Question

Impact of COVID 19 on the Australian economy

Reserve Bank of Australia (2020) Statement on Monetary Policy, Economic outlook.

The outlook for the Australian and global economies is being driven by the COVID-19 pandemic. The necessary social distancing restrictions and other containment measures that have been in place to control the virus have resulted in a significant contraction in economic activity, but economic conditions will improve as the pandemic is brought under control and containment measures are relaxed.

Global GDP is expected to fall sharply in the first half of 2020. The declines in the March quarter were driven by a contraction in Chinese and euro area activity as well as the rollout of containment measures elsewhere late in the quarter. A further fall in global GDP is expected in the June quarter, with many countries expected to record quarterly declines in GDP.

The Australian economy is expected to record a contraction in GDP of around 10 per cent over the first half of 2020; total hours worked are expected to decline by around 20 per cent and the unemployment rate is forecast to rise to around 10 per cent in the June quarter. Inflation is expected to be negative in the June quarter largely as a result of lower fuel prices and free child care. (Source RBA)

Fiscal Policy Responses

Over the past month, the Federal Government has announced an unprecedented fiscal injection of $194 billion (almost 10 per cent of GDP) consisting of $39 billion directly to business, $25 billion to households and the $130 billion Job-Keeper payment to support business and households through the COVID-19 shutdown.

Monetary Policy responses

The Reserve Bank of Australia has reduced the cash rate to 0.25%

Possible Outcome

A plausible baseline scenario is that the various restrictions are progressively relaxed in coming months and are mostly removed by the end of September, except for some restrictions such as international travel. If this occurs, and the spread of the virus in Australia remains limited, GDP growth is likely to turn around in the September quarter and the recovery would strengthen from there.

Tasks

1. Use the ADAS model to describe the fiscal policy responses of the Australian government. Is this fiscal response a demand side policy or a supply side policy? What are the intended effects?

2. Assuming the marginal propensity to consume is 0.9, calculate the multiplier effect of the fiscal policy response package of $194 billion. Do you think the realised policy effect will be as big as that which you calculated in the previous task? Elaborate on your answers.   

Answer 1

Answer 1:

The fiscal policy responses of the Australian government involve payments to the households and businesses which will help in increasing the level of consumption and investment expenditure in the economy which in turn which help in increasing the level of aggregate demand in the economy.Thus, fiscal policy responses of the Australian government is a demand side policy of the government. The effects will lead to rightward shift of the aggregate demand curve which leads to increase in price level and increase in the level of Real GDP in the economy.

Answer 2;

he value of multiplier = 1 / 1- MPC = 1/ 1-0.9

= 1 / 0.1 = 10.

Given the response package of $194 billion, the increase in the value of output = Multiplier * Increase in government expenditure = 10 * $194 billion = $1940 billion

The impact of the policy in the realistic economy is not as big as the full multiplier effect because increase in government expenditure also increases the level of interest rate in the economy which reduces the level of private investment and thus reduces the level by which National Income in the economy will increase.

Thus, the realized policy effect will not be as big as that calculated in the previous task.