Question

The Australian economy is "weak", with households weighed down by slow wages growth and higher taxes, the OECD has declared in a report that backs lower interest rates, calls for more government spending and paves the way for unconventional monetary policies. In its six-monthly review of the global economy, the Paris-based think tank has sharply downgraded its expectations for Australia while raising serious concerns about the level of debt being carried by households. The Morrison government this week announced $3.8 billion of infrastructure projects would be pulled forward or given additional funding over the next four years. The decision followed calls from the Reserve Bank of Australia (RBA), which has sliced official interest rates to a record low 0.75 per cent, for a lift in public spending plus productivity-enhancing structural reforms. But economists have warned the new spending will equate to less than 0.1 per cent of gross domestic product (GDP), arguing much more needs to be done to get the economy growing fast enough to bring down the national unemployment rate. The Organisation for Economic Co-operation and Development (OECD), which noted the global economy was now growing at its slowest rate since the global financial crisis, said it expected Australian GDP to expand by 2.3 per cent this year and next, well short of the federal government's forecast. It also expects private consumption, which accounts for about 60 per cent of total economic activity, to barely grow faster than inflation over the next two years. In March, the OECD was expecting unemployment to start edging down. It has now lifted its forecasts, tipping unemployment to average 5.3 per cent in 2020. 3 ECON 1007 Macroeconomics Assignment SP2 2020 "Economic activity has been weak," the OECD said about Australia. "Private consumption spending has been sluggish, weighed down by slow wage growth and an increase in taxes paid by households." While the government has argued its recent tax cuts will help households offset slow wages growth, the OECD and other organisations such as the RBA have noted overall tax levels are increasing as the budget returns to surplus. Research this week from National Australia Bank found Australian household debt was now at a record high of 202 per cent of annual income. The OECD said high household indebtedness could "exacerbate" any economic shock that hit Australia. It said with the RBA likely to cut interest rates further, which in turn could feed into a lift in house prices, lending standards might have to be tightened to protect households. "High household indebtedness means that the authorities should stand ready to tighten macroprudential policy settings if lower interest rates fuel house price inflation through a sharp pickup in credit," the OECD found. While expecting further rate cuts, the organisation said the Morrison government should "loosen fiscal policy" to help get the economy growing faster. "Fiscal policy is expected to provide little support to economic growth, in accordance with the federal government's commitment to future budget surpluses," it said. "A more expansionary fiscal stance may be warranted given that the economy is growing well below its potential and the relatively low public debt burden. "At the same time, growth-enhancing tax reforms should be prioritised. These include shifting the tax mix away from direct taxes and inefficient taxes like real estate stamp duty to the GST and land taxation." Treasurer Josh Frydenberg said the nation's economic fundamentals remained sound, with the country now in its 29th consecutive year of growth. He said there were "headwinds", particularly due to trade policy tensions that have hit confidence and business investment globally since May, but "the government's focus on productivity-enhancing reform will ensure our economy remains resilient". "The international challenges are a stark reminder of why we must stick to our economic plan which has delivered lower taxes so you can keep more of what you earn, more infrastructure to boost productivity and which will return the budget back to surplus so we can meet the challenges that lie ahead," he said.

Consider the following statement “The Australian economy is "weak", with households weighed down by slow wages growth and higher taxes, the OECD has declared in a report that backs lower interest rates, calls for more government spending…” Use the dynamic AD-AS model to describe a longer run scenario where the government is trying to pursue higher economic growth using higher government spending, but were incorrect in their estimation of the major parameters governing long run full employment equilibrium. In your analysis discuss the implications of an incorrect scenario predicted by the government when effecting their stimulus policy on equilibrium output and (un)employment. Make sure to outline the assumptions you have made to reach your conclusion.

Answer 1

An incorrect scenario has huge economic implications for example if debt to GDP ratio is found high and unemployment too is high, the government may incurr higher fiscal stimulus packages and lower interest rates by RBA which all lead to inflation ajd higher fiscal deficit.

However if correct figures are obtained then a combination of expansionary monetary policy by RBA through reduced interest rates- CRR- SLR rates and bond buying programmes as well as expansionary fiscal policy by reducing taxes and inducing higher spending will all lead to lower unemployment, higher money supply, higher investment and consumption, higher aggregate demand and thus ultimately growth in economic outputs or real GDP and prices in long run scenarios.

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