduction in the rate of demand of these resources, the country’s economy might face the need to consider an increase in inflation in order to control its capital market. In addition, Australian economic trends are forcing policy makers to start thinking of ways of improving productivity. Interesting to note also is how the RBA has managed to work across all these. It is, therefore, expected that the policy makers must consider terms of trade, productivity and capital market alongside reducing unemployment while tackling economic stability for a better future for the Australian economy. References: Connolly, E., & Lewis, C. (2010). Structural change in the Australian economy. Bulletin| September Quarter, 1. Dungey, M., & Pagan, A. (2009). Extending a SVAR Model of the Australian Economy*. Economic Record, 85(268), 1-20. Fenna, A. (2013). The Economic Policy Agenda in Australia, 1962–2012. Australian Journal of Public Administration, 72(2), 89-102. Garnett, A. & Lewis, P. (2008). The Economy’, in Aulich, C. and Wettenhall R. (eds), Howard’s Fourth Term, New South Wales University Press, Sydney. Gordon, C. & Valentine, T. (2009), Economics in Focus: The Global Financial Crisis, New South Wales: Pearson Education. Jacobs, D., & Rayner, V. (2012). The Role of Credit Supply in the Australian Economy. Reserve Bank of Australia. Lewis, P. E. (2010). The Australian Economy: Your Guide. New South Wales: Pearson Australia. Lim, G. C., Chua, C. L., Claus, E., & Tsiaplias, S. (2010). Review of the Australian Economy 2009–10: On the Road to Recovery. Australian Economic Review, 43(1), 1-11. Lim, G. C., Chua, C. L., Claus, E., & Nguyen, V. H. (2012). Review of the Australian economy 2011–12: A case of déjà vu. Australian Economic Review, 45(1), 1-13. Otto, G. (2007) `Central Bank Operating Procedures: How the RBA Achieves Its Target for the Cash Rate’, Australian Economic Review, 40(2), 216-224. Taylor, C., Bradley, C., Dobbs, R., Thompson, F., & Clifton, D. (2012). Beyond the boom: Australia's productivity imperative. McKinsey Global Institute, Sydney, pp. 59Á76. The Australian Industry Group. (2013). ‘National CEO Survey: Business Prospects in 2013: Australia’s gap Year’ accessed October 13, 2013 from < http://www.aigroup.com.au/portal/binary/com.epicentric.contentmanagement.servlet.ContentDeliveryServlet/LIVE_CONTENT/Publications/Reports/2013/CEO_Business_Prospects_2013_report-FINAL.pdf> Read More