Question

a) At the same time as the RBA is reducing interest rates the Australian Government will be running a budget deficit in 2020. How this will affect aggregate demand? A diagram would assist your answer here and attract further marks

b) How will the size of the marginal propensity to consume affect the size of the multiplier and how will this impact on this fiscal policy initiative?

c) If consumers decide to increase their rate of savings due to increasing uncertainty about the future, explain how this will affect the fiscal policy initiative.

d) Discuss whether this fiscal policy initiative aligns with the RBA’s decision to reduce interest rates.

Answer 1

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Question:

a). Answer:

At the same time as the RBA is reducing interest rates the Australian Government will be running a budget deficit in 2020. How this will affect aggregate demand? A diagram would assist your answer here and attract further marks.

When the government increase spending and the government spending is more than its revenue then the problem of budget deficit is arise. Normally during the recession or economic fall down then the government adopts an expansionary fiscal policy to boost the economic growth. Other side decreasing interest rate increase demand for money in the economy. So, increasing spending and increasing demand for money will increase AD and AD curve will shift right that will increase output and price level. Increasing price level increase production that decrease unemployment and increase income that boost the economic growth.

Graphical representation:

Suppose the economy is equilibrium at the point "E" and increasing government spending and decreasing interest rate increase AD and AD curve shift right from AD to AD1 that increase output and price level both.

Graph:

b). Answer:

How will the size of the marginal propensity to consume affect the size of the multiplier and how will this impact on this fiscal policy initiative?

Marginal Propensity to Consume is the proportion of an increase in income that gets spent on consumption.

MPC = Change in consumption/Change in income

MPC Multiplier = 1/1-MPC

So, when Consumption increase (change) more than income then MPC increase and vice-versa. When MPC increase its increase the value of MPC multiplier.

When the government adopts expansionary fiscal policy then its increase income level and increasing (change) income level increase the spendable income of consumers and they consume more. When MPC is high, the % change (increase) in consumption is higher than the % change in income and increasing consumption level increase AD that increase output and price level.

c). Answer:

If consumers decide to increase their rate of savings due to increasing uncertainty about the future, explain how this will affect the fiscal policy initiative.

Saving = Disposable income - Consumption

It means when consumption increase saving decrease and vice-versa. So, if consumers decide to increase their rate of savings due to increasing uncertainty about the future then they will spend less and when they will spend less then it will negatively affect AD. A fiscal policy gets success when its increase consumption more (or MPC is high) otherwise its can be get failure or not get expected result.

d). Answer:

Discuss whether this fiscal policy initiative aligns with the RBA’s decision to reduce interest rates.

During the crisis or recession the main objective of the policy makers is to increase AD because decreasing AD will the main reason of the economic crisis or recession. When AD decrease its decrease output and price level and when price level decrease its decrease production level. Decreasing production level decrease income level and increase unemployment level. Decreasing income level decrease AD further and the economy get enter into recession. Here both the government and the central bank are adopting the same policy. The central bank and the government are adopting expansionary monetary and fiscal policy respectively together. But other side increasing spending will increase income level that will increase AD that will increase output level with price level. But during the recession or crisis inflation is very low and increasing price do not increase inflation but increasing price increase production that help in decreasing unemployment. The main objective of these policy are to boost the economic growth, decrease unemployment and stabilized inflation and both are working for the same objective in the right direction.

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