Question

1. 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
2. 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?
3. 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.
4. Discuss whether this fiscal policy initiative aligns with the RBA’s decision to reduce interest rates.

Answer 1

a) A government is said to be under budget deficit when its expenditure is over its revenue.

Under the situation of budget deficit, the interest rates would rise. As the budget deficit increases the government would increase the money supply to reduce its deficit. As money supply increases the price level increases, so would increase the rate of interest. An increase in the rate of interest, would give stimuli to investment. As investment increased the aggregate demand curve would shift to the right.

b) The formula for government multiplier is:

b= Marginal propensity to consume.

If the value of marginal propensity to consume increaes, the value of the multiplier would increase, and if the MPC falls, the value of the multiplier would decrease.

If the value of the multiplier is more, fiscal policy would be more affective, if the value of the multiplier is less, fiscal policy would be less effective.

c) If the MPS (1-b) of the consumer increases the multiplier would decrease, and this would make fiscal policy less effective.