Economic Objectives

Economic Objectives (Macroeconomic Policy Objectives - First 3)

• Sustainable economic growth
  • approx. 3-4% GDP
• Low unemployment (full employment)
  • 4-5% unemployment rate, 0% Cyclical
  • Anymore lowering of the unemployment rate means that inflation will be impacted
  • Changes very often
• Low inflation ⇌ Price stability
  • 2-3% Inflation rate over the course of the business cycle
• A more equitable (fair) distribution of income (Equity)
• The efficient allocation of resources (Efficiency)

Policy Objectives of the RBA (Monetary Policy)

• The stability of the currency of Australia - (Internal and external, Prices and Exchange Rate)
• The maintenance of full employment in Australia; and
• The economic prosperity and welfare of the people of Australia.
• ‘Economic prosperity and welfare’ can be taken to mean the achievement of rising living standards in the long term (economic growth), along with the management of the business cycle through monetary policy.
• ‘Full employment’ can be taken to mean achieving the ‘natural’ rate of unemployment, which is currently thought to be about 4 percent of the workforce. (Cyclical is 0)

Economic Growth is defined as the capacity of the economy to satisfy the material wants of its members

• Growth is usually measured by calculating the rate of change in real Gross Domestic Product (GDP) over a period of time.
• Potential growth is determined by growth in the labour force, and growth of productivity - If for example, the labour force grew by 1.75 percent, and productivity by 1.5 percent. Then potential GDP growth would be 3.25 per cent.
• The actual rate of growth in any year, however, depends upon the level of aggregate demand at any point in time. (CIG(X-M))
• Growth is the key objective because it delivers higher real income and enables people to satisfy more wants.
• Growth creates more demand for productive resources, including labour.
• In developed countries, a rule of thumb is that economic growth rates have to exceed 3 percent per annum (removal of cyclical unemployment), before unemployment can be reduced.

The pandemic brought on a recession because of its dual impact on aggregate demand and aggregate supply, and it will also impact on Australia’s long-term growth potential because net migration stopped for two years. (Can show on a diagram)

Price stability occurs when there is little change in the general price level – that is, there are low rates of inflation.

• Prices were within the range since 1990s but there was a big spike due to GST implemented in 2000
• Inflation has increased markedly in the last two years due to the combined effect of:
  • Supply side pressures - associated with the pandemic (interruptions to supply chains; periodic lockdowns; high rates of absenteeism from work), the war in Ukraine and floods in eastern Australia; and (SRAS)
  • Demand pressures – pent-up demand, pandemic stimulus payment sans record-low interest rates. (AD)
• Sustained inflation rates above the target range bring a number of economic costs.

Firstly, inflation erodes purchasing power of household incomes (real income).

• Price increases mean consumers are able to buy smaller quantities of goods and services than they previously could, unless their income increased at the same rate as general prices.
• Inflation also feeds into higher interest rates, which are an important influence on business decisions concerning investment and household discretionary spending.
• When prices rise, interest rates must follow otherwise lenders are paid in inflated dollars and they do not receive a positive rate of return.
• The real interest rate is more important than the nominal interest rate – the real interest rate is the nominal interest rate minus the inflation rate.
• If the inflation rate is 3 percent, and the nominal interest rate is 7 percent, the real rate of interest is 4 percent.
• Persistent inflation erodes the confidence people have in money as a store of value, so many seek ‘hedges’ against expected price rises by purchasing assets which are likely to appreciate in value, such as property, antiques or precious metals.
• Such ‘speculative activity’ reduces potential output of the economy if it diverts resources away from productive resources,
• Business investment decisions are more risky in an inflationary environment because rising prices make it more difficult to contain costs and operate profitably.