Economics  Notes  Global  Economy  and  Globalisation    global  economy  refers  to  the  international  economy.  It  includes  the  links  between  national  economies  developed  through  increasing  trade  flows,  flows  of  funds  and  flows  of  other  resources  and  ideas.      4  economy  categories  

• Advanced  Industrialised  (AIE)  e.g.  Japan,  USA  • Newly  industrialised  (NIE)  e.g.  Taiwan,  Singapore  • Less  Developed  e.g.  Pakistan  • Transitional  E.g.  Russia,  Poland.    

   gross  world  product  (GWP)  measures  the  value  of  production  globally    Globalisation:  

• process  of  increasing  economic  integration  between  countries,  through  the  breaking  down  of  international  boundaries,  leading  to  the  emergence  of  a  global  market  place  

• accelerated  after  WW2  • LABOUR:  workers  travel  to  where  rewards  are  highest,  cover  labour  

shorteges,  still  tight  restrictions  • INVESTMENT:  Acquiring  assets  abroad.  FDI  and  portfolio  investment.  

Direct  investment  driven  up  by  TNCs.  Wealthy  countries  have  comparative  advantage  due  to  technology  gap.  Investment  has  made  int’l  business  and  economies  of  scale  more  achievable  

• FINANCE:  development  of  a  complex  global  financial  system  • TRADE:  Globalisation  =  fast  trade  growth.  Favours  high  income  

economies,  which  account  for  86%  of  GWP,  82%  of  world  exports  measure  of  the  extent  of  trade  is  trade  dependency  i.e.  the  importance  of  exports  and  imports  relative  to  GDP.  NIEs  growing  in  trade  rapidly  due  to  Manufacturing  booms  

 International  Business  cycle:  

• alternating  periods  of  upward  and  downward  movements  in  the  aggregate  level  of  output  relative  to  long  term  trends  

• economic  growth  in  individual  countries  more  likely  to  follow  global  pattern  

• GFC  an  example,  cycle  perpetuated  by  links  from  globalisation  • regional  business  cycle  similar,  but  pertains  to  geographic  regions,  not  

whole  globe.  E.g.  Europe,  North  America  • expansion/upswing,  boom/peak,  contraction/downswing,  trough.  

       

Trade  and  Financial  Flows  • Goods  can  be  primary  or  secondary.  • Secondary:  STMs  and  ETMs  –    • ETMs  growth  significant  over  past  decade  • Services  and  Tourism  growth  more  than  Goods  

 Causes:  

§ International  organisations  promoting  free  trade  (WTO)  § Individual  nations  removing  barriers  § Trade  blocs  and  agreements  

 Investment  has  experienced  sharp  increases  globally  FDI  decreasing  compared  to  Portfolio  Investment  was  ratio  2:1.  By  1990,  it  was  1:1,  and  by  2000  it  was  1:2.    In  1990s  large  proportion  of  investment  went  to  developing  economies,  but  more  recently  to  AIEs    Foreign  exchange  market  required  so  that  trade  and  investment  can  take  place  internationally.      PARTICIPANTS:    -­‐  Firms  buying  goods  and  services  abroad,  as  well  as  foreign  investment  

§ Individuals  travelling  abroad  or  migrating  § Governments  buying  or  selling  goods  overseas  or  undertaking  foreign  

investment  § Financial  institutions  investing  overseas  to  take  advantage  of  profitability  

areas  § Speculators  wishing  to  make  a  profit  by  buying  or  selling  foreign  currencies  

 Impact  on  economies:    Heavy  reliance  on  trade  and  investment  for  economic  growth  Firms:    

§ changes  in  amount  of  trade  affects  revenue  for  exporters  § Up  investment  =  Up  international  competition,  if  protection  is  in  place.  § Firms  invest  to  avoid  protection  

Individuals  § Up  trade  =  Up  consumer  choice,  but  structural  change  due  to  low  output  § Up  portfolio  =  Inflation  

Government:    § trade  policy  altered  with  trade  and  investment  changes  § Aim:  maximise  benefit  § Changes  in  MP  and  FP  § Portfolio  investment  hard  to  control,  and  taking  money  out  of  a  country  

will  depreciate  currency,  lead  to  inflation      

Free  trade  and  Protection:  Absolute  advantage:  produce  the  same  amount  of  a  good  (a)  with  fewer  resources  than  other  economies,  (b)  more  cheaply  than  other  countries,  or  (c)  more  of  the  good  with  the  same  amount  of  resources  Comparative  advantage:  produce  it  relatively  more  efficiently  (i.e.  with  a  lower  opportunity  cost)  than  another  economy    

Advantages  of  Free  Trade:    

§ A  more  efficient  allocation  of  resources  § Increased  economic  growth  § Higher  living  standards  § Economies  of  scale  § Increased  competition,  leading  to  increased  efficiency    Disadvantages  of  Free  Trade:    

§ Dumping  may  occur  § There  may  be  an  increase  in  short  term  unemployment  § Greater  volatility  in  a  countries  business  cycle  due  to  interdependence  § Infant  industries  may  be  disadvantaged  § BOP  problems  may  emerge  if  exports  do  not  fully  finance  imports.    Reasons  for  Protection:  Defence,  Domestic  Employment,  Dumping,  infant  industry  protection  Methods  of  Protection:    Tariffs,  Quotas,  Local  content  rules,  subsidies,  export  incentives  such  as  tax  breaks  etc.      Effects  of  Protection  

§ The  revenue  effect  –  an  increase  in  revenue  for  the  government  from  tariff  taxes  

§ The  retaliation  effect  –  firms  may  lose  export  markets  as  foreign  economies  enforce  protection  in  retaliation  to  domestic  protection  

§ The  redistribution  effect  –  from  consumers  to  producers  as  consumers  are  now  paying  higher  prices  to  producers  

§ The  reallocative  effect  –  because  there  is  an  increase  in  demand  by  domestic  producers,  there  will  be  a  reallocation  of  resources  

   

§ Firms  –  domestic  firms  would  be  able  to  supply  more.  There  would  be  an  increase  in  derived  demand,  from  other  firms,  for  resources  and  from  individuals  for  labour.  Retaliation  is  likely  

§ Individuals  –  higher  prices,  a  decline  in  consumer  sovereignty.  There  would  also  be  an  increase  in  employment  as  demand  for  labour  has  increased  

§ Governments  –  higher  prices  cause  inflation  § Imported  good  price  is  higher  § Higher  domestic  price  prevails  § Greater  wage  pressures  § There  would  also  be  an  increase  in  government  revenue  

   International  organisations:  

 § The    role  of  international  organisations  is  to  assist  the  growth  of  the  

global  economy  and  to  provide  assistance  to  nations  with  particular  problems  in  gaining  the  benefits  form  the  greater  economic  interdependence  of  the  world’s  nations.  

§ WTO:  promote  free  trade  globally  § IMF:    assisting  nations  in  dealing  with  exchange  rate  problems,  which  

may  have  been  caused  by  floating  exchange  rates.    § World  Bank:    provision  of  finance  for  long-­‐term  environmentally  friendly  

projects  that  have  the  potential  to  raise  living  standards    Global  economic  development:    Economic  growth  is  the  changes  in  a  nation’s  level  of  output  over  a  given  period  of  time  (measured  by  GDP  or  GNP)  and  is  a  purely  quantitative  measure.  

 Economic  development  refers  to  the  physical  quality  of  life.  It  is  frequently  measured  using  the  Human  Development  Index  (HDI),  which  takes  into  account  health,  education  and  income.  

 The  main  reason  for  differences  in  development  between  nations  is  differences  in  resource  wealth  and  access  to:  

§ capital  § Labour  –  health,  skill,  quality  § Entrepreneurial  § Natural  Resources  § World  globalisation  i.e.  acceptance  § Institutional  factors  i.e.  their  political  system,  infrastructure  etc  § Government  policies  i.e.  focus  on  developing  the  economy,  civil  unrest,  

involvement  in  war  etc.    Impact  of  Globalisation:    there  are  many  impacts  of  globalisation,  the  main  ones  are:  

§ International  convergence:  a  theory  that  proposes  that  economies,  as  a  result  of  closer  economic  integration,  start  moving  in  sync  with  each  other.  Think  international  business  cycle  

§ Economic  Growth,  Development  and  Quality  of  life:  globalisation  perpetuates  gaps  between  rich  and  poor,  as  economic  growth  in  some  countries  is  complementary  to  development  and  SOL.    

§ Trade  Investment,  TNCs:  Globalisation  has  boosted  these  flows,  resulting  in  higher  TNC  revenue,  and  increased  FDI  

§ Income/wealth  distribution:  Globalisation  causes  greater  disparities  between  rich  and  poor,  and    

§ Environment:  industrialised  nations  cause  climate  change,  loss  of  biodiversity,  deforestation,  and  environmental  health  of  the  seas  and  seabed  

§ Financial  markets:  these  have  become  a  lot  more  complex  due  to  globalisation,  and  

§      Case  Study:  China    Economic  Growth,  development  and  quality  of  life  China  sustained  a  high  rate  of  average  annual  growth  in  real  GDP  of  over  10%  between  2005  and  2008,  but  it  slowed  to  9.2%  in  2009  due  to  the  impact  of  the  Global  Financial  Crisis  (GFC),  slowing  Chinese  exports.  The  rapid  growth  (up  to  10.3%  in  2010)  for  2  years  is  now  resting  at  9.6%  in  2011,  the  slowest  growth  China  has  experienced  in  years.    Growth  has  been  driven  through  foreign  investment  and  international  trade,  following  a  path  to  industrialization.  China  has  undergone  many  transformations,  moving  from  a  planned  socialist  economy  to  a  market  capitalist  economy,  agricultural  economy  to  industrialized  economy  with  a  trade  oriented  focus.  It  has  become  a  major  world  economic  power,  contributing  substantially  to  global  output.  This  growth  leads  to  rising  national  output,  income  and  living  standards.  China’s  HDI  value  rose  from  0.368  in  1980  to  0.663  in  2010,  but  despite  improvements,  15.9%  of  the  population  live  below  the  international  poverty  line  of  US  $1.25  per  day  in  2005.    Distribution  of  Wealth  and  Income  China’s  rapid  growth  has  not  benefited  all  provinces,  where  there  are  large  geographic  disparities  in  the  distribution  of  income.  Per  capita  incomes  are  higher  in  urban  areas  and  coastal  provinces  in  the  east  and  south  compared  to  the  rural  west  and  north.    

 China  suffers  from  income  inequality  due  to  immigration  and  migration  as  well  as  the  widening  gap  between  the  rural  and  urban  even  though  China  is  one  of  the  few  countries  that  are  performing  well  in  terms  of  the  United  Nation’s  Millennium  Development  Goals.  The  fastest  growing  zones  such  as  Beijing  and  Shanghai  have  an  average  annual  growth  that  is  five  times  the  level  of  its  slowest  regions  such  as  Tibet,  since  most  of  China’s  national  income  is  concentrated  in  metropolitan  and  coastal  regions.    Trade,  Investment  and  International  Corporations  International  trade  makes  up  a  large  amount  of  China’s  overall  economy,  and  in  2010  they  are  the  second  largest  goods  trading  nation  in  the  world  after  the  US,  accounting  for  13.6%  to  global  growth  and  9.4%  of  world  merchandise  trade.  China’s  exports  grew  an  average  of  20%  annually  between  2005  and  2010,  where  even  though  the  GFC  in  08-­‐09  reduced  their  exports  and  imports,  they  recovered  in  2010  as  global  economic  conditions  improved.    China  is  a  major  exporter  of  manufactured  goods,  including  machinery  and  transport  equipment,  where  China  plays  the  role  in  processing  higher  value  added  goods,  such  as  ICT  equipment.  Much  of  the  growth  in  exports  is  also  because  of  the  expansion  in  processing  of  goods  that  have  been  imported  from  other  countries.  While  some  imports  have  value  added  to  them  and  re-­‐exported,  the  rest  of  the  goods  have  been  for  domestic  use,  reflecting  the  growing  importance  of  domestic  demand  as  a  future  source  of  growth,  especially  after  exports  were  reduced  by  the  GFC.  Investment  in  domestic  demand  includes  household  consumption  and  business  investment.    Current  surveys  show  that  25%  of  urban  investment  is  in  infrastructure,  utilities,  water  and  environmental  management,  and  another  25%  are  in  the  real  estate  sector.  Investment  in  urban  areas  resulted  in  a  rapid  increased  in  urbanization  in  China,  and      Foreign  direct  investment  (FDI)  in  China  is  still  the  key  driver  of  Chinese  economic  growth  even  though  they  are  going  to  focus  more  on  domestic  investments,  as  capital  flows  fell  during  the  GFC  in  08-­‐09.  China  attracts  high  levels  of  FDI  as  the  cheap  labour  markets  are  taken  advantage  of  by  production  

companies  who  shift  their  production  to  major  Chinese  cities  such  as  Beijing  and  Shanghai.  China  had  surpassed  the  US  to  become  the  top  recipient  of  FDI  in  2002,  and  multinational  corporations  (MNCs)  moved  to  China  to  manufacture  goods  for  export.  The  opening  of  the  domestic  market  to  foreign  competition  in  2007  and  surge  in  foreign  investment  because  of  the  Beijing  Olympics  in  2008  helped  to  support  the  high  growth  in  domestic  consumption  and  investment.    Environmental  Consequences  The  rapid  economic  growth  in  China  has  led  to  high  resource  use  and  severe  environmental  degradation  as  well  as  resource  depletion.  A  study  conducted  by  the  OECD  (Organisation  for  Economic  Co-­‐Operation  and  Development)  showed  that  unless  pollution  in  China  is  controlled,  there  will  be  600k  premature  deaths  in  urban  areas  and  20m  cases  of  respiratory  illness  each  year.  It  also  found  that  up  to  7%  of  China’s  GDP  is  lost  because  of  pollution,  and  it  could  rise  if  stronger  environmental  laws  aren’t  implemented  and  enforced.    Cheap  labour  attracts  many  foreign  investors  to  set  up  factories  in  China,  where  the  levels  of  noise,  air  and  water  pollution  increases.  The  overwhelming  reliance  on  coal  for  70%  of  its  energy  needs  contributes  to  carbon  dioxide  emissions,  which  were  2.2  metric  tonnes  in  1990  and  5.3  in  2008.    The  Chinese  government  has  begun  to  recognize  and  address  environmental  problems,  and  policies  have  been  made  to  move  towards  reliance  on  hydroelectric  and  nuclear  power.  Targets  have  been  set  for  pollution  levels,  and  a  market  has  been  established  for  tradable  emission  permits  which  give  firms  an  incentive  to  reduce  their  pollution  levels.      There  have  been  both  negative  and  positive  impacts  of  globalization  on  the  Chinese  economy.  While  economic  growth  and  development  is  constantly  increasing,  the  distribution  of  wealth  and  income  across  the  nation  has  been  unequal,  causing  the  quality  of  life  to  be  inconsistent  in  different  regions.  However,  with  increased  interaction  across  national  barriers,  many  other  countries  have  benefited  from  China  through  cheap  labour.  A  downside  is  the  constantly  rising  pollution  level,  but  China  has  started  to  make  changes.  Globalization  will  continue  to  contribute  to  Chinese  economy,  and  it  will  soon  become  one  of  the  major  economic  participants  in  the  global  economy.          

Trends  in  Australia’s  trade  patterns:    

-­‐ International  trade  has  historically  played  a  very  significant  role  in  the  development  of  the  Australian  economy  

-­‐ We  export  one  fifth  of  what  we  produce  and  import  one  fifth  of  GDP  and  as  a  result  world  economic  developments  can  have  a  very  significant  impact  on  Australia  

 

The  changing  direction  of  trade:  -­‐ 1950s  mainly  traded  with  UK  and  Europe  -­‐ In  subsequent  decades  Japan  became  the  major  buyer  of  Australian  

exports  and  China,  South  Korea  and  ASEAN  countries  became  increasingly  important  as  export  markets  

-­‐ UK’s  decision  to  join  the  EU  in  1973,  creating    barriers  to  trade  with  Australia,  was  a  key  factor  in  the  changed  direction  of  trade  

-­‐ There  was  a  shift  of  focus  to  North  East  Asian  and  ASEAN  countries  as  exporters  found  it  increasingly  difficult  to  gain  access  to  European  markets  

-­‐ 1960s,  Japan  was  sustaining  rapid  economic  growth  and  Australia  responded  to  this  opportunity  and  Japan  became  our  largest  export  market  

-­‐ 1980s,  Japan’s  growth  rates  slowed  and  Australia’s  trade  shifted  -­‐ Early  2000s,  exports  to  China  increased,  making  it  Australia’s  largest  

trading  partner  since  2007  -­‐ In  2013-­‐14  China  accounted  for  approx.  one-­‐third  of  Australia’s  export  

earnings    The  changing  composition  of  trade  

-­‐ Primary  industries  have  been  the  main  focus  of  Australian  exports  as  Australia  has  a  comparative  advantage  in  commodities  due  to  its  vast  natural  resources  

-­‐ While  other  advanced  economies  generally  developed  substantial  manufacturing  industries  in  the  second  half  of  the  twentieth  century,  Australia  has  continued  to  reply  on  its  primary  exports  (wheat,  wool,  beef  and  coal)  and  import  large  quantities  of  capital  and  manufactured  goods  

-­‐ Agriculture  has  declined  in  relative  importance  as  an  export  earner  (due  to  large  fluctuations  in  world  prices  as  well  as  trade  protection  policies),  while  exports  of  minerals  and  metals  have  increase  in  relative  importance  

 

   

-­‐ Australia’s  best  long-­‐term  alternative  to  relying  heavily  on  mineral  and  energy  exports  is  to  diversify  exports  towards  goods  and  services  demand  by  the  rapidly  growing  population  of  middle  class  across  Asia  as  service  exports  hold  the  greatest  potential  for  growth  over  the  medium  to  longer  term  

1989-­‐90  

Minerals  

Other  

Rural  

Services  

Manufacturing  

2013-­‐14  

-­‐ Composition  of  imports  has  changed  moderately  with  capital  goods  remaining  at  around  one  fifth  of  imports  

-­‐ Consumer  goods  as  a  percentage  of  imports  have  increased  due  to  the  shift  away  from  large-­‐scale  manufacturing  with  the  gradual  reduction  of  tariffs  and  local  content  rules.  

 Trends  in  Australia’s  financial  flows:  

 -­‐ 1970s,  international  system  of  fixed  exchange  rates  came  to  an  end  and  

exchange  rates  were  floated  allowing  financial  flows  to  grow  rapidly  as  it  was  easier  to  sift  finance  between  countries  

-­‐ The  level  of  foreign  investment  over  the  past  decade  has  more  than  doubled  and  has  been  rising  since  the  1980s  

-­‐ Prior  to  the  deregulation  of  the  financial  sector,  most  financial  flows  into  Australia  were  in  the  form  of  direct  investment.  This  was  preferred  by  the  government  because  of  job  creation  and  technology  transfer.  

-­‐ Portfolio  investment  was  not  as  important  as  the  levels  of  overseas  purchase  of  shares  was  small  and  overseas  loans  were  uncommon  (due  to  previous  market  regulation)  

-­‐ The  growth  of  portfolio  investment  into  Australia  has  been  significantly  faster  than  the  growth  in  longer  term  direct  investment  

-­‐ Australia’s  investment  overseas  is  around  100  times  what  it  was  in  1980  -­‐ Australia  has  always  been  a  net  capital  importer;  the  level  of  foreign  

investment  in  Australia  is  consistently  close  to  twice  the  level  of  Australian  investment  abroad  which  reflects  the  historically  low  level  of  domestic  savings  within  Australia  

-­‐ For  many  years,  Australia  has  relied  on  financial  flows  from  overseas  to  make  up  for  the  shortfall  between  savings  and  investment  in  Australia  

 The  balance  of  Payments  

-­‐ All  financial  transactions  that  Australia  has  with  the  rest  of  the  world  over  a  given  period  of  time  

-­‐ Comprised  of  two  accounts;  the  current  account  and  the  capital  and  financial  account  (CAFA)  

 CA  +  CAFA  =  0  (under  a  floating  exchange  rate)  

 THE  CURRENT  ACCOUNT  (non-­‐reversible)  

-­‐ Shows  the  money  flow  from  all  exports  and  imports  of  goods  and  services,  income  flows  and  non-­‐market  transfers  for  a  period  of  one  year  

 Net  goods  –  refers  to  the  difference  between  what  Australia  receives  for  its  exports  and  pays  out  for  its  imports.  Possible  outcomes:  

o Balance  –  where  export  receipts  =  import  payouts  o  Surplus  –  where  exports  >  imports  o Deficit  –  where  imports  >  exports  

 

Net  services  –  refers  to  services  bought  and  sold  without  people  receiving  a  good.    The  balance  of  goods  and  services  (BOGS)  is  an  amount  that  is  derived  by  adding  net  goods  and  net  services  together.    Net  Primary  Income  -­‐  return  on  investment  in  terms  of  interest,  dividends,  rent  and  profits  

-­‐ Major  contributor  to  CAD  More  outflows  because  we  pay  interest  to  foreign  owners,  due  to:  (structural  reasons)  

-­‐ low  domestic  savings    -­‐ small  economy  -­‐ market  deregulations  

Always  a  deficit,  problem  because    -­‐ we  can  lose  AAA  rating,  and    -­‐ it  is  a  constraint  on  growth  -­‐ can  lead  to  debt  trap  

 Net  Secondary  Income  –  refers  to  non-­‐market  transfers  

-­‐ has  little  impact  on  balance  of  payments  -­‐ Includes:  

o Payout  on  insurance  claims  o Worker’s  remittances  (foreign  workers  sending  money  overseas)  o Unconditional  aid  (funds  given  as  a  gift)  o Pensions  received  by  residents  from  foreign  governments  

 THE  CAPITAL  AND  FINANCIAL  ACCOUNT  (reversible)  

-­‐ Concerned  with  financial  assets  and  liabilities  -­‐  money  flows  that  result  from  international  borrowing,  lending  and  purchases  of  assets  such  as  shares  and  real  estate  for  a  period  of  one  year    

Capital  account  Capital  transfers:  conditional  foreign  aid,  linked  to  specific  capital  projects  and  debt  forgiveness    Purchase  and  sale  of  non-­‐produced,  non-­‐financial  assets:  intellectual  property  rights  such  as  patents,  copyrights,  trademarks    Financial  account  

-­‐ Australia  consistently  records  a  positive  financial  account  balance  resulting  in  a  deficit  in  NPI    

Direct  Investment  –  refers  to  foreign  financial  transactions  to  fund  new  investment  in  Australia  or  overseas  or  to  buy  more  than  10  per  cent  of  shares  in  an  existing  company.    

Portfolio  investment:  loans  and  other  forms  of  securities  and  smaller  shareholdings  in  companies.  Foreign  debt  is  also  recorded  here.  It  is  often  the  largest  component  on  the  CAFA.    Financial  derivatives  –  are  a  category  of  complex  financial  assets  that  have  become  increasingly  significant  in  recent  years.    Reserve  assets  –  refer  to  foreign  financial  assets  that  are  available  or  controlled  by  the  central  authorities  or  regulating  payment  imbalances.    Other  investment  –  a  residual  category  that  captures  transactions  not  classified  as  the  previous  categories.      NET  EMISSIONS  AND  ERRORS  –  refers  to  statistical  discrepancies      Links  between  key  balance  of  payments  categories:  

-­‐ An  increase  in  CAD  results  in  a  rise  in  the  CAFA  surplus  -­‐ Strongest  link  between  CA  and  CAFA  can  be  seen  on  the  NPI  as  all  

investments  into  Australia  must  receive  some  kind  of  return    

Trends  in  Balance  of  Payments  -­‐ BOP  is  an  important  indicator  of  the  health  of  the  economy  and  has  

significant  influence  on  business  confidence  and  foreign  investors  -­‐ Since  the  1980,  CAD  has  fluctuated  between  3  and  6  percent  of  GDP,  

making  it    among  the  highest  of  the  industrialized  world  -­‐ Since  GFC,  CAD  has  improved;  2007-­‐08  (6.2%),  2013-­‐14  (3%)  

 THE  BALANCE  ON  GOODS  AND  SERVICES  -­‐  Varies  from  occasional  surpluses  to  deficits  of  around  2%  of  GDP  

-­‐ BOGS  is  the  main  cyclical  component  of  CAD,  but  is  also  influenced  by  structural  factors  

 Cyclical  factors:  

-­‐ Affected  by  exchange  rate,  terms  of  trade,  economic  growth  -­‐ Movements  in  the  exchange  rate  affect  the  international  competitiveness  

of  exports  and  the  relative  price  of  goods  and  services  that  Australia’s  imports  

o A  depreciation  decreases  the  foreign  currency  price  of  Australia’s  exports,  increasing  the  international  competitiveness  of  them  as  well  as  increases  the  $AUS  price  of  imports,  discouraging  consumers  to  purchase  imports  and  results  in  an  improvement  of  BOGS  

-­‐ Greatest  influence  on  BOP  in  recent  years  has  been  terms  of  trade  (the  relationship  between  the  prices  Australia  receives  for  its  exports  and  the  prices  it  pays  for  it  imports)  

o An  improvement  in  terms  of  trade;  i.e.  the  same  volume  of  exports  can  buy  more  imports;  would  lead  to  an  improvement  on  the  balance  on  goods  and  services  and  a  decrease  in  the  CAD.  

-­‐ An  upturn  in  the  domestic  business  cycle  results  in  higher  disposable  income  which  leads  to  higher  consumption,  some  of  which  spills  over  to  imports  and  worsens  CAD.  During  the  GFC  a  slowdown  in  growth  helped  the  BOGS  move  into  a  surplus  in  2008-­‐09.  

-­‐ Strong  global  economic  growth  and  strong  growth  in  Australia’s  key  regional  trading  partners  both  increase  demand  for  Australia’s  exports,  improving  BOGS.  

 Structural  factors:  

-­‐ Narrow  export  base;  Australia’s  exports  are  heavily  weighted  towards  primary  commodities  

-­‐ Competitive  advantage  lies  in  low  value-­‐added  products  such  as  minerals  and  agriculture  which  account  for  two  thirds  of  export  earnings  

-­‐ Australia  lacks  international  competitiveness  in  manufacturing  and  imports  more  High  value-­‐added  goods  and  as  a  result,  in  the  long  run  the  BOGS  tends  to  be  in  deficit  rather  than  surplus  

-­‐ Global  commodity  prices  are  more  volatile  than  the  prices  for  manufactures  and  services,  which  contributes  to  large  fluctuations  in  BOGS  

-­‐ Capacity  constraints  on  Australia’s  mineral  exports  related  to  transport  infrastructure  and  skills  shortages,  physically  prevent  Australian  exporters  taking  advantage  of  favourable  cyclical  conditions  by  increasing  export  volumes  

-­‐ Skills  shortages  have  become  less  of  a  constraint,  with  less  demand  for  skilled  workers  due  to  slower  domestic  growth  and  a  continued  flow  of  skilled  workers  from  overseas.  

                                       

Growth    Definitions:  Economic  Growth:  an  increase  in  the  Volume  of  goods  and  services  that  an  economy  produces  over  a  certain  period  of  time.  It  can  be  measured  by  the  rate  of  change  between  the  real  GDP  of  the  current  and  previous  year.    Equation:    Economic  Growth  (as  a  percentage):  Real  GDP  Current  –Previous  year            x100               Real  GDP  Previous  year                      1    Aggregate  Demand  (AD):  total  demand  for  goods  and  services    within  an  economy.  This  includes  consumption  C,  investment  I,  Government  spending  G,  and  net  exports  (X-­‐M).  AD  =  C  +  I  +  G  +  (X-­‐M)    Aggregate  supply:  the  total  capacity  of  an  economy,  in  other  words,  the  potential  output  when  all  the  factors  of  production  are  utilized  fully.  It  includes  consumption  C,  household  savings  S,  Government  taxation  T.    Y  =  C  +  S  +  T    Equilibrium:  this  occurs  in  an  economy  when  aggregate  demand  and  aggregate  supply  are  equal,  so:  Leakages  =  Injections  or    S  +  T  +  M  =  I  +  G  +  X    Simple  Multiplier:  A  greater  than  proportional  increase  in  national  income  resulting  from  an  increase  in  aggregate  demand.  K  =  1/MPS  à  ∆Y  =  K  x  ∆AD    Trends:  

• Over  time,  market  economies  usually  experience  an  overall  trend  of  growth  in  real  GDP,  however  the  forces  of  the  business  cycle  is  an  important  factor  in  acceleration  or  slowing  of  growth.    

• Recently,  Australia’s  performance  in  Economic  growth  has  been  sustainable  and  stable,  over  the  last  few  decades  

• The  last  full  recession  (when  the  economy  has  a  negative  rate  of  economic  growth)  Australia  experienced  was  in  the  early  1990s.    

• Since  1991,  though,  Australia  has  experienced  its  longest  period  of  economic  growth  ever,  with  growth  rates  averaging  3.3%  of  GDP  per  year.  This  was  higher  than  the  average  for  other  industrializing,  advanced  economies,  which  was  at  2.7%    

• In  the  2000s,  the  growth  rate  slightly  slowed,  to  3.1%,  although  it  was  still  above  the  OECD  average  rate.  

• During  the  GFC  of  2008-­‐09,  Economic  growth  slowed  in  Australia  to  2.4%,  which  was  still  good  in  comparison  to  the  USA  and  Europe,  who  faced  the  worst  of  the  GFC.  This  minor  effect  of  the  GFC  on  Australia,  and  the  sustained  growth  following  it,  up  to  the  present  can  be  attributed  to  domestic  and  external  factors,  including  the  successful  management  of  economic  growth  through  government  policies.  

• Growth  over  the  past  few  decades  has  been  positively  impacted  by  booms  in  the  USA  in  the  1990s  and  in  China  in  the  2000s.    

• Australia  has  experienced  increases  in  our  Terms  of  Trade  (TOT)  due  to  the  rise  in  commodity  exports  triggered  by  the  Mining  investment  boom  in  Western  Australia.  The  TOT  reached  its  highest  level  in  140  years  in  Sept  2011,  this  helped  to  increase  our  national  income  by  15%  

• Monetary  Policy  has  helped  to  maintain  a  stable  rate  of  economic  growth  within  the  band  of  2-­‐3%  ,  since  1992.  

• In  2015  to  2016,  economic  growth  is  predicted  to  rise.  • Productivity  growth  boomed  in  the  1990s  due  to  extensive  

microeconomic  reforms,  and  new  technologies    Causes:  

• Aggregate  Demand  and  supply  play  a  major  role  in  determining  economic  activity.    

• Consumption  can  determine  the  level  of  growth,  as  household  consumption  makes  up  over  half  of  expenditure  in  an  economy  (aggregate  Demand).  Consumption  is  higher  when  incomes  are  higher,  which  is  why  developed  economies  have  higher  consumption.  Therefore,  changes  in  income  will  affect  the  level  of  economic  growth.  The  Average  propensity  to  consume  and  the  average  propensity  to  save  take  into  account  other  factors  that  affect  consumption  other  than  income.  These  factors  include:  -­‐    Consumer  expectations:  price  rise  expectations  =  greater  consumption  =  increased  growth    -­‐  Interest  rates:  higher  =  less  consumption  =  less  growth  and  vice  versa    -­‐  Distribution  of  income:  higher  overall  spending  when  more  income  equality  as  more  people  have  disposable  incomes.  (inequality  means  the  rich  will  save,  invest  to  become  richer,  poor  will  be  forced  to  spend,  but  wont  have  enough  money  to  spend  a  lot)  

• Influences  of  investment:  -­‐  changes  in  interest  rates,  government  policies  and  price  and  productivity  of  labour  will  effect  the  cost  of  capital  equipment,  and  will  in  turn  effect  the  amount  of  investment,  as  lower  costs  will  make  it  more  attractive.      -­‐  Business  expectations:  investment  is  influenced  by  the  future  prospects  of  a  company,  as  factors  of  future  demand,  economic  outlook  and  inflation  effect  the  general  prospects.  If  prospects  are  good,  investment  is  more  likely  to  occur  

• Government  spending  and  taxation:  as  GS  makes  up  20-­‐25%  of  AD,  and  taxation  makes  up  the  same  amount  of  aggregate  supply,  increased  spending,  decreased  taxation  will  strengthen  growth  in  the  short  term,  as  there  is  more  income,  and  more  consumption.  

• Increased  export  revenue  is  an  injection,  so  will  boost  growth.  This  is  caused  by  overseas  prosperity  and/or  a  weak  exchange  rate.  

• Aggregate  supply  can  be  increased  though  increased  efficiency  in  production  of  output  e.g.  up  productivity,  training,  technology.  

Impacts:  

• It  increases  living  standards,  as  real  GDP  increases  per  capita  so  real  wages  will  rise  and  there  is  more  disposable  income  available  to  increase  material  living  standards.  This  is  benefitted  by  Government  policies  to  redistribute  income  more  equally.  

• Employment  rates  will  increase,  as  economic  growth  will  create  jobs  and,  and  provide  more  higher  skilled,  higher  earning  jobs  

• Inflation:  inflation  rill  rise  due  to  rising  wages  and  prices,  and  when  spending  is  increasing  in  times  of  economic  booms  

• External  Stability:  as  growth  causes  increased  consumer  and  business  spending,  import  volumes  will  rise,  which  will  increase  the  CAD.  Therefore,  higher  rates  of  growth  can  lead  to  a  decrease  in  stability.  

• Income  Distribution:  high  growth  can  sometimes  benefit  a  particular  group  in  society,  usually  high  earners  and  shareholders,  which  will  make  the  rich  richer,  increasing  income  inequality  

• Environment:  increased  output  and  use  of  G+S  will  generally  have  a  negative  impact  on  the  environment,  unless  government  restrictions  to  stop  this  are  tight.  

 Policies:  

• Governments  aim  to  achieve  stable,  sustainable,  high  growth  rates  to  benefit  national  wealth  and  standard  of  living.    

• Macroeconomic  Policies:  these  are  helpful  for  the  short  term,  as  they  influence  aggregate  demand  and  smooth  out  fluctuations  in  the  business  cycle.    

• Fiscal  policy:  the  government  can  adjust  the  level  of  expenditure  and  revenue  in  order  to  influence  AD,  which  will  thus  influence  economic  growth.  In  order  to  increase  growth,  it  can  cut  taxation,  and  increase  expenditure.  The  opposite  will  occur  in  order  to  constrain  economic  growth  .  

• Monetary  Policy:  this  is  used  to  influence  interest  rates  to  move  up  or  down,  which  will  affect  AD  by  encouraging  or  discouraging  spending.  In  recent  years,  Monetary  Policy  has  been  the  most  useful  tool  for  an  economy  in  terms  of  influencing  the  rate  of  economic  growth.  To  promote  growth,  the  cash  rate  will  be  cut,  encouraging  spending  and  investment  in  businesses,  to  increase  aggregate  demand,  which  will  increase  economic  growth.  

• Microeconomic  policies:  these  are  aimed  at  increasing  sustainable  growth  in  the  long  term  by  promoting  an  increase  in  aggregate  supply,  and  making  sure  the  growth  rate  doesn’t  increase  to  unsustainable  proportions.    

• An  increase  in  investment  in  physical  infrastructure  and  workforce  skills  over  the  past  decade  has  aimed  to  increase  aggregate  supply  to  overcome  capacity  constraints  on  the  economy.    

• Since  2006,  COAG  (Council  of  Australian  Governments)  has  had  productivity  boosts  on  its  agenda,  along  with  increase  in  LFPR,  human  capital  and  international  competitiveness.  

   Limitations:    

• MP  and  FP  are  not  viable  government  policies  for  the  long  term,  as  they  do  not  help  to  build  up  Aggregate  supply  they  just  influence  aggregate  demand,  which  is  helpful  for  the  short  to  medium  term.  

                                                                                         Unemployment  

 Definitions  

• Employment:  Persons  aged  15  and  over  who  are  currently  employed  for  at  least  one  hour  per  week  of  paid  work.    

• Labour  Force  Participation  Rate:  The  percentage  of  the  Population  aged  15  and  over  in  the  labour  force  in  a  given  country  at  any  particular  time,  including  those  employed  and  those  unemployed  

 LFPR  (%)    =          Labour  force   x100       WAP  (15+)  

• Unemployment:  refers  to  a  situation  where  individuals  want  to  work  but  are  unable  to  find  a  job,  and  as  a  result  labour  forces  in  an  economy  are  not  used  

 UE  (%)        =      No.  Persons  employed   x100       Total  labour  force    

• NAIRU  (The  non  accelerating  inflation  rate  of  Unemployment):  refers  to  the  level  of  unemployment  at  which  there  is  no  cyclical  unemployment,  in  other  words,  the  economy  is  at  full  employment  

• Structural  Unemployment:  structural  changes  in  an  economy  caused  by  changes  in  demand,  technology  will  cause  a  mismatch  between  skills  of  workers  and  positions  available  

• Cyclical  unemployment:  Occurs  because  of  an  economic  downturn,  as  there  are  fewer  employment  opportunities  available.  

• Frictional  Unemployment:  People  who  are  out  of  work  temporarily  due  to  changing  jobs.  There  will  be  a  period  of  time  spent  unemployed  between  jobs.  This  type  of  Unemployment  is  inevitable.  

• Seasonal  Unemployment:  as  some  types  of  jobs  are  only  seasonal,  there  will  be  predictable  unemployment  in  seasons  that  these  positions  are  not  required  e.g.  fruit  picking  n  regional  areas  is  seasonal,  so  the  non  harvesting  season  will  have  a  higher  rate  of  regional  unemployment  

• Hidden  Unemployment:  People  considered  unemployed,  but  not  counted  in  the  ABS’s  definition  of  unemployment  e.g.  discouraged  job  seekers.  

• Underemployment:  those  working  over  one  hour  a  week,  and  less  than  full  time,  but  who  are  willing  or  wanting  to  work  more  hours  per  week  

• Long  Term  Unemployment:  People  who  have  been  unemployed  for  12  months  or  longer,  usually  as  a  result  of  structural  unemployment.  

• Hard  Core  Unemployment:  refers  to  Long  term  unemployed  people  who  might  be  considered  as  unemployable  by  employers  due  to  their  personal  circumstances,  which  can  include  physical/mental  disability,  drug  use,  or  anti  social  behaviour.  

           Trends:  

• 2013-­‐2014  Unemployment  Rate:  5.8%,  expected  to  rise  • LFPR  at  all  time  high  of  65.8  in  Nov  2010  • Since  2011,  Australia’s  economic  growth  rate  fell  below  long  term  average  • As  many  as  1.3  million  hidden  unemployed  (2010  ABS  estimate)  • 936,500  Australians  unemployed  (may  2014  ABS  estimate)  • from  1975  to  2000,  Unemployment  was  a  significant  economic  policy  

challenge  in  Australia,  as  this  is  when  we  started  experiencing  higher  unemployment.  

• A  recession  in  the  early  1990s  caused  unemployment  to  peak  at  10.7%  in  1991,  highest  since  Great  Depression.  This  was  due  to  closure  of  firms,  and  structural  change  and  microeconomic  reform  

• After  GFC  of  2008,  demand  for  labour  in  Australia  reduced,  and  Unemployment  rose  from  4%  to  5.9%,  but  recovering  to  under  5%  in  2011  

• Underemployment  rose  from  5.9%  to  7.8%  due  to  GFC  • 2014-­‐15  sees  unemployment  reaching  as  high  as  6.25%  due  to  our  

economic  slowdown  from  the  end  of  the  mining  boom,  and  the  slowing  economic  growth  of  our  major  trading  partner,  China  

• Okun’s  law  states  that  Economic  growth  must  be  at  3.5%  or  higher  to  reduce  unemployment  rates  in  Australia.  

• In  the  2000s,  productivity  rate  slowed  down  in  Australia,  so  unemployment  was  able  to  fall,  with  a  growth  rate  of  only  3%  

• In  first  4  years  of  resources  boom,  unemployment  down  to  4%    

Causes:  • The  level  of  economic  growth:  the  demand  for  labour  is  derived  from  the  

Demand  for  goods  and  services  in  an  economy,  as  labour  is  needed  to  produce  these  goods  and  services.  A  fall  in  AD  will  cause  an  increase  in  UE.  Unemployment  is  closely  linked  with  economic  growth.  Fall  in  AD  can  be  attributed  to:    -­‐  Contractionary  FP  or  MP    -­‐  Economic  downturn,  when  growth  is  under  3%    -­‐  Global  recession  causing  reduced  demand  for  exports.  

• Macroeconomic  Policies:  can  influence  the  level  of  cyclical  unemployment  in  short  to  medium  term,  as  these  policies  influence  the  business  cycle  

• Economic  Growth  constraints:  is  growth  is  significantly  constrained,  the  economy  won’t  be  able  to  create  enough  jobs  to  reduce  unemployment.  Over  the  long  term,  unemployment  rates  rely  on  the  sustained  level  of  economic  growth  that  a  country  achieves  

• Rising  Participation  Rates:  this  will  cause  UE  in  the  short  term,  as  more  people  are  seeking  work  than  before  

• Structural  change:  a  loss  of  jobs  in  less  efficient  industries,  or  sectors  undergoing  radical  reforms  will  cause  short  term  unemployment  as  retrenched  workers  will  not  have  skills  for  available  jobs  

• Technological  change:  this  can  cause  industry  to  have  less  reliance  on  labour  resources,  and  more  on  capital  resources,  causing  the  labourers  to  be  out  of  work  

• Productivity:  High  productivity  will  cause  an  increase  in  unemployment,  as  less  labour  is  needed  to  achieve  targeted  output.  In  the  long  term,  high  productivity  is  good,  as  it  promotes  economic  growth,  so  new  jobs  will  be  created  

• Inadequate  training:  workers  with  irrelevant  skills,  structurally  unemployed  will  increase  unemployment,  and  create  skills  shortages,  as  the  workforce  doesn’t  have  an  adequate  number  of  people  trained  for  newly  created  jobs.  

• Increase  in  Labour  Costs:  this  will  cause  wage  inflation,  and  eventually  an  economic  downturn,  a  decline  in  demand  for  labour.  

• Labour  market  inflexibility:  employers  become  discouraged  from  strict  regulations  of  the  labour  market  e.g.  high  minimum  wages  

 Impacts:  Economic  Costs:  

• Opportunity  Cost:  Resources  aren’t  fully  utilized,  so  economy  operates  below  PPF.  à  lower  output  à  lower  sales  and  profits.  Higher  UE  can  lead  to  less  business  investment,  production  and  employment  and  sometimes  business  failure  

• Lower  SOL:  As  UE  are  on  social  security,  Employed  forced  to  pay  for  this  with  tax,  and  shoulder  the  costs  of  decreased  labour  market  productivity,which  will  eventually  lower  SOL.  High  UE  means  lower  output,  and  lower  growth.  

• Decline  in  skills  of  LT  UE:  Discouraged  workers  will  lose  workplace  skills,  and  self  esteem,  making  them  harder  to  employ.  Young  People  who  are  unable  to  attain  employment  will  not  gain  necessary  skills  for  practical  work  after  finishing  their  education  

• Government  costs:  influences  revenue  and  expenditure,  as  high  UE  will  cause  less  revenue  and  more  expenditure,  which  will  negatively  affect  budget  balance  

• Lower  Wage  Growth:  excess  labour  supply  will  lead  to  fall  in  equilibrium  level  of  wages  

Social  Costs:  • Increased  Inequality:  UE  more  likely  to  affect  lower  classes,  so  they  will  

more  often  be  worse  off  than  before,  leading  to  greater  gap  between  rich  and  poor  

• LT  UE  will  lead  to  serious  social  and  personal  problems,  such  as  family  tension,  debt,  depression,  homelessness,  increased  crime,  social  isolation.  This  takes  its  toll  on  whole  communities,  some  areas  affected  worse  than  others.    

• Young  people  more  susceptible  to  UE,  along  with  the  elderly,  and  unskilled  migrants  

 Policies:  

• Macroeconomic  Policies:  Avoid  sharp  downturns,  such  as  recessions  through  expansionary  MP,  in  order  to  reduce  cyclical  UE.  Maintaining  growth  at  3-­‐4%  and  inflation  at  2-­‐3%  will  help  the  economy’s  stability,  and  these  criteria  are  central  to  successful  Macroeconomic  policies  in  developed  economies.  Stimulus  packages  during  times  of  economic  

recessions  are  integral  in  dampening  the  effects  of  a  recession,  including  preventing  the  UE  rate  from  rising  too  sharply.  

• Microeconomic  Policies:  as  structural  change  is  the  major  contributor  to  Australia’s  UE,  Microeconomic  reform  is  relied  on  by  the  government  to  increase  job  creation  and  employment  over  the  longer  term.  Microeconomic  reform  aims  to  increase  efficiency,  competitiveness  and  productivity  in  the  labour  market.    

• Labour  Market  Policies  such  as  wage  subsidies,  Work  for  Dole  and  government  funded  education  and  training  programs  are  integral  to  reducing  unemployment  in  Australia  

 Limitations:    The  Government  can  only  use  FP  and  MP  to  counter  the  effects  of  the  Business  cycle  on  UE  for  the  Short  term.  The  long  term  Microeconomic  reforms  aimed  at  reducing  UE  over  the  Long  term  will  cause  structural  change  and  unemployment  in  the  short  term                                                                    

 Inflation:    Definitions:  Inflation:  A  sustained  increase  in  the  general  level  of  prices  in  an  economy.  The  best  measure  of  inflation  is  the  CPI  (consumer  price  index)    CPI:  summarizes  the  movement  of  prices  of  a  basket  of  goods  and  services  according  to  their  significance  in  Australia  Households.    Inflation  Rate  (%)  =  Current  CPI  –  Prev.  Year  CPI     x100           Prev.  Year  CPI  Headline  inflation:  is  calculated  using  the  CPI,  and  includes  volatile  prices  of  goods  and  services,  that  may  be  affected  by  freak  factors.  It  can  be  unreliable  or  misleading,  as  it  doesn’t  provide  a  long  term  picture  of  the  inflation  rate.    Underlying  inflation:  Also  known  as  Core  inflation,  it  is  a  measure  that  doesn’t  count  volatile  price  movements,  and  therefore  is  not  as  variable  as  headline  inflation.    Underlying  Inflation:  Trimmed  Mean  +  Weighted  Median             2    Trimmed  Mean:  a  measure  of  Underlying  inflation,  which  is  determined  by  excluding  the  15  %  of  largest  price  rises  and  falls  in  the  CPI    Weighted  Median:  a  measure  of  Underlying  inflation,  which  is  calculated  through  comparing  inflation  rate  with  every  CPI  item  and  identifying  the  middle  observation.      Trends:    

• There  was  a  significant  reduction  in  inflation  rates  since  the  early  1990s,  which  has  been  sustained,  although  initially  caused  by  the  severe  recession  of  the  early  1990s.  This  is  an  improvement  from  the  high  inflation  of  the  mid  1970s  and  throughout  the  1980s.    

• Introduction  of  Inflation  Targeting  in  1993  of  2  to  3%  per  annum,  which  was  formalized  in  1996  has  caused  a  reduction  in  the  volatility  of  inflation,  and  locked  in  the  lower  inflation  rates  caused  initially  by  the  recession  

• The  Introduction  of  the  goods  and  Services  tax  (GST)  in  2000  resulted  in  a  one  off  increase  in  the  inflation  rate  

• From  1996  to  present:    -­‐  Headline  inflation  averaged  at  2.6%    -­‐  Underlying  Inflation  averaged  at  2.8%  

• When  Inflationary  pressures  were  prevalent  –  in  1994,  1999,  2003,  2007  and  2010,  the  RBA  influenced  interest  rates  to  be  higher  through  a  contractionary  monetary  policy,  to  ease  inflation.  This  was  successful  

   

• Between  2005  and  2008,  underlying  inflation  peaked  at  5%.  This  was  due  to  higher  global  commodity  prices,  and  strong  economic  activity.    

• The  GFC  caused  inflationary  pressures  to  ease,  as  global  demand  was  down  

• The  recent  lower  exchange  rate  has  caused  inflation  to  increase  by  0.25  to  0.5%,  as  slowing  economic  growth  and  increased  wage  and  price  pressure  push  inflationary  pressures  up.    

• Inflation  is  forecasted  to  ease  worldwide  in  the  coming  years,  and  in  Australia  it  is  predicted  to  stay  within  the  targeted  band.  

 Causes  

• Demand  Pull  inflation:  Occurs  when  AD  or  spending  grows  while  an  economy  is  near  to  its  supply  capacity.  This  means  that  higher  demand  will  lead  to  higher  prices  rather  than  increased  output.  In  a  market  economy,  demand  and  supply  determine  prices,  so  when  demand  is  higher  than  supply,  prices  will  inevitably  rise,  so  inflation  will  increase.  Consumers’  demand  for  goods  and  services  will  push  prices  up,  as  they  will  be  willing  to  pay  higher  prices  for  the  same  goods  and  services.  

• Cost  Push  Inflation:  this  is  caused  by  an  increase  in  the  costs  of  the  factors  of  production  –  Labour,  capital,  resources,  wages.  In  order  to  keep  profits  up,  businesses  will  need  to  sell  their  goods  and  services  at  higher  prices  in  order  to  maintain  their  business.  The  inflated  prices  passed  onto  consumers  is  considered  inflation  if  the  wages  of  the  workforce  do  not  increase  to  match  the  rising  prices  

• Inflationary  expectations:  If  there  are  predictions  of  high  or  low  inflations,  then  consumers  will  act  on  these  expectations,  that  will  cause  the  expectation  to  come  true.  For  example:    -­‐  If  the  price  of  goods  and  services  are  expected  to  increase,  then  consumers  will  act  to  purchase  these  products,  before  the  price  rises  and  they  re  left  out  of  pocket.  The  greater  demand  that  ensues  will  cause  inflation  through  increased  demand  pull  inflation.  Employees  will  ask  for  wage  rises  if  inflation  is  expected  to  increase  over  the  next  few  years,  so  their  SOL  is  not  negatively  affected.  This  will  cause  cost  push  inflation,  as  employers  need  to  pay  more  for  labour.  On  the  other  hand,  if  inflation  is  expected  to  fall,  consumers  will  put  off  household  spending  until  prices  are  lower,  which  will  cause  excess  supply  and  decreased  demand,  forcing  business  to  sell  their  products  cheaper.  

• Imported  inflation:  this  is  inflation  passed  on  to  Australia  through  international  transactions.  A  major  cause  is  an  increase  in  the  price  of  imports,  which  will  have  the  same  effect  on  inflation,  as  rises  in  the  price  of  domestically  produced  goods.  Depreciation  of  AUD  will  also  cause  a  rise  in  the  price  of  imports,  which  will  lead  to  inflation.  

• Government  Policies:  indirect  taxes,  industry  deregulation  and  changing  of  tariffs  will  affect  the  inflation  rate  

• Large  increases  in  money  supply  can  cause  inflation,  as  when  excess  supply  of  money  to  Goods  and  services  occurs,  prices  of  the  goods  and  services  are  likely  to  rise  

   

Effects:    Effects  of  Inflation:    Inflation  has  many  short  term  and  long-­‐term  impacts  on  the  economy.  A  strong  emphasis  has  been  placed  on  sustaining  low  inflation  because  of  its  adverse  effects    Economic  Growth  and  uncertainty  

• Inflation  is  a  constraint  on  economic  growth  as  fast  economic  growth  raised  inflation  through  increased  wage  demand  and  consumer  demand  and  forcing  interest  rates  up,  which  is  a  constraint  on  economic  growth.  

• A  sustained  low  inflation  has  positive  impacts  on  savings  and  investment  and  confidence  in  the  economy  

 Wages  During  an  inflationary  period,  employees  will  seek  large  nominal  wage  increases  to  compensate  for  the  reduction  of  real  purchasing  power.  This  is  known  as  the  wage  price  inflationary  spiral  leading  to  hyperinflation.      Income  distribution  Lower  incomes  do  not  rise  as  quickly.  But  low-­‐income  earners  also  face  higher  interest  rates  at  the  same  time,  eroding  the  value  of  existing  savings.  So  high  inflation  tends  to  negatively  impact  on  low-­‐income  earners  and  thus  the  distribution  of  real  income.    Unemployment  Inflationary  pressures  mean  contractionary  MP  and  FP,  slower  growth,  lower  AD  and  lower  demand  for  labour  (Phillips  Curve).  Stagflstion  occurs  when  inflation  and  UE  rise  simultaneously,  resulting  in      International  Competitiveness  

• Low  inflation  improves  competitiveness  as  it  keeps  costs  low  • High  inflation,  on  the  other  hand,  reduces  competitiveness  as  it  increases  

cost  and  lowers  demand    Exchange  Rate  

• High  inflation  can  cause  depreciation  in  the  AUD  over  time  • Long-­‐term  low  inflation  strengthens  the  value  of  the  AUD  • Inflation  can  attract  financial  flows,  which  will  boost  the  exchange  rate  

 Benefits  of  inflation:  these  are  generally  limited,  but  having  inflation  means  less  likelihood  of  experiencing  deflation,  which  has  negative  consequences  of  delaying  consumer  spending,  which  will  cause  an  economic  downturn.  This  is  why  the  RBA  doesn’t  aim  for  zero  inflation,  as  there  would  then  by  the  risk  of  deflation  and  economic  recession.    Interest  Rates:  Low  inflation  =  Low  interest  rates    

Policies:    Contractionary  MP:  To  reduce  inflation,  increase  interest  rate  to  reduce  AD.    Target  a  higher  cash  rate.    In  the  DMO,  sell  CGS  to  reduce  cash,  which  will  increase  interest  rates      Fiscal  Policy  

1. Automatic  Stabiliser:    • Tax  revenue  through  progressive  tax  system  • Redistrubution  through  the  welfare  system    

2. Discretionary  spending:    • Govt.  Spending  through  the  budget  where  the  govt  chooses  where  

to  spend      

• Macro  Economic  Policy    

• Monetary  Policy    Manipulating  interest  rates  is  the  major  tool  used  to  reduce  inflation,  sustaining  growth  and  ensuring  inflation  remains  within  its  targeted  band    This  lowers  inflationary  expectations  and  there  is  a  high  level  of  confidence  in  the  economy    The  RBA  can  use  pre-­‐emptive  MP,  which  is  a  proactive  way  of  dealing  with  inflation  before  it  emerges  as  a  problem    Contractionary  Fiscal  Policy    The  Contractionary  stance  of  a  budget  will  keep  inflation  low    Tax  cuts,  Government  Handouts  will  cause  a  surge  in  demand  and  can  result  in  inflationary  pressures    Micro  Economic  Reform    Policies  to  improve  productivity  and  competitiveness    

• Tax  reforms  to  reduce  taxes  that  add  to  the  cost  of  production  • Labour  market  reforms  –  wage  increase  linked  to  productivity  • Corporatisation  and  Privatisation  –  increases  competition  lowers  price  

Reduced  protection  to  improve  competition  –  lower  price    Limitations:  fiscal  limit:    The  fiscal  limit  is  defined  as  the  point  where  the  government  no  longer  has  the  ability  to  finance  higher  debt  levels  by  increasing  taxes,  so  either  an  adjustment  to  fiscal  spending  or  monetary  policy  must  occur  to  stabilize.  External  Stability:  Exchange  Rate:  

 Definitions:  External  Stability:  An  aim  of  Government  policy  that  seeks  to  promote  sustainability  on  the  external  accounts  so  that  Australia  can  finance  foreign  liabilities  in  the  long  run  and  avoid  currency  volatility    Current  Account  Deficit:  Occurs  when  there  are  a  BOGS  and  Net  primary  and  secondary  income  deficit  in  the  Current  Account.  This  is  balanced  with  a  surplus  in  the  CAFA.  CAD  is  useful  in  assessing  external  stability  as  it  enables  the  examination  of  trends  over  time,  and  accurate  comparisons  of  countries    Net  Foreign  Debt  (NFD):  total  amount  of  loans  owed  by  Australians  to  overseas  countries.  It  is  measured  as  a  percentage  of  GDP,  and  allows  us  to  track  levels  of  change  of  it  over  time,  to  check  the  sustainability  of  servicing  the  Debt.    Net  Foreign  Liabilities  (NFL):  NFD  –  overseas  financial  obligations  to  Australia    (NFD  +  Net  Foreign  Equity)    Terms  of  Trade  (TOT)  the  ratio  of  export  to  import  prices.  This  is  important  to  the  BOGS    Exchange  Rate:  Value  of  AUD  to  foreign  currencies.  It  can  affect  the  BoP    by  impacting  on  international  competitiveness,  and  the  size  of  servicing  costs  of  NFD.    Recent  Trends:  

• High  CAD:  the  trade  problem,  and  BOGS  deficit  used  to  be  blamed  for  the  high  CAD,  but  more  recently,  the  CAD  is  considered  to  be  more  of  a  structural  issue,  being  related  to  the  net  primary  income  section  of  the  current  account.  This  is  the  result  of  a  savings  and  investment  gap,  which  is  caused  by  the  geography  of  Australia,  big  size,  small  population,  vast  natural  resources  –  mineral  commodities.  Since  2007  to  2008,  gap  has  narrowed  due  to  GFC  and  household  savings  

• NFL  –  due  to  globalisation  ,  our  NFL  has  dramatically  increased,  although  it  is  more  stable  recently,  but  still  on  a  positive  gradient  slope.  

• 75%  of  2014  NFD  from  private  sector  means  that  Australia  shouldn’t  be  too  concerned  about  external  stability,  as  normal  market  mechanisms  haven’t  been  distorted.  This  is  outlined  in  the  Pitchford  thesis  

• Since  the  Floating  of  the  Exchange  rate,  there  has  been  increased  volatility  in  Stability,  but  the  benefits  of  a  floating  exchange  rate  have  outweighed  this  risk.  

• In  2013-­‐2014,  NFD  was  55%  of  gdp  • Net  Foreign  equity  –  when  foreign  investors  buy  assets  in  Australia  –  was  

highest  in  the  1990s,  and  has  since  fallen  • There  has  been  a  rise  in  Australia  investing  Overseas,  with  the  value  of  

Australia’s  equity  overseas  3x  more  last  year  than  in  2000-­‐2001,  now  being  at  $918  billion  

 Causes  of  High  CAD:  

 • Trade  deficit:  BOGS  deficit  occurs  when  a  nation  imports  more  than  it  

exports.  Causes  for  this  can  include  capacity  constraints,  narrow  export  base,  low  international  Competitiveness  and  high  spending  levels.  

•  • Savings  investment  Gap:  Domestic  spending  surpasses  domestic  output.  

This  causes  a  deficit  on  the  Current  account  as  we  need  to  attract  investment  from  overseas,  which  is  on  the  CAFA.  

•  • High  NFD  and  NFL  –  if  we  owe  more  money  to  foreign  countries,  this  wil  

increase  out  CAD,  as  we  need  to  pay  investors  profits,  rent  on  land,  dividends  on  shares    

Causes  of  changes  in  Exchange  rate:      

• Floating  Exchange  rate:  our  currency  can  be  bought  and  sold  on  the  foreign  exchange  market  (FOREX),  so  it  is  subject  to  fluctuations  due  to  changes  of  demand  and  supply  for  AUD  over  other  currencies.  Causes  of  these  fluctuations  can  be  due  to  Terms  of  Trade;  economic  activity  (growth  or  decline)  compared  to  other  economies,  the  business  cycle,  and  government  intervention  “dirtying  the  float”.  The  government  intervenes  by  the  RBA  buying  or  selling  Australian  and  foreign  currencies  and  holding  them,  in  order  to  influence  the  supply  of  these  currencies,  which  will  in  turn  influence  the  demand  for  the  AUD,  and  cause  an  appreciation  or  depreciation.      

• BoP  changes  can  influence  the  exchange  rate,  e.g.  if  imports  rose,  but  not  exports,  the  CAD  would  worsen,  and  AUD  would  increase  in  supply,  causing  a  depreciation  in  the  currency  

 Effects  of  a  high  CAD:    

• Large  build  up  of  NFL  –  this  will  make  debt  servicing  costs  unsustainably  high,  as  interest  paid  as  part  of  the  costs  will  build  up,  and  an  economy  may  fall  into  a  debt  servicing  trap  

 • Exchange  rates  may  become  more  volatile,  as  the  economy  becomes  more  

unstable,  subject  to  fluctuations  in  prices  of  international  borrowing  and  debt  servicing.  An  economy  becomes  more  reliant  on  other  economies  to  support  it,  through  loans  and  investment  

               Effects  of  a  volatile  exchange  rate:  

 • Australia  has  benefitted  from  the  floating  exchange  rate,  as  it  has  helped  

us  to  adjust  to  changing  global  economic  conditions.  In  weaker  growth  conditions,  a  low  exchange  rate  has  improved  international  competitiveness,  and  stimulate  export  sector  growth.    

• The  synchronisation  of  falling  exchange  rates  with  falling  commodity  prices  in  the  GFC  cushioned  us  from  the  Effects  of  the  GFC  to  an  extent.      

• The  volatile  exchange  rate  impacts  external  stability  by  influencing  out  international  competitiveness,  which  influences  the  BoP,  and  the  size  of  our  servicing  costs.    

• If  currency  swings  are  too  large,  this  can  create  policy  challenges  and  economic  instability.  

 Policies  to  Achieve  external  stability:  

• Recently,  external  stability  has  not  been  a  major  objective  of  Australian  macroeconomic  policy.  This  reflects  the  growing  acceptance  of  the  Pitchford  thesis  that  claims  that  much  of  our  debt  lies  in  the  private  sector,  which  will  sort  itself  out  without  government  intervention.  

 • Historically,  MP  was  used  to  reduce  import  spending,  to  improve  BOGS  in  

the  short  term.  This  policy  is  now  seen  as  ineffective.    

• Fiscal  policy  can  be  used  to  encourage  higher  national  savings  e;g;  compulsory  superannuation  

 • Microeconomic  reforms:  

 • Reductions  in  protection  causes  inefficient  industries  to  adapt  or  close,  

freeing  up  resources  for  more  efficient  industries.  This  is  helpful  for  the  long  term,  as  resources  will  flow  to  industries  with  comparative  advantage,  such  as  the  mineral  industry  in  Australia.  This  will  cause  increased  exports,  and  a  lower  CAD  

 • Fiscal  Consolidation  is  used  to  reduce  the  drain  on  national  savings,  and  

therefore  have  less  reliance  on  international  borrowing,  which  will  help  to  reduce  debt  servicing  costs  and  the  CAD.  

 Limitations:    Macroeconomic  Policies  to  increase  external  stability  are  not  viable  as  they  are  only  short-­‐term  fixes,  and  cause  economic  slowdowns.                

   Environmental  Sustainability  Environmental  issues:  Preserving  Natural  Environments  

• Important  for  managing  the  Economy,  as  economic  growth  isn’t  viable  in  the  long  run  if  the  environment  is  degraded  

• Environmental  damage  degrades  human  health  -­‐  Air  and  Water  pollution  restrict  availability  of  resources  

• Aim  of  preserving  environment  is  to  avoid  social  and  economic  problems  • Measures  include:    

-­‐  restrictions  on  development  in  environmentally  sensitive  areas    -­‐  protecting  native  flora  and  fauna    -­‐  controls  over  emissions    -­‐  plantations  over  logged  areas  

• E.g.  reef  2050  Long  term  sustainability  plan  –  to  protect  GBR,  deal  with  key  threats  of  poor  water  quality  and  pest  organisms  -­‐  $40million  funding  

• Australia  has  poor  record  of  preserving  environment  and  biodiversity,  only  13%  of  land  in  National  parks,  190  endangered  plants  in  Australia  

• Government  problems  with  Preserving  environment:    -­‐  limit  economic  growth  in  Short  Term,  as  interventions  in  price  mechanism  increase  prices,  reduce  supply.  E.g.  water  restrictions  hurt  crops    -­‐  Industries  face  higher  prices,  to  comply  with  environmental  standards,  which  can  reduce  economic  competitiveness.  This  could  affect  exports    -­‐  cost  of  repairing  damage  to  environment  carried  by  taxpayers,  in  the  form  of  government  environmental  initiatives    

Pollution  • Occurs  where  the  natural  environment  is  degraded    • Causes  can  be  chemicals,  noise,  untreated  rubbish,    • Effects  can  be  harms  to  atmosphere,  water,  resources  or  land  • All  sectors  of  economy  contribute  to  pollution  • Problem  in  populated  areas  since  Industrial  Revolution.  • Worst  polluted  places  are  Linfen  in  China,  Sukinda  in  India  • Global  impacts,  therefore  is  a  global  as  well  as  national  problem  • E.g.  Acid  rain  has  affected  whole  regions,  from  some  areas  of  pollution  

creating  areas  • Policies  to  combat  pollution  include  banning  damaging  production  

techniques,  emission  quotas,  subsidies  for  environmentally  friendly  practices,  taxes  to  discourage  damaging  economic  activity  

• Renewable  resources:  naturally  regenerate  in  short  time  frame,  however  can  deplete  to  extent  that  they  become  non  renewable  

• Non  renewable  Resources:  limited  supply,  take  long  time  to  replenish.    Climate  change  

• Caused  by  emission  of  greenhouse  gases  e.g.  CO2,  CH4,  H2  into  atmosphere,  resulting  from  Human  activity  

• Increased  from  1979  to  2010,  highest  in  2000’s  according  to  IPCC  • Half  of  all  CO2  emissions  in  last  40  years  since  1750  • Actions  Causing  it:  

-­‐  Burning  fossil  fuels  for  electricity  and  transport  for  individuals  and  business:  1/3  of  greenhouse  gases    -­‐  Changes  in  land  use  e.g.  agriculture,  deforestation,  landfill:  1/3  of  emissions  

• High  economic  Growth  =  high  emissions  due  to  reliance  on  fossil  fuels  • High  emissions  needed  for  high  SOL  • China  and  India  expected  to  account  for  much  of  the  increase  per  annum  

(2.7%)  from  2001  to  2025  •  

   Distribution  of  income  and  wealth    The  distribution  of  income  and  wealth  is  a  reflection  of  how  the  benefits  of  economic  growth  are  shared  amongst  the  population.  Most  democratic  societies  have  in  place  policies  to  ensure  that  inequality  s  minimized  and  a  social  safety  net  exists  to  protect  those  on  minimum  incomes.  Redistributive  policies  are  also  aimed  at  reducing  the  extent  of  poverty  in  society.    Lorenz  Curve:  measures  the  distribution  of  income  and  wealth  for  equal  groupings  of  the  population  such  as  20%  quintiles.      Gini  Coefficient  is  a  measure  of  the  extent  of  income  inequality.  The  gini  coefficient  raises  from  zero  (all  being  equal)  to  1  (single  household  holds  the  income).  A  rise  in  the  value  of  the  gini  coefficient  implies  an  increase  in  income  inequality,  a  fall  in  the  value  implies  a  reduction  in  inequality.    Gini:                A     -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐  

A      +      B    

Sources  of  income:  • Income  comes  from  wages  (labour),  rent  (land),  Interest  (capital),  

Profit  (enterprise)  • Wages  from  labour  (earned  income)  make  up  56%  of  household  

income  • Rent  from  Land  and  earnings  from  capital  –  11.5%  • Profit  from  sale  of  entrepreneurial  skills  –  17.6%  • Social  Benefits  (Pensions  and  means  tested  government  

allowances)  –  9.7%    Sources  of  Wealth:    Personal  wealth  is  the  net  value  of  real  and  financial  assets  owned  by  individuals  at  a  particular  point  in  time.  Largest  assets  of  wealth  in  Australia  are  Houses  and  Superannuation.    

Owner  occupied  property  (44%);  Investment  Property  (14%);  Super  (13%);  Shares  etc.  (6%)    Trends  in  the  distribution  of  income  and  wealth:  Inequality  in  Australia  is  around  average  level  for  developed  nations.  Since  1990s,  inequality  has  been  increasing.    Lowest  20%:  7.4%  of  Income  ($314pw)  Second  20%:  12.4%  of  Income  ($524  pw)  Middle  20%:  17%  of  Income  ($721  pw)  Fourth  20%:  23%  of  Income  ($975  pw)  Top  20%:  40.2%  of  Income  ($1704  pw)        Distribution  of  income  also  varies  in  age,  gender,  occupation,  ethnicity,  and  geographical  location.    

• Ages  25-­‐64  main  years  of  working  and  earning  life  • 35-­‐44  earn  largest  incomes  (highest  education)  • 15-­‐19  earn  the  lowest  incomes  (lowest  education)  

 • AWE  for  women  =  $818  and  for  adult  males  is  $1273  • Managerial  roles  and  high  educational  roles  earn  more    • English  speaking  migrants  earn  higher  incomes  than  Australians  • Non-­‐English  speaking  migrants  earn  lower  incomes  than  Australians  • Indigenous  Australians  are  amongst  the  lowest  income  earners  • Geographic  divides,  e.g.  state  vs  state,  city  vs  rural  

 Costs  and  Benefits  of  Inequality  Inequality  is  a  result  of  free  market  operations,  some  argue  increases  in  inequality  drive  to  achieve  increasing  productivity,  others  argue  it  creates  economic  disparity  and  class  divides    Economic  Benefits  of  Inequality:  Incentive  effect:  whereby  workers  will  work  harder  to  achieve  higher  wages.  Encourages  the  labour  force  to:  

• Increase  education  and  skill  levels  • Work  longer  and  Harder  • Be  more  mobile  • Encourage  entrepreneurs  to  accept  risks  more  readily  • Create  potential  for  higher  savings  and  capital  formation  and  ultimately  

allowing  for  more  domestic  investment.    Economic  Costs  of  Inequality:  

• Reduce  economic  growth  due  to  lower  levels  of  consumption  • Creates  poverty  and  social  problems  • Increase  the  cost  of  social  welfare  support  • Poverty  trap  

 Social  Benefits  of  Inequality:    Very  little  due  to  Inequality  of  Opportunity    Social  Costs  of  Inequality:  

• Social  class  division  • Tension  divides  can  lead  to  social  and  economic  instability  

             Government  Policies  and  Inequality    Reduces  Inequality  

• General  developments  in  the  economy  reduces  inequality  • Employment  is  vital  to  sustaining  low  levels  of  inequality,  as  wages  are  

the  main  source  of  income  • Governments  aim  to  avoid  long  term  unemployment  and  Hidden  

unemployment  as  they  are  a  drain  on  welfare,  and  increase  inequality    Increases  inequality  

• Changes  in  the  labour  market:  Recent  Growth  in  part  time  and  casual  employment  has  created  underemployment  –  resulting  in  lower  incomes  and  high  inequality.  

• Decentralization  of  the  labour  market  has  increased  income  inequality  with  a  widening  of  the  skills  gap  –  higher  skilled  workers  can  achieve  higher  incomes  compared  to  low  skilled  workers  relying  on  Award  wages  

 Government  Policies  to  reduce  inequality    

• Progressive  Tax  system  and  Transfer  payments  are  aimed  at  reducing  inequality  and  redistribution  of  income  

 Current  Tax  Structure:      0  –  18,200      0%  18,  201  –  37,000    19%  37,001  –  80,000    32%  80,001  -­‐  180,000    45%    

• Compulsory  Superannuation  has  improved  distribution  of  wealth  as  lower  income  earners  have  higher  assets  

• Fair  Work  act  2009  introduced  the  National  Employment  Standards  to  minimum  wage  levels  to  ensure  minimum  wage  outcomes  for  low  income  earners  

• Expansionary  Fiscal  Policy  

Fiscal  policy  Fiscal  policy  is  at  the  heart  of  the  management  of  the  economy.  Although  is  generally  plays  a  less  important  role  than  monetary  policy  in  influencing  economic  growth,  fiscal  policy  can  influence  the  overall  level  of  economic  activity  and  can  have  a  targeted  impact  on  specific  sectors  of  the  economy  such  as  individual  industries  or  social  groups  Fiscal  policy  involves  the  use  of  the  Commonwealth  Government’s  Budget  in  order  to  achieve  the  government’s  economic  objectives.  By  varying  the  amount  of  government  spending  and  revenue,  the  government  can  alter  the  level  of  economic  activity,  which  in  turn  will  influence  economic  growth,  inflation,  unemployment  and  the  external  indicators  in  the  economy.  Federal  Government  budget  and  budget  outcomes  

Federal  Government  budget  

§ The  budget  is  the  annual  statement  for  the  government  of  its  income  and  expenditure  plans  for  the  next  financial  year.  It  is  normally  released  in  May.  The  Budget  includes  all  forms  of  revenue  received  by  the  Government,  including  both  taxation  (indirect  and  direct  taxation)  and  revenue.  The  major  items  of  expenditure  in  the  Budget  are  social  welfare,  health,  education,  defence  and  public  administration  

§ Although  the  Budget  is  released  once  every  year,  it  has  become  for  governments  at  different  times  throughout  the  year  to  announce  changes  to  specific  areas  of  spending  or  taxation  that  affect  the  Budget  (fiscal  policy  is  about  sustaining  a  balanced  budget)  

§ Changes  to  the  budget  throughout  the  course  of  the  year  is  known  as  the  Mid-­‐Year  Economic  and  Fiscal  Outlook  statement  (MYEFO)  

§ Governments  can  gain  greater  political  advantage  from  spending  out  ‘good  news’  announcements  such  as  new  spending  programs  

Budget  outcomes  

The  overall  outcome  of  the  Budget  is  known  as  the  budget  outcome  (the  most  important  feature  of  the  fiscal  policy).  The  Budget  outcome  gives  an  indication  of  the  overall  impact  of  fiscal  policy  on  the  economy  

 -­‐  There  are  three  possible  budget  outcomes  

1.  Budget  surplus              →          (Revenue  >  Expenditure)  

2.  Balanced  Budget      →          (Revenue  =  Expenditure)  

3.  Budget  deficit                  →          (Revenue  <  Expenditure)  

Measuring  the  Budget  Outcome:  

§ Budget  outcome  (deficit/surplus)  General  economic  concept  

§ Fiscal  outcome:  (fiscal  deficit  or  fiscal  deficit)  is  calculated  as  total  revenue  less  total  expenses  less  net  capital  investment.  This  measure  excludes  one-­‐off  items,  such  as  proceeds  from  the  privatisation  of  previously  government-­‐owned  businesses  such  as  Telstra,  which  are  recoded  in  the  Statement  of  Other  Economic  Flows.  The  fiscal  outcome  is  calculated  using  the  accrual  accounting  method,  which  measure  expenditure  and  revue  when  they  are  incurred  or  earned,  rather  than  when  cash  transactions  actually  occur.  The  fiscal  outcome  is  regarded  as  the  most  accurate  long-­‐term  indicator  of  fiscal  policy  

 § Underlying  cash  outcome:  (cash  surplus  or  cash  deficit)  is  calculated  in  a  

similar  way  as  the  fiscal  outcome,  expect  that  it  is  calculated  using  the  cash  accounting  method  (which  records  revenue  &  expenditures  when  the  money  is  collected  or  spent).  The  underlying  cash  surplus  or  deficit  gives  the  best  indicator  of  the  shorter  term  impact  of  fiscal  policy  on  the  level  of  economic  activity.  The  government’s  main  fiscal  policy  aim  is  to  achieve  fiscal  surplus,  on  average,  over  the  course  of  the  economic  cycle.    

 § Headline  cash  outcome:  is  the  less  important  measure  of  budget  outcome  

that  shows  one-­‐off  transactions.  This  is  not  regarded  as  useful  indicator    

 Effects  of  budgetary  changes  on  resources  use,  income  distribution  and  economic  activity  

§ Each  year,  the  levels  of  government  spending  and  revenue  collection,  and  thus  the  budget  outcome,  change.  This  reflects  the  impact  of  two  key  factors:  changing  economic  conditions  (which  are  known  as  cyclical  or  discretionary  changes)  and  changes  in  government  policy  (known  as  structural  or  discretionary  factors):  

§ Discretionary  changes  in  fiscal  policy.  Discretionary  changes  involve  deliberate  changes  to  fiscal  policy,  such  as  reduced  spending  or  changing  taxation  rates.  If  the  government  deliberately  increased  expenditure  in  order  to  stimulate  demand,  this  would  be  an  example  of  discretionary  fiscal  policy.  Discretionary  changes  influence  the  structural  components  of  the  budget  outcome.  (Discretionary  fiscal  policy  involves  new  laws  designed  to  fix  the  economy,  for  example  manipulating  taxes  and  expenditure  in  order  to  influence  economic  outcomes)  

§ Non-­‐discretionary  changes  in  fiscal  policy  (Automatic  stabiliser/Counter-­‐cyclical).  The  fiscal  budget  outcome  can  be  influenced  by  factors  other  than  planned  (discretionary)  changes  to  government  revenue  and  expenditure.  These  non-­‐discretionary  changes  are  caused  by  changes  in  the  level  of  economic  activity.  When  an  economy  

is  in  recession,  the  budget  deficit  will  increase  whereas  during  a  period  of  strong  economic  growth  the  deficit  will  contrast  or  the  budget  will  shift  into  surplus.  Non-­‐discretionary  changes  influence  the  cyclical  component  of  the  budget  (Non-­‐discretionary  fiscal  policy  involves  laws  that  automatically  speed  up  or  slow  down  the  economy.  For  example,  a  progressive  tax  system  and  unemployment  benefits  help  to  slow  economic  growth  or  increase  economic  growth  by  redistributing  income)  

§ Budgetary  changes  that  are  influenced  by  the  level  of  economic  growth  are  also  known  as  automatic  stabiliser  can  be  defined  as    those  changes  in  the  level  of  government  revenue  and  expenditure  that  occur  as  a  result  of  changes  in  the  level  of  economic  activity.  They  are  refer  to  as  automatic  as  they  are  built  into  the  Budget,  and  are  anticipated  by  a  change  in  the  level  of  economic  activity,  not  by  a  deliberate  change  in  government  policy  (discretionary)  relating  to  either  revenue  or  expenditure  

There  are  two  main  automatic  stabiliser:  

 -­‐  Unemployment  benefits.  When  the  economy  movers  into  recession,  the  level  of  economic  activity  falls,  causing  a  rise  in  unemployment.  An  increase  in  unemployment  leads  to  greater  government  expenditure  on  unemployment  benefits.  Thus,  a  decline  in  the  level  of  economic  activity  automatically  leads  to  an  increase  in  government  expenditure  and  vice  versa  

 -­‐  The  progressive  income  tax  system.  Progressive  income  tax  means  that  people  on  higher  income  pay  proportionality  more  tax  than  those  on  lower  income.  During  an  economic  boom,  employment  opportunities  are  increasing  and  income  are  rising.  Rising  income  move  workers  into  higher  income  tax  brackets  and  previously  unemployed  persons  start  paying  income  tax.  Both  situations  lead  to  an  increase  in  government  taxation  revenue.    

§ Automatic  stabilisers  are  built  into  the  Budget  to  play  a  counter-­‐cyclical  role.  When  economic  growth  is  high,  demand  is  automatically  slowed  through  higher  tax  revenues  and  reduced  government  expenditure.  On  the  other  hand,  when  the  economy  moves  into  recession,  it  is  given  a  boost  by  increased  government  expenditure  through  unemployment  benefits  

Effects  of  budgetary  changes  on  Resources    

§ Changes  in  fiscal  policy  can  influence  the  allocation  of  resource  in  the  economy  directly  and  indirectly  

§ The  government  can  take  direct  measures  to  provide  a  good  or  service  if  they  expect  the  market  not  to  intervene  or  quickly  enough  (e.g.  providing  public  good  or  infrastructure  projects[spending])  

§ The  government  can  intervene  indirectly  through  fiscal  policy  to  influence  the  appeal  of  goods  and  services  (e.g.  increasing  taxes  on  tobacco  to  discourage  use  and  prevent  long-­‐term  health  care  costs  [negative  externalities]  or  the  carbon  tax  to  influence  more  environmental  means  of  production)  

§ Effect  of  budgetary  changes  on  income  distribution  § Changes  in  fiscal  policy  plays  an  important  role  in  influencing  the  level  of  

income  distribution.  A  progressive  tax  system  and  transfer  payments  ensure  a  more  equitable  distribution  of  income  

§ Changes  in  taxation  arrangements  can  affect  income  distribution  significantly  (reducing  in  taxes  for  high  income  earners  will  create  a  less  equal  distribution  of  come)  as  well  as  change  involving  government  spending  on  community  services  will  reduce  income  equality  because  they  tend  to  have  a  greater  benefit  to  low  income  earners  

Effect  of  budgetary  changes  on  economic  activity  

§ The  most  significant  short  term  impact  of  fiscal  policy  is  how  it  affects  economic  activity.  The  budget  stance  (not  to  be  confused  with  the  budget  outcome)  refers  to  the  impact  of  fiscal  policy  on  economic  growth,  and  can  be  described  as  expansionary,  contractionary  or  neural:  

§ An  expansionary  stance  is  one  where  the  government  is  planning  to  increase  the  level  of  economic  activity  in  an  economy.  This  can  occur  through  either  a  reduction  in  taxation  revenue  and/or  an  increase  in  government  expenditure,  creating  either  a  smaller  surplus,  or  a  larger  deficit  than  I  the  previous  year,  Expansionary  fiscal  policy  leads  to  a  multiplied  increase  in  consumption  and  investment  and  stylus  aggregate  demand,  which  will  increase  the  level  of  economic  activity  

§ A  contractionary  stance  is  one  where  the  government  is  planning  to  decrease  the  level  of  economic  activity  in  an  economy.  This  can  occur  through  either  an  increase  in  taxation  revenue  and/or  a  decrease  in  government  expenditure,  creating  either  a  smaller  deficit  or  a  bigger  surplus  than  in  the  previous  year.  Contractionary  fiscal  policy  leads  to  a  multiplied  decrease  in  consumption  and  investment,  dampening  aggregate  demand,  which  will  decrease  economic  activity  

§ A  neutral  fiscal  policy  stance  occurs  when  the  government  plans  to  maintain  the  gap  between  revue  and  spending  at  around  the  same  level  as  the  previous  year.  A  Neutral  fiscal  policy  should  have  no  effect  of  the  overall  level  of  economic  activity  

Methods  of  financing  deficits  

When  the  government  budget  for  a  deficit,  it  is  planning  to  spend  more  than  it  receives  in  revenue  over  the  current  financial  year.  In  short,  this  deficit  is  

financed  through  borrowing  form  domestic  private  sector  or  overseas  investors  or  from  the  Reserve  Bank  (by  printing  money)  

 

Borrowing  from  the  private  sector  

 -­‐  The  main  form  of  deficit  financing  is  through  borrowing  from  the  private  sector  by  selling  Treasury  Bonds  domestically  under  a  tender  system.  Under  this  system,  the  government  sets  the  value  of  bonds  to  be  sold  (determined  by  the  size  of  the  deficit  to  be  financed),  and  the  prospective  purchasers  tender  to  buy  a  certain  quantity  at  a  particular  rate  of  interest.  The  government  then  accepts  the  tenders,  starting  with  those  offering  to  buy  at  the  lowest  rate  of  interest  to  the  highest  until  the  bond  is  sold.  The  advantages  of  this  system  are  two  :  

§ The  government  can  always  be  certain  that  it  will  fully  finance  its  deficit  § The  market  will  set  the  interest  rate  on  these  newly  issued  bonds  § The  impact  of  a  private  sector  funding  (particularly  private  investment)  

on  the  private  sector  and  private  sector  spending  is  the  crowding  out  effect  (see  below)  

Borrowing  from  overseas  

§ Governments  may  borrow  from  overseas  financial  markets  in  order  to  minimise  the  crowding  out  effect,  while  still  stimulating  growth.  Globalisation  has  allowed  it  to  be  more  affordable  and  convenient  to  borrow  money  overseas.  If  the  budget  was  in  deficit,  the  government  can  at  any  time  borrow  money  overseas  should  this  be  a  less  expensive  option  that  domestic  borrowing  

Borrowing  from  the  Reserve  Bank  (monetary  financing)  

§ The  Government  may  simply  borrow  from  the  RBA  but  has  avoided  it  ever  since  1982  as  it  does  not  want  to  increase  the  money  supply  and  thus  stimulate  inflation  

Selling  assets  

§ Selling  assets,  such  as  Commonwealth  land  or  shares  does  not  reduce  the  level  of  the  fiscal  deficit  because  the  purchaser  still  has  to  borrow  from  domestic  savings,  therefore  privatisation  is  merely  an  alternative  way  of  financing  the  budget  deficit  

   

Use  of  a  surplus  

When  the  government  budgets  for  a  surplus,  it  is  planning  to  receive  more  revenue  than  it  spends  in  the  current  financial  year.  The  government  can  use  the  surplus  in  three  ways:  

A)  Depositing  it  with  the  Reserve  Bank  

B)  Using  it  to  pay  off  public  sector  debt  

C)  Placing  the  money  in  a  specially  established,  governed-­‐owned  investment  fund  

 The  crowding  out  effect  For  example:  In  a  situation  of  a  recession  or  when  a  there  is  a  deficit  in  the  budget  a  government  could  use  demand  side  polies.  The  government  can  use  Expansionary  fiscal  policy  through  decreased  taxes  or  increased  spending  or  both.      This  will  cause  a  shift  in  the  demand  curve.  However  because  the  government  is  in  recession/unable  to  finance  deficit,  the  decreases  in  taxes  means  that  it  must  source  funds/  finance  deficit  from  the  private  sector  (e.g.  financial  institutions).            When  the  government  borrows  it  puts  upwards  on  demand  on  money  causing  a  shift  on  the  demand  for  money.  Because  of  the  shortage  of  supply  for  money,  this  causes  a  short  term  increasing  in  interest  rates  and  ‘crowding  out’  the  private  sector  investors  who  cannot  borrow  at  the  higher  rates  of  interest    As  a  result  the  move  by  the  government  to  boost  growth  simply  shifts  activity  from  the  private  sector  to  the  public  sector,  and  leaves  the  economy  with  higher  interest  rates            

Copyright  2013  |  Majd  Abdulwali  

Copyright  2013  |  Majd  Abdulwali  

Monetary  policy  Monetary  policy  involves  action  by  the  Reserve  Bank,  on  behalf  of  the  

government,  to  influence  the  cost  and  availability  of  money  and  credit  in  the  economy.  Monetary  policy  is  a  macroeconomic  policy  that  may  be  used  to  smooth  the  effect  of  fluctuations  in  the  business  cycle  and  influence  the  level  of  economic  activity,  employment  and  prices    As  the  primary  monetary  authority  in  the  country,  the  RBA  is  the  only  organisation  in  the  economy  that  is  allowed  to  print  money.  This  gives  it  a  special  relationship  with  the  financial  sector  The  main  instrument  of  monetary  policy  is  domestic  market  operations  (DMO),  which  influence  the  level  of  interest  rates  in  the  economy.  A  detailed  explanation  of  how  DMO  work  is  covered  later  in  this  chapter.  The  Reserve  Bank  does  not  regulate  the  level  of  interest  rates  directly,  but  its  actions  influence  market  interest  rates,  helping  it  to  achieve  its  objectives  relating  to  the  level  of  economic  activity,  inflation  and  unemployment  In  the  short  term,  a  tightening  of  monetary  policy  through  upward  pressure  on  interest  rates  will  slow  down  economic  activity.  Higher  interest  rates  will  cause  a  reduction  in  consumer  spending,  as  consumers  face  higher  costs  for  mortgages  and  consumer  loans.  Businesses  also  usually  need  to  borrow  money  in  order  to  purchase  new  capital  equipment.  Higher  interest  rates  will  make  borrowing  more  expensive  so  business  investment  will  also  decline.  The  overall  effect  will  be  a  fall  in  aggregate  demand  and  lower  economic  activity.    

Purpose  of  monetary  policy  

§ Monetary  policy  is  the  primary  macroeconomic  policy  used  to  manage  the  level  of  economic  growth.  The  Reserve  Bank’s  policy  stance  can  be  described  as  expansionary  or  contractionary,  reflecting  its  impact  on  economic  growth  

§ If  the  RBA  wished  to  boost  economic  activity,  it  could  do  so  by  loosening  monetary  policy  (reducing  interest  rates).  Lower  interest  rates  would  boost  consumer  and  investment  spending,  resulting  in  a  higher  level  of  economic  activity  and  a  reduction  in  unemployment.  However,  if  growth  rises  too  fast,  inflationary  pressures  will  also  increase,  putting  at  risk  the  low  inflation  objective,  which  is  not  consistent  with  one  of  the  government’s  long  term  aims.  

§ On  the  other  hand,  a  tightening  of  monetary  policy  (  increasing  interest  rates)  would  tend  to  reduce  inflation,  but  slow  down  the  rate  of  economic  and  increase  unemployment  

§ Because  of  this  tension  between  policy  objectives,  it  is  not  always  possible  for  the  RBA  to  pursue  all  the  goals  of  economic  policy  at  once,  at  least  in  the  short  term.  Instead,  the  government  needs  to  identify  its  priorities  and  provide  direction  to  the  Reserve  Bank  as  to  which  objectives  are  most  important  in  the  conduct  of  monetary  policy  

§ The  objectives  of  monetary  policy  are  laid  out  formally  in  the  Reserve  Bank  Act  1959,  which  states  that  in  its  implementation  of  monetary  policy  the  RBA  should  aim  for:  

§ The  stability  of  Australia’s  currency  (Which  now  means  maintaining  a  low  inflation  and  minimising  fluctuation  sin  the  value  of  the  Australian  dollar  

§ The  maintenance  of  full  employment  in  Australia  (which  in  effect  means  reducing  the  level  of  unemployment)  

§ Promoting  the  economic  prosperity  and  welfare  of  the  people  of  Australia  (which  means  encouraging  a  sustained  level  of  economic  growth)  

§ Inflation  Targeting:  § The  RBA  operates  independently  from  the  government  and  sets  a  

target  range  for  inflation  with  the  appropriate  interest  rate  to  keep  inflation  with  2-­‐3%  

§ Monetary  policy  is  particularly  suit  to  fight  inflation,  which  is  often  related  to  monetary  factor  

 Implementation  of  monetary  policy  by  the  Reserve  Bank  of  Australia  

§ Monetary  policy  involves  influencing  the  cost  and  availability  of  money  in  the  economy.  There  are  two  possible  instruments  form  implement  monetary  policy  

§ The  RBA  may  control  the  growth  in  the  money  supply  in  the  economy  through  its  control  over  the  money  base  (currency  in  the  hands  of  the  public  and  deposits  of  banks  and  other  financial  institutions  with  RBA).  This  form  of  monetary  implementation  is  referred  to  as  monetary  targeting    

§ The  RBA  may  influence  the  general  level  of  interest  rates  in  the  economy  by  setting  the  short  run  cash  rate  (sometimes  referred  to  as  rate-­‐setting  monetary  policy  (DMO))  

§ In  the  past,  Monetary  targeting  (1970s)  has  proved  to  be  unsuccessful  and  therefor  the  TBA  now  implements  monetary  policy  

How  domestic  market  operation  works  

§ DMOs  are  conducted  directly  with  financial  institutions,  including  the  banks  and  some  NBF’s,  through  their  exchange  settlement  accounts  with  the  RBA.    

§ Banks  need  to  hold  a  certain  proportion  of  their  funds  with  the  RBA  in  E.S  accounts  in  order  to  settle  repayments  with  other  banks  and  the  RBA,  having  no  net  impact  on  the  supply  of  money  (For  example,  an  ANZ  customer  withdraws  money  from  a  NAB  ATM).  The  short  term  money  market  (or  overnight  market)  is  the  market  where  banks  borrow  money  

if  they  need  to  add  to  their  E.S  account,  or  to  lend  money  if  they  have  an  excess  of  funds  beyond  what  they  need  in  their  E.S  account.  As  with  any  other  market,  when  the  supply  of  funds  held  in  the  short  term  money  market  is  too  high,  the  price  of  borrowing  money  (cash  rate)  falls.  On  the  other  hand,  when  the  supply  of  funds  in  the  settlement  market  decreases  the  cash  rate  will  rise  

§ Domestic  market  operations  is  the  buying  and  selling  of  commonwealth  government  bonds  in  order  to  influence  interest  rates.  This  affects  the  supply  of  funds  in  the  short-­‐term  money  market  in  order  to  set  the  cash  rate.  This  has  a  direct  influence  on  the  return  for  short  term  loans,  and  an  indirect  influence  on  interest  rates  on  longer  term  loans.  

§ The  government  would  buy  commonwealth  government  bonds  or  Government  Bonds  in  order  to  increase  the  availability  of  funds  in  the  Exchange  settlement  account  or  short-­‐term  money  market,  thereby  reducing  the  cash  rate.  This  is  known  as  expansion  or  loosening  of  monetary  policy.  

§ The  government  would  sell  commonwealth  government  bonds  or  Government  Bonds  in  order  to  decrease  the  availability  of  funds  in  the  Exchange  settlement  account  or  short-­‐term  money  market,  thereby  raising  the  cash  rate.  This  is  known  as  a  contraction  or  tightening  of  monetary  policy.  

§ The  RBA  also  intervenes  in  the  short-­‐term  money  market  to  maintain  the  cash  rate  as  its  target  level  because  of  changes  in  banks’  demand  for  exchange  settlement  funds.  

§ An  increase  in  the  cash  rate  means  that  it  becomes  more  expensive  for  financial  institutions  to  obtain  funds  in  the  short-­‐term  money  market.  This  increases  the  overall  cost  structure  (bank’s  expenses)  of  borrowing,  eventually  flowing  through  to  longer  term  and  mortgages  interest  rates,  as  banks  try  to  maintain  their  profit  margins.  A  decrease  in  the  cash  rate  means  that  it  becomes  less  expensive  for  financial  institutions  to  obtain  funds  in  the  short-­‐term  money  market.  This  decreases  the  overall  cost  structure  of  borrowing,  thereby  flowing  through  to  nominal  interest  rates.  

§ Changes  in  the  general  level  of  interest  rates  cause  by  changes  in  the  cash  rate  impacts  upon  the  level  of  economic  activity.  If  the  interest  rate  falls,  it  encourages  consumption  and  investment  spending,  which  increases  the  level  of  economic  activity.  If  interest  rates  rises,  this  stifles  consumption  and  investment  spending  and  reduces  the  overall  level  of  economic  activity  

   

§ Impact  of  changes  in  interest  rates  on  economic  activity  and  the  exchange  rate  

§ The  main  effect  of  changes  in  the  general  level  of  interest  rates  is  to  change  the  demand  for  credit.  Higher  interest  rates  make  borrowing  more  expensive,  which  is  likely  to  deter  borrowing,  while  lower  interest  rates  will  encourage  it  

§ The  transmission  mechanism  is  the  process  by  which  monetary  policy  impacts  upon  the  economy  to  influence  economic  objectives  (e.g.  inflation).  This  includes:  

§ Downward  pressure  on  interest  rate  s  through  DMO  makes  borrowing  cheaper  for  both  consumers  and  business.  Consumer’s  often  need  to  borrow  to  make  major  purchases  such  as  housing  and  consumer  durables.  Similarly,  businesses  borrow  for  the  purpose  of  investment  in  capital,  plant  upgrades  and  expansions.  In  addition,  the  interest  rate  the  can  obtain  by  investing  in  financial  assets  represents  and  opportunity  cost  of  investing  funds  in  the  business  for  business  owners.  Thus  a  fall  in  the  level  of  interest  should  encourage  borrowing  by  both  business  and  consumers,  leading  to  rising  consumption  and  investment  demand  in  the  economy  (multiplier  effect),  thus  increasing  the  level  of  spending  and  raising  the  level  of  economic  activity  fall  in  the  level  of  interest  rates  also  discourages  financial  inflows  into  Australia  and  leads  to  a  depreciation  of  the  currency  

§ The  increase  in  aggregate  demand  ,  which  result  from  lower  interest  rates,  will  lead  to  either  higher  output  and  employment  (if,  for  example,  the  economy  was  preciously  in  a  recession)  or  will  spill  over  into  higher  prices  and  wages  if  the  economy  is  close  to  full  employment  

§ Higher  interest  rates  offer  lenders  in  an  economy  a  higher  return  relative  to  other  countries.  Therefore,  higher  interest  rates  attract  foreign  capital  and  cause  the  exchange  rate  to  rise.  However,  the  impact  of  higher  interest  rates  is  lessened  if  inflation  in  the  country  is  much  higher  than  in  others,  or  if  additional  factors  serve  to  drive  the  currency  down.  The  opposite  relationship  exists  for  decreasing  interest  rates  -­‐  that  is,  lower  interest  rates  tend  to  decrease  exchange  rates  

§ Hence,  monetary  policy  can  be  either  tightening  or  loosening  depending  on  whether  the  government  wishes  to  dampen  or  stimulate  the  level  of  economic  activity  

§ A  tightening  of  monetary  policy  would  invoke  DMO  putting  upward  pressure  on  interest  rates,  which  would  have  the  effect  of  dampening  consumer  and  investment  spending,  resulting  in  a  lower  level  of  economic  activity,  with  lower  level  of  economic  activity,  with  lower  inflation  and  the  possibility  of  higher  unemployment  

§ A  loosening  of  monetary  policy  would  involve  DMO  putting  downward  pressure  on  interest  rates,  stimulating  consumer  spending  and  investment,  resting  in  a  higher  level  of  economic  activity,  with  falling  unemployment,  and  often  an  increase  in  inflationary  pressures  

§ Monetary  policy  can  consist  of  a  time  lag  up  to  6-­‐18  month  before  the  full  impact  is  of  interest  rate  changes  is    felt  on  the  economy  

                           

     

     

   

                             Discuss  the  effectiveness  of  microeconomic  policies  in  achieving  Australian  Government’s  economic  objectives    Objectives:  Sustainable  growth,  low  inflation,  full  employment,  Secondary  are  income  and  wealth  equality  and  Environmental  sustainability.  Do  objectives  and  the  policies  which  fit  best  with  them    Sustainable  Economic  Growth    

Price  Stability    Full  Employment    Income  and  Wealth  Equality    Environmental  sustainability