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ECONOMIC

POLICIES AND
MANAGEMENT
TOPIC FOCUS

4

This topic focuses on the aims and operation of economic policies in the Australian economy
and hypothetical situations.
Students should learn to examine the following economic issues and apply the following economic
skills in Topic 4 of the HSC course:

Analyse the opportunity cost of government decisions in addressing specific economic
problems or issues;

Investigate structural changes in the Australian economy resulting from microeconomic
policies;

Apply economic theory to explain how a government could address an economic problem or
issue in hypothetical situations; and

Analyse alternative ways to finance a budget deficit.

ECONOMIC SKILLS

Explain how governments are restricted in their ability to simultaneously achieve economic
objectives;

Use simple multiplier analysis to explain how governments can solve economic problems;

Identify limitations of the effectiveness of economic policies;

Explain the impact of key economic policies on the economy;

Propose and evaluate alternative policies to address an economic problem in hypothetical
and the contemporary Australian contexts;

Explain, using economic theory, the general effects of macroeconomic and microeconomic
policies on an economy; and

Select an appropriate policy mix to address a specific economic problem.

The Australian government has three key economic objectives it attempts to achieve. Firstly, it
tries to sustain a rate of economic growth which leads to permanent employment creation, rising
incomes and living standards. Secondly, the internal balance objective consists of trying to
achieve price stability and full employment. Thirdly, external balance is the objective of achieving
a sustainable current account balance, level of net foreign debt, and a stable exchange rate.
The three main policy instruments used by the Australian government to achieve these objectives
are monetary policy, fiscal policy and microeconomic policy. Monetary and fiscal policies can be
used for the stabilisation of aggregate demand and microeconomic policies (including industrial
relations policy) for long term improvements in resource allocation and productivity in the economy.
© Tim Riley Publications Pty Ltd

TOPIC FOUR

ECONOMIC ISSUES

Year 12 Economics 2014

Price Stability and External Stability 277 • Environmental Sustainability and an Equitable Distribution of Income 279 280 Macroeconomic Policies and the Stabilisation of Aggregate Demand 280 • Potential Conflicts among Economic Objectives • Chapter 14: Fiscal Policy 287 • The Federal Government Budget 287 • Possible Budget Outcomes 288 • The Economic Effects of the Budget 292 • Recent Trends in Fiscal Policy 301 Chapter 15: Monetary Policy 311 • The Goals or Objectives of Monetary Policy 311 • The Implementation of Monetary Policy 313 • The Economic Impact of Changes in Interest Rates 316 • Recent Trends in Monetary Policy 318 • Transparency. Accountability and Effectiveness of Monetary Policy 322 Chapter 16: Microeconomic Policy 329 • The Rationale for Microeconomic Policies 329 • Structural Change and Microeconomic Policies 332 • Reforms in Product Markets 333 • Reforms in Factor Markets 335 • Regulation.276 Chapter 13: Economic Objectives and Policies 277 • Economic Growth. Deregulation and Competition Policy 337 • The Costs and Benefits of Microeconomic Reform 346 Chapter 17: Labour Market Policy 351 • The Role of the National and State Industrial Relations Systems 351 • Evolution of the National Industrial Relations System 352 • The Role of Institutions in the Current Industrial Relations System 364 • Evaluation of the Fair Work Act 2009 • Evaluation of the Current Industrial Relations System 367 369 Chapter 18: Australia’s Recent Economic Performance 377 • The Limitations of Economic Policies 377 • Australia’s Recent Economic Performance 380 Glossary and Index 392 • Glossary of Terms 392 • Index 402 Year 12 Economics 2014 © Tim Riley Publications Pty Ltd . Full Employment.

ECONOMIC GROWTH AND THE QUALITY OF LIFE Economic growth involves increasing the economy’s production of goods and services over time and is measured by changes in real GDP. employment creation and higher standards of living for the Australian people. • Economic growth is consistent with more opportunities for investment in private infrastructure (such as new plant and equipment). Fluctuations in the business cycle occur when economic activity (or real output as measured by changes in real GDP) deviates from its long run trend. and that economic growth is ecologically sustainable in terms of environmental quality being maintained for current as well as future generations (i. 2. © Tim Riley Publications Pty Ltd Year 12 Economics 2014 277 . which can all add to the economy’s productive capacity and improve the quality of life over time. which is nominal GDP (or GDP at current prices) adjusted for the rate of inflation. which involves financing import expenditure with export income. causing excessive levels of inflation in booms. The three major objectives of government economic policy are: 1. health and education). • Economic growth is accompanied by an expansion in the economy’s productive capacity. Economic growth averaged 3% to 4% per annum between 1996 and mid 2008. External balance. This is called the conduct of counter cyclical or stabilisation policy. However the Global Financial Crisis in 2008-09 led to lower growth and a rise in the unemployment rate to 5. which refers to the achievement of full employment of resources (including labour) and price stability where the inflation rate is at or near zero. This target represented a higher growth outcome than the historical average of the 3% annual growth rate achieved by Australia between the 1960s and 1980s. Other objectives of economic policy include ensuring that the benefits of economic growth are shared by the majority of the population in terms of a fair or equitable distribution of income and wealth. and 3. This helps to reduce existing levels of unemployment and the rate of unemployment.8%. as well as advances in the rate of technological progress. Sustaining economic growth is important for a number of reasons: • Increases in the rate of economic growth lead to rising real per capita incomes. Economic growth which is sustainable in terms of delivering rising real incomes whilst minimising inflationary pressures and the current account deficit as a percentage of GDP. and public infrastructure (such as transport. stability of the exchange rate. and the levels of net foreign liabilities and net foreign debt as percentages of GDP. Higher rates of economic growth should be accompanied by increased exports and imports and more opportunities for employment in export industries. intergenerational equity).e. The government uses macroeconomic and microeconomic policies to target long term economic growth which can lead to the achievement of rising living standards and economic prosperity for Australian residents over time. and the creation of employment opportunities to accommodate increases in the size of the potential workforce. Internal balance.© Tim Riley Publications Pty Ltd Chapter 13: Economic Objectives and Policies Chapter 13 Economic Objectives and Policies A major rationale for government macroeconomic intervention is to stabilise fluctuations in the business cycle. This contributed to a significant reduction in the unemployment rate from 7% in 1996 to 4. or excessive levels of unemployment in recessions.2% by mid 2008. the Australian government committed itself to ‘going for growth’ by setting a target of 4% real GDP growth per annum for the Australian economy. • Economic growth leads to more opportunities to realise the gains from international trade and investment through the specialisation of production according to comparative advantage. After the release of the Mortimer Report on industry policy (Investing for Growth) in late 1997.

278 Chapter 13: Economic Objectives and Policies © Tim Riley Publications Pty Ltd FULL EMPLOYMENT Full employment refers to the achievement of the objective of full employment of the economy’s resources of land.g. there should be a fall in the rate of unemployment. excessive wage and price demands). which can cause a wage-price spiral to develop in the economy. Year 12 Economics 2014 © Tim Riley Publications Pty Ltd . labour. leading to an acceleration in the rate of inflation. capital and enterprise. Rising inflation can also cause distortions in the economy such as a misallocation of resources and a loss in international competitiveness. 1%). Ian Macfarlane was reappointed governor of the Reserve Bank for a further three years in July 2003. structural and frictional factors in the economy would still lead to an unemployment rate of around 5% to 6%. 2%) and the growth in the workforce (e. In policy terms. If economic growth exceeds productivity growth plus labour force growth.g. Rising inflation can also lead to higher inflationary expectations (i. and minimising the economic and social costs of unemployment.g. The underlying rate of inflation is a calculation of inflation that removes ‘one off’. Okun’s Law states that the rate of economic growth (e. The non accelerating inflation rate of unemployment (NAIRU) is the rate of unemployment that is consistent with a constant or non accelerating inflation rate. The important relationship that exists between economic growth and the rate of unemployment is known as Okun’s Law (developed by the American economist Arthur Okun). In the first Statement on the Conduct of Monetary Policy signed by the former Reserve Bank governor Ian Macfarlane and Treasurer Peter Costello in 1996. However this does not mean that unemployment will be zero in the labour market as some unemployment will still exist due to frictional and structural unemployment.e. for the unemployment rate to fall (e. and this was contained in the second Statement on the Conduct of Monetary Policy on July 29th 2003 which reaffirmed the Reserve Bank’s independence in conducting monetary policy and the use of an inflation targeting regime for the conduct of monetary policy. If the labour force is fully employed. 4%) must exceed the sum of productivity growth (e. For example. not accelerating).g.g. during the Global Financial Crisis in 2008-09 the Australian government used expansionary macroeconomic policies to support economic growth and minimise the rise in the unemployment rate. seasonal or volatile factors from the headline or CPI calculation of inflation.e. This means that if inflation is not increasing (i. Between 1996 and 2008 inflation was contained by the Reserve Bank and averaged about 2. Full employment is defined as that level of employment where the demand for labour is equal to the supply of labour. This is known as the natural rate of unemployment. 2%) + Labour force Growth (e. 1%) Okun’s Law provides the theoretical basis for the Australian government wanting to achieve a growth rate of around 4% in real GDP in order to reduce the rate of unemployment. However in 1998 changes to the method used to calculate the CPI by the ABS improved its reliability as a measure of inflation and the Reserve Bank adopted the CPI measure as its formal target for inflation.g.e. This was formalised as a key operating objective for the conduct of Australia’s monetary policy.g. The NAIRU is estimated at 5% to 6% of the workforce in Australia. The main benefits of reducing the rate of unemployment include increasing the economy’s productive capacity and living standards. The government attempts to keep unemployment at the NAIRU by containing inflation and using reforms in the labour market (such as enterprise bargaining) to reduce the natural rate of unemployment over time by increasing the flexibility of the labour market and the efficiency and productivity of labour. PRICE STABILITY Price stability or low inflation is a major objective of government economic policy because rising inflation reduces real incomes and living standards. a target was set for underlying inflation of 2% to 3% over the economic cycle. it is assumed that the other factors of production will also be fully employed. Economic Growth (e.6% per annum. full employment is taken to mean the full employment of the labour force. 4%) > Productivity Growth (e. by -1%) i.

health. However in 2008-09 lower demand and cost pressures due to the Global Financial Crisis (GFC) led to lower inflation and an easing in the stance of monetary policy. EQUITABLE DISTRIBUTION OF INCOME There is not perfect equality in the distribution of income in market economies like Australia because of differences in the quality and quantity of resources and their factor income returns. outlining the Reserve Bank’s role in using its powers where appropriate to promote the stability of the Australian financial system. Maintaining stability of the exchange rate in currency markets through international confidence in the Australian economy’s performance and the conduct of the government’s economic policy. prompting a tightening in monetary policy. The government’s policy objective of achieving a more equitable distribution of income is supported by: • • • • Providing transfer payments to disadvantaged social groups unable to earn market income. and transfers. transport. This role was endorsed by Glenn Stevens and the Treasurer. External stability has three main dimensions or elements: 1. The sustainability condition for the current account deficit is that it should be kept to under -5% of GDP to stabilise net external liabilities and the level of net foreign debt over time. Ensuring that the current account in the balance of payments is in equilibrium. ENVIRONMENTAL SUSTAINABILITY Environmental sustainability as an objective of government policy means that current levels of economic growth and development should meet the needs of the present generation without compromising the ability of future generations to meet their own needs. Climate Change. finances expenditure on imports of goods and services. This means that the income received from exports of goods and services. and transfers. With economic recovery in the second half of 2009 and early 2010 inflationary pressures rose and the Reserve Bank tightened monetary policy to reduce inflation. © Tim Riley Publications Pty Ltd Year 12 Economics 2014 279 . after the turmoil in financial markets during the GFC. Wayne Swan. Making the taxation system progressive to redistribute income from high to low income earners. However the government has a social responsibility to redistribute income from high to low income earners to make the distribution of income more equitable. and access to other environmental resources. housing and community services. and the World Heritage. and to alleviate absolute and relative poverty. Glenn Stevens was appointed as the new governor of the Reserve Bank for a term of seven years. Peter Costello. A new section was added to the Statement. EXTERNAL STABILITY External stability refers to the goal of Australia meeting its short term and long term financial obligations with the rest of the world. Australia’s assets abroad. Protection of the Ozone Layer and Biological Diversity global conventions to preserve natural environments. Ensuring that the levels of net foreign liabilities and net external debt are sustainable as percentages of GDP. This reflects ecologically sustainable development (ESD) principles by maintaining environmental quality such as clean air and water. Using a proportion of taxation revenue to finance spending on elements of the social wage such as public education. This can be achieved by meeting environmental standards and preserving and conserving both renewable and non renewable natural resources.© Tim Riley Publications Pty Ltd Chapter 13: Economic Objectives and Policies The third Statement on the Conduct of Monetary Policy was released in 2006 by the former Treasurer. the Kyoto Protocol to reduce greenhouse gas emissions. various UN environmental treaties (such as the Antarctic Treaty and the Law of the Sea Treaty). It also commits the Australian government to meeting its obligations under the Montreal Protocol to reduce CFC emissions. Australia’s external liabilities. Inflationary pressures rose between 2006 and 2008 as the economy reached full employment and capacity constraints emerged. 3. The fourth Statement on the Conduct of Monetary Policy (30th September 2010) reaffirmed the Reserve Bank’s use of inflation targeting to conduct monetary policy in a transparent and accountable manner. and Reducing the incidence of poverty traps through the selective targeting of welfare assistance. 2.

economic growth may become unsustainable and lead to inflationary pressures and a lack of price stability. Changes in the growth of aggregate demand will then impact on the growth of output (real GDP). aggregate demand (AD1) would be less than the level of spending or aggregate demand (AD) necessary to achieve the full employment level of income at Yf. an inflationary gap may emerge in the economy and result in a rising price level and inflation. The full employment level of national income is Y f. rising rates of land degradation and a reduction in biodiversity. may lead to rising unemployment and the government’s inability to achieve the objective of full employment. Year 12 Economics 2014 © Tim Riley Publications Pty Ltd . government policies (e. These fiscal objectives can be achieved through the government’s control of the two budgetary instruments of taxation and government spending. Monetary policy is generally used for counter cyclical stabilisation in the economy as it is quicker to implement than fiscal policy. Fiscal policy refers to the government’s use of the federal budget to affect the level of economic activity. output. These measures may also conflict with achieving a more equal distribution of income if displaced workers suffer a loss of income. a deflationary gap may occur in the economy and result in a rise in the rate of unemployment. the Australian government may experience conflicts or tradeoffs between the main goals of economic policy in both the short and long runs: • Price stability and full employment may conflict with each other in the short run because if the government pursues policies to promote economic growth and full employment (such as budget deficits or cuts in interest rates). An unsustainable current account deficit imposes an external constraint on domestic economic growth and may also lead to a depreciation in the exchange rate which can raise inflation through higher import prices. Both of these situations are illustrated in Figure 13. through its monetary authority. • Economic growth may conflict with environmental quality in the long run if economic growth is ecologically unsustainable. increasing levels of pollution.1. This may lead to a depletion of renewable and non renewable resources. income distribution and resource allocation in the economy. The Australian government may change the settings of macroeconomic policies if the economy’s equilibrium level of income does not coincide with the full employment level of income in the following situations: • If aggregate demand is less than aggregate supply at the full employment level of income. thereby influencing spending. where all of the economy’s resources including labour are fully employed. prices and employment in the economy. Alternatively. Changes in interest rates will indirectly affect the growth and cost of credit.280 Chapter 13: Economic Objectives and Policies © Tim Riley Publications Pty Ltd POTENTIAL CONFLICTS AMONG ECONOMIC OBJECTIVES In seeking to achieve its economic objectives simultaneously. the Reserve Bank of Australia. Macroeconomic policies operate on the demand side of the economy since changes in the settings or stances of fiscal and monetary policies will impact on the growth of aggregate demand. If the economy’s equilibrium level of income is Ye1. Monetary policy on the otherhand refers to the government’s ability. • If aggregate demand exceeds aggregate supply at the full employment level of income.g. MACROECONOMIC POLICIES AND THE STABILISATION OF AGGREGATE DEMAND Macroeconomic policies refer to policies directed at stabilising the aggregate level of economic activity or aggregate demand. budget surpluses or rises in interest rates) designed to reduce the rate of economic growth and inflation. to affect the level of interest rates in the economy. The two main tools or instruments of macroeconomic management are fiscal policy and monetary policy. • Economic growth and full employment may conflict with external balance in the short run if an unsustainable rate of economic growth leads to rising import spending (because of excess aggregate demand) and a deterioration in the current account of the balance of payments. • The pursuit of microeconomic efficiency to raise domestic economic growth may conflict in the long term with full employment as some structural unemployment will result from the structural changes induced by various microeconomic reform measures. employment and prices.

e. to discourage consumption and investment spending and the growth in aggregate demand. The government could try to close the inflationary gap of cd by tightening the settings of monetary and fiscal policies to discourage spending and growth. If we assume a fiscal multiplier of k = 2 then an increase in autonomous government spending (∆G) of $100m will lead to an increase in national income (∆Y) of $200m: ∆G x k = ∆Y $100m (∆G) x 2 (k) = $200m (∆Y) Alternatively if the economy’s equilibrium level of income was Ye2. An inflationary gap of cd would arise causing inflation to increase. through a larger budget deficit or a smaller budget surplus) by cutting taxes and/or increasing government spending to stimulate aggregate demand. © Tim Riley Publications Pty Ltd Year 12 Economics 2014 281 . The government could try to close the deflationary gap of ab by easing the stances of monetary and fiscal policies to encourage more spending. The size of the deflationary gap is measured by the shortfall in aggregate spending between AD1 and AD. If for example. This would increase aggregate demand from AD1 to AD in Figure 13. • The government could adopt a more expansionary stance of fiscal policy (e. This could occur if there was a recession such as the Global Financial Crisis in the business cycle in 2008-09.e. This situation could arise if there was a boom in the business cycle (such as the resources boom between 2006 and 2008) which caused over full employment and inflation. the government could increase its level of spending by $100m to close the deflationary gap. This would lead to a decrease in aggregate demand from AD2 to AD in Figure 13. The size of the inflationary gap is measured by the excess of spending between AD2 and AD. G > T).g. aggregate demand (AD2) would exceed the level of spending (AD) necessary to achieve the full employment level of income of Yf. to close the inflationary gap. G < T) or a reduction in the size of an existing budget deficit (i.© Tim Riley Publications Pty Ltd Chapter 13: Economic Objectives and Policies Figure 13.1 and could be achieved by using more contractionary settings or stances of monetary and/or fiscal policies: • The government could raise interest rates in the economy.200m. This may result in a larger budget surplus (i. Any change in autonomous government spending (∆G) will have a multiplier effect (k) on national income (Y).1: Macroeconomic Stabilisation of Aggregate Demand Expenditure AS deflationary gap c d a b AD2 AD AD1 inflationary gap 0 450 Ye1 Yf Ye2 National Income A deflationary or unemployment gap of ab would arise causing unemployment to increase. Lower interest rates would encourage more borrowing and spending.000m and the full employment level of income at Yf was $1.1 and could be achieved by using more expansionary settings of monetary and/or fiscal policies: • The government could ease the stance of monetary policy by cutting interest rates in the economy to encourage consumption and investment spending and the growth in aggregate demand to close the deflationary gap. • The government could adopt a more contractionary stance of fiscal policy by raising taxes and/or decreasing government spending to reduce the growth of aggregate demand. the economy’s equilibrium level of income at Ye1 was $1.

Examples include major reforms in factor markets such as labour market reform and financial deregulation. Aside from balancing the budget over the medium term. Microeconomic policies are more effective in promoting structural change or reform in product and factor markets to make markets more competitive. Despite fiscal policy having a more medium term focus in achieving external balance. efficient and productive. Microeconomic policies have a longer term focus by changing the allocation of resources in the economy. 2. and the use of the national competition policy to maintain competitive conduct by businesses in Australian markets. and one microeconomic policy instrument (in the longer term) to achieve its three main policy objectives as illustrated in Figure 13. it can also be used for counter cyclical stabilisation if economic conditions change. Fiscal policy is largely assigned the role of achieving external balance by ensuring that the budget is kept in balance over the medium term and that higher public saving (through accumulated fiscal surpluses) can be used to reduce Australia’s call on foreign saving. Conversely a more expansionary fiscal stance would be adopted if the rate of economic growth fell and the rate of unemployment rose as occurred in 2008-09 because of the impact of the Global Financial Crisis and recession. in the Statement on the Conduct of Monetary Policy 2010) is a pre-condition for achieving the other two objectives of economic growth and full employment. for each instrument there should be a short term policy target so that the medium or long term objective can be achieved. The Australian government therefore attempts to achieve three policy objectives with three policy instruments. Furthermore. The next step is to assign each policy instrument to an objective the government is trying to achieve. These objectives include economic growth.2. such as the reform of tariffs and quotas. The key relationship is that the difference between domestic saving and investment is equal to the size of the current account deficit.282 Chapter 13: Economic Objectives and Policies © Tim Riley Publications Pty Ltd ECONOMIC POLICY INSTRUMENTS AND OBJECTIVES Macroeconomic theory suggests that a government should have at least as many policy instruments as the number of objectives it is trying to achieve. The Howard government. Year 12 Economics 2014 © Tim Riley Publications Pty Ltd . 3. If this is the case the government has greater policy flexibility and does not need to achieve more policy objectives than it has policy instruments. and reforms in product markets. the Rudd government and the Gillard government used the following policy assignment: 1. the main fiscal policy target is keeping the current account deficit to under -5% of GDP over time. The inflation target is explicitly stated as 2% to 3% consumer price inflation on average over the economic cycle. The achievement of the inflation target set by the Reserve Bank and the Treasurer (i.2: Economic Policy Instruments and Objectives Australian Government Economic Policy Instruments Monetary Policy Fiscal Policy Microeconomic Policy Industrial Relations Policy Economic Policy Objectives Internal Balance Economic Growth External Balance The Australian government uses a combination of two macroeconomic policy instruments (monetary and fiscal policies) in the medium term. This would involve a more contractionary fiscal stance if inflationary pressures arose in the economy as they did between 2006 and 2008 due to the resources boom and capacity constraints. Monetary policy is assigned the role of counter cyclical stabilisation through the use of an inflation target for the conduct of monetary policy by the Reserve Bank. This is known as the targets and instruments approach to policy design. internal balance and external balance. This is known as policy assignment.e. Figure 13.

Explain how deflationary and inflationary gaps may arise in the economy. How are macroeconomic and microeconomic policies assigned to objectives by the Australian government? 14. 10. Discuss the targets and instruments approach to economic policy design in Australia. Which three elements are involved in the Australian government achieving external stability? 8. How and why does the Australian government pursue the objective of price stability? 7. What does Okun’s Law suggest about the relationship between the rate of economic growth and the rate of unemployment? What implications does Okun’s Law have for the conduct of Australian economic policy? 6. Why does the government use macroeconomic policies to intervene in the economy? 2.© Tim Riley Publications Pty Ltd Chapter 13: Economic Objectives and Policies REVIEW QUESTIONS ECONOMIC OBJECTIVES AND POLICIES 1. Explain the difference between the economic objectives of internal and external balance. Discuss the conflicts or tradeoffs that may arise in the short and long runs in the simultaneous achievement of the Australian government’s main economic objectives. 3. 12. Define the following terms and add them to a glossary: aggregate demand aggregate supply deflationary gap ecologically sustainable development economic growth economic objectives economic policies efficiency equitable distribution of income external balance fiscal policy full employment © Tim Riley Publications Pty Ltd inflationary gap internal balance macroeconomic policies microeconomic policies monetary policy natural rate of unemployment non accelerating inflation rate of unemployment Okun’s Law price stability productivity resource allocation stabilisation policy Year 12 Economics 2014 283 . 13. Briefly explain the economic objectives of an equitable distribution of income and ecologically sustainable development.1 in your answer. 9. What is meant by full employment? Why does the government pursue the objective of full employment? 5. Why does the government pursue economic growth as an objective of economic policy? 4. How can changes in the settings of macroeconomic policies be used to close deflationary and inflationary gaps by shifting aggregate demand? Refer to Figure 13. 11.

5 2. Explain how the government of this economy could use a combination of macroeconomic and microeconomic policies to increase economic activity in Year 5. Explain TWO examples of evidence from the table that suggest Year 5 was a period of low economic activity in this economy. Describe and account for the relationship between inflation and unemployment between Years 2 and 5.5 5 1. (4) Year 12 Economics 2014 © Tim Riley Publications Pty Ltd . What stage of the business cycle did this economy experience in Year 2? (1) 2.0 -4.0 3 2.5 -3. (3) 4.0 -6.8 6.0 6.5 2.284 Chapter 13: Economic Objectives and Policies © Tim Riley Publications Pty Ltd [CHAPTER 13: SHORT ANSWER QUESTIONS Year Real GDP CPI Inflation (%r) (%r) Unemployment Rate Current Account (% of workforce) Deficit (% of GDP) 1 3.5 1.5 2 4.0 -2.8 Refer to the table above of selected economic indicators for a hypothetical economy and answer the questions below.0 4 2. (2) 3.0 -4.6 7.5 4.2 3.0 5.1 1. Marks 1.

The source of the problem however is the policy failure which permitted these pressures to emerge in the first place. Explain how conflicts or tradeoffs can arise in the Australian government’s attempts to achieve its economic objectives simultaneously.© Tim Riley Publications Pty Ltd Chapter 13: Economic Objectives and Policies [CHAPTER FOCUS ON ECONOMIC OBJECTIVES AND POLICIES The Objectives. Budget Strategy and Outlook 1997-98.” Source: Commonwealth of Australia (1997). © Tim Riley Publications Pty Ltd Year 12 Economics 2014 285 . with the emergence of unwanted inflation and external current account pressures. [CHAPTER 13: EXTENDED RESPONSE QUESTION Discuss the main economic objectives of the Australian government and explain how it can use macroeconomic and microeconomic policies to achieve these objectives. Targets and Instruments of Australian Economic Policy Objective Target Instruments Price Stability 2% to 3% CPI inflation over the economic cycle Monetary and fiscal policies Full Employment NAIRU of 5% to 6% of the workforce Monetary and fiscal policies Economic Growth Sustainable growth of 3% to 4% in real GDP Monetary and fiscal policies External Balance Sustainable current account deficit of less than -5% of GDP Monetary and fiscal policies “The maintenance of stable economic conditions in Australia has proven to be a challenging task. Policy action to address these and other pressures has frequently contributed to a short term downturn and inevitably constrained the sustainable pace of economic growth.

11. For example. Microeconomic policies are directed at the supply side of the economy and have a long term focus on improving resource allocation and productivity in markets. the national competition policy and labour market reform are used by the government to raise productivity. and fiscal policy to raise taxes and reduce government spending. if a deflationary gap arises in the economy. to increase the level of aggregate demand. the achievement of sustainable economic growth and full employment may be compatible in the short run. Achieving full employment involves minimising the unemployment rate to the NAIRU which is estimated at between 5% and 6% of the labour force in Australia.286 Chapter 13: Economic Objectives and Policies © Tim Riley Publications Pty Ltd CHAPTER SUMMARY ECOnomic objectives and policies 1. The major objectives of Australian government economic policy are to: • • • Achieve a sustainable rate of economic growth to raise living standards and the quality of life. Achieving price stability involves the Reserve Bank of Australia meeting its inflation target of 2% to 3% average CPI inflation over the economic cycle. Microeconomic policies such as tariff reform. Conflicts can arise between the simultaneous achievement of the Australian government’s economic objectives. 5. ensuring that the levels of net foreign liabilities and net foreign debt are sustainable as a percentage of GDP. 2. 12. 10. 3. but could conflict with achieving price stability and external balance in the long run. A major problem that emerged in the Australian economy between 2005 and 2008 was higher inflation. full employment and external balance. 9. Achieving external balance involves the current account being in equilibrium in the balance of payments. Achieve internal balance by securing price stability and full employment of resources. Year 12 Economics 2014 © Tim Riley Publications Pty Ltd . Achieving sustainable economic growth means increasing Australia’s productive capacity without adding to inflationary pressures or the current account deficit as a percentage of GDP. 6. if an inflationary gap arises in the economy. to reduce the growth of aggregate demand. price stability. it can be closed by the government using a tighter stance of monetary policy to raise interest rates. Conversely. efficiency and international competitiveness in the economy. and Achieve external balance by ensuring export income finances import expenditure. it can be closed by the government using a more expansionary stance of monetary policy to reduce interest rates. The use of microeconomic policies complements the use of macroeconomic policies by improving competition and efficiency. and fiscal policy to reduce taxes and increase government spending. Macroeconomic policies such as monetary and fiscal policies are directed at stabilising the growth of aggregate demand. 4. thereby helping the government to achieve its macroeconomic objectives of sustainable economic growth. and there is stability in the level of net foreign liabilities. 8. The major rationale for the use of government counter cyclical or stabilisation policies is to counteract adverse fluctuations in the business cycle such as higher inflation during booms and higher unemployment during recessions. whereas in 2008-09 the GFC led to lower economic growth and higher unemployment. 7. For example. Other economic objectives of the Australian government include achieving an equitable distribution of income and environmental sustainability. net foreign debt and the exchange rate. and the exchange rate is also stable over time.