Gov Econ Policy

Government Economic Policy

In 1988 the government of the day was at a downswing of the business cycle with high unemployment rate (UE%) coupled with high inflation. This caused the real income (YR) to fall. The populus of Australia had less purchasing power causing the aggregate demand to fall (УD). With the people of Australia spending less and firms not selling enough inventories the government (G) had less taxation revenue and with firms trying to cut costs, they laid off workers. This caused G non-profitable expenditure (G1) to increase and thus caused deficit budgets. This is when Private Investment (I), Economic Growth (GDP) and Private Consumption started to fall tremendously.

In later years the G borrowed money from other nations because worsening Fiscal policy. The trouble was that the G was borrowing to pay G1 expenditure not G2. This caused a lack of I multiplier effect within the economy. The lack of money circulating in the economy lowered the Production Possibilities Curve (PPC) making the nation not able to provide enough goods and services for the people. If we look at the aggregate supply equation (У supply= GDP+ imports (M)), when GDP falls imports are the only option have enough supply to satisfy the economy. Making the overseas sector the only means cheap enough to buy goods and services from. Consequently this acted as a leakage because money was flowing into other nations and not into Australia's.

The PPC graph shows Australia's shift in GDP with the PPC moving from A to B. therefore the difference between A and B is imports.

This made economic conditions worse. As a result of the high inflation and UE% the national savings pool and thus private investment fell and foreign ownership rose. With all the money going out of the Australian economy and into others' this caused stagflation. Stagflation occurs when an economy doesn't grow (GDP doesn't increase) but inflation increases. The inflation type is cost-push inflation.

This graph shows cost-push inflation by showing the shift in aggregate supply causing a shift in the price (due to the law of demand) thus causing inflation, but in this case stagflation.

Finally the Australian economy is 'busted' AKA recession. This was due to a number of factors one of these was the Terms of Trade (TOT) falling. This caused Australia's main industry 'agriculture' to be severely effected. With the Interest rates ( I %) rising for long periods of time this caused strong decline in private investment, lessening the multiplier effect. The high amount of debt within the economy both public and private caused lack of consumer confidence. This caused a further dampening of investment and consumption. In addition asset prices fell remarkably to low levels and Australia's national wealth fell with this news. This caused disinflation not to be confused with deflation, disinflation is where there is a very low level of inflation. Disinflation usually occurs when recessions are apparent and extremely good economic management is applied.

During 1992-1995 to get out of the recession the G would ease the cash rate. To allow national investment to increase. This causes a decrease in demand deficient unemployment because of the notion 'one man's spending is another's earning'.

The Transmission Mechanism (above) shows how cash rates affect the sectors of the economy.

Also the decrease in cash rate would allow УD (AD) to increase raising GDP.

To combat demand-pull inflation union agreements will be signed bring stability to the economy. This made certainty within the economy causing confidence to rise. The extra confidence causes further increase in consumption and investment. To avoid the inflation that was apparent in the 1980's the fiscal policy would contractual allowing for the private sector to gradually increase GDP, rather than G because the multiplier effect would be to strong. Also with G's huge debt surplus budgets must be run to pay of the debt. Advertising campagnas by the G trying to educate the people about the economics of buying M. This makes M go down and domestic consumption go up. Net exports (X-M) would become more positive and the dollar value would increase causing the foreign debt to decrease because 1 AUD buys more foreign currency therefore decreasing the 'real rate' of money paid back. As a result of this the UE% would fall and more G revenue would follow. Also the G wins twice because of the UE% falling it doesn't have do pay as much G1 expenditure causing the budget to be in bigger surplus increasing the ability to pay off