Question

Question 5                                                                       

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. RBA ( Reserve Bank of Australia ) is reducing interest rates along with expansionary fiscal policy that ,makes budget deficit of Australian Government . Reduction in interest rate will increase the money supply in Australian economy.Lower interest rate increases private investment in the economy. It will provide higher employment opportunities in the economy. Higher employment rate increases income level in the economy. As a result consumption of economy will increase. Increase in private investment and consumption boosts the aggregate demand for good and services. Suppose economy is equilibrium at point F where aggregate demand curve and aggregate supply of good and services. Fall in interest rate rises private investment and consumption which results rightward shift in AD curve to AD1 . It increases the price level from P to P1 and output from Y to Y1 b. As income increases ( fall in interest rate by RBA ), consumption level increases, Hence ,marginal propensity to consume rises. Increase in marginal propensity to consume leads to increase in multiplier level. Fall in interest rate and increase in multiplier leads to a positive impact on government policy initiatives. A nation can combat recession with expansionary and fiscal policy. So reduction of interest rate by RBA and thereby increase in multiplier , will speed up the impact of fiscal policy c. If consumer decide to increase their rate of saving, due to increasing uncertainty about the future, consumption of individual will decrease. Even the government implement s expansionary policy , due to increase in saving MPC and private investment will be low due to uncertainty about future and low expected profits from investment . d. Fiscal policy initiative aligns with the RBA 's decisions to reduce interest rates. Because during a recessionary period, it is the responsibility of government and central bank to apply expansionary fiscal and monetary policy. Expansionary fiscal policy refers to the action of increasing government spending and tax cut . Expansionary monetary policy refers to the action of cutting interest rates to increase money supply. A fiscal policy can not be achieve better results without monetary policy and vice versa