The government implements an economic policy mix involving macroeconomic and microeconomic policy in order to achieve their objectives. The three main objectives include:
•Internal stability – low inflation (price stability) and full employment •External stability – stable exchange rate, a sustainable level of foreign debt and the current account deficit (CAD) •Economic growth
Other government objectives include equal distribution of income and environmental management. Though, it is evident that not all of these objectives can be achieved simultaneously as some are conflicting. Thus the government must trade-off some of their objectives in favour of others that they hold of higher importance, for example low unemployment and low inflation.
The Government’s macroeconomic policy, also known as counter-cycle policies, is comprised of monetary policy (MP) and fiscal policy (FP) which forms a part in their policy mix. This is designed to impact upon economic activity, smoothing the peaks and troughs of the economic cycle. It aims to influence the level of aggregate demand in the economy.
One form of macroeconomic policy is monetary policy which, through a process called Domestic Market Operations (DMO) smooths out the effects of fluctuations in the business cycle. The Reserve Bank of Australia (RBA) on behalf of the government is responsible for its implementation whose objectives mirror that of the government. These include the stability of Australian currency (which includes minimising inflation), maintenance of full employment, and promoting the economic prosperity and welfare of the people of Australia (i.e. encouraging a sustained level of economic growth). In recent years, the main objective of the RBA is to minimise inflation and keep it within its target range of 2-3%, on average, over the course of the business cycle. The main instrument used by the RBA to conduct monetary policy is through DMO, influencing the general level of interest rates through setting the short fun cash rate.
Monetary policy is effectively used in order to impact upon economic growth; the RBA can adjust its MP stance to suit the current or expected economic situations. To reduce the severity of a recession the RBA can adopt a MP stance of loosening. Here, the RBA buys government securities through the process of DMO an excess of borrowable funds in the overnight cash market a fall in the cash rate a fall in the market interest rates. This will boost economic activity through increasing the level of aggregate demand as consumer and investment spending increases. This will also help to achieve lower unemployment, though it will contribute to inflationary pressures. Alternatively, to dampen strong economic activity during a booming period, the RBA can develop a MP stance of tightening. Here, the RBA sells government securities through the process of DMO a shortage of borrowable funds in the overnight cash market a rise in the cash rate a rise in the market interest rates. This will slow economic activity through decreasing the level of aggregate demand as consumer and investment spending decreases. This is likely to lower inflation but increase the level of unemployment. Recently, this has been the case as the RBA has given priority to low inflation and engaged in significant MP tightening.
This tightening has been the recent stance as Australia has been experiencing strong levels of economic growth and activity. Australia has been booming since the early 2000’s, where this is now the 17th year of continuous expansions since the last recession (the longest expansion phase). The low unemployment rate and high participation rate supports this point. The RBA has consistently tightened MP in order to achieve low inflation, where the cash rate in May 2002 was 4.25% and the current case is 7.25%, increasing at a...