Question

explain the effectiveness of a cut in interest rate on boosting aggregate
demand (i.e. consumption and investment) for Australian economy
*
Explain the role of government stimulus in increasing the effectiveness on boosting
aggregate demand for Australian economy?

Answer 1

Ans 1: A cut in interest rate, means the central bank is conducting an expansionary monetary policy which implies the money supply has increased. A cut in interest rate means commercial banks would offer loan at cheaper rate. This raises the liquidity in the economy. A cut in interest rate would raises the consumption and investment spending in the economy. This raises the aggregate demand in Australian economy. The Aggregate demand curve shifts to right. The final outcome will be a rise in Price level and rise in real GDP.

Ans 2: To boost the Australian economy, the government should use expansionary fiscal policy, which includes lowering taxes or raising the government spending or a combination of both. This raises the government purchases component in Aggregate expenditure (if government spending rises) or consumption expenditure rises (if government reduces tax rates), so overall due to expansionary fiscal policy, the aggregate expenditure in the economy rises. This raises the aggregate demand. The aggregate demand curve shift to right. As a result, price and real GDP rises.

Diagram for both the situation is same in AD-AS model: