Question

what kind of fiscal and monetary policy should government authorities implement? Explain why and give specific examples of each policy that might be implemented. What effect would these policies have on aggregate demand (AD)?

Country facing a lost decade of growth, ANZ warns

By Shane Wright (Sydney Morning Herald, 21 January 2020)

Australia is facing a lost decade of economic growth, ANZ has warned, that will see living standards slip and wages grow modestly while putting pressure on the Morrison government's plan for a string of budget surpluses.

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ANZ head of Australian economics David Plank said growth through the current decade would average 2.6 per cent, with that tipped to fall to between 2 and 2.5 per cent across the 2020s. He said that level of growth, lower than both estimated by the Reserve Bank and the federal Treasury, would be driven by tepid non-mining business investment, weak productivity and household consumption held back by high debt and modest wage increases.

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Australian households, despite record levels of wealth due to high house prices, were carrying record levels of debt that would crimp their spending plans.

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In its December budget update, Treasury forecast economic growth to lift to 2.75 per cent through 2020-21 and then climb to 3 per cent for the next two years. That level of growth is expected to help drive down unemployment and push up wages.

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Answer 1

The above article related to Australian economy shows that the economy is currently in recession with actual level of GDP in the economy below the full employment level of GDP in the economy with the economy being currently in recessionary gap. There has been fall in the level of aggregate demand caused by decrease in consumption expenditure and investment expenditure in the economy.

In order to increase growth rate and eliminate recessionary gap in the economy, the government authorities should implement expansionary fiscal and expansionary monetary policy. Expansionary fiscal policy involves increase in the level of government expenditure and reduction in taxes which will increase consumption expenditure and increase aggregate demand in the economy eliminating recessionary gap of the economy. Expansionary monetary policy also aimed at increasing money supply will decrease rate of interest and increase investment expenditure in the economy which in turn increases aggregate demand and helps in increasing Real GDP which increases growth rate of real GDP in the economy.

Thus, given the current economic situation, expansionary fiscal and expansionary monetary policy is needed which will increase aggregate demand and thus increase growth rate of the economy.