Economic Notes Topic 4: Economic Objectives and Policies Macroeconomic Policy The recent GFC foregrounded a reordering of Australias

s economic priorities Currently, the Principe concern for the Australian economy is high levels of economic growth, with low unemployment (which is a derived demand) The aim for economic growth is 2-3% p.a. over the full business cycle, whilst the desired position of unemployment is full employment within the current economic conditions, GDP has recorded 2.7% , whilst unemployment measures 5.3% The remaining economic objectives are somewhat lesser, however, with the most recent IR rise; the Reserve bank has clearly raised concern of potential future inflation, (aim 2-3% over the course of the business cycle), which currently measures 2.9% yet has the potential to increase Also, residual concern lays upon the environment (ESD), income distribution (equitable) and the current account Monetary Policy Definition Monetary policy refers to the manipulation of interest rates to influence the level of economic activity 2-3% inflation full employment growth between 2-3% Historic Inflationary Targeting saw interest rates rise to 7.25% in March 2008 However, priorities have been redirected towards growth and unemployment with their fall to 3.0% in April 2009 However have raised to 4.50% in May 2010 Domestic market Operations Are conducted between the RBA and financial institutions and banks in the Short Term Money Market The short term money market fives financial institutions access to deposit and lending facilities to settle debt between themselves through their exchange settlement account The cash rate is the price of borrowing from the STMM To increase the cash rate (tighten monetary policy), sells commonwealth government securities to the banks this decreases liquidity (availability of funds) To decrease the cash rate (loose) it purchases CGS to increase liquidity and decrease competition for cash and therefore decrease the cash rate Cash rate movements are passed on in a competitive banking environment in order to ensure products and due t their competitive nature Keynesian Transmission Mechanism Consideration should first go towards the RBAs contractionary policy. They Keynesian Transmission mechanism diagram is an economic theory used to explain how monetary policy affects the economy See diagram next page

In the case of contractionary monetary policy, the following impacts apply

Economic Notes

If the RBA uses DMO to sell back T notes(S to S1), it decreases liquidity in the official cash market (shift from r to r1), causing short term yields and interest rates to increase (R to R1) due to the competitive banking structures As interest rates increase the marginal efficiency of capital (determined by the rate of profits compared with interest rates) increases causing a decrease in autonomous investment from I to I1 There is a certain quantity of investment for which it is no longer profitable, due to increased interest rates As demonstrated by panel 2, the increase in investment shifts AD from Ad1 to Ad2. As autonomous investment decreases, the level of national income and employment decreases via the multiplier effect The RBA can use monetary policy to bring about price stability, through reducing the inflationary gap Expansionary policy can reduce unemployment, through increasing aggregate demand, which increases the demand for resources including labour Contractionary policy can decrease output due to increased production costs and decreased future sales

Recently, the RBA has increased the cash rate from 3-4.5% between October 2009 and May 2010 Concerned with external inflationary pressures, and that Australia had remained resistive to the GFC (lower unemployment than expected, positive growth), the RBA pre empted future inflation

Exchange rate (not related to diagram) Changes in domestic interest rates affect the exchange rate An increase in Australian interest rates relative to overseas will attract an inflow of foreign capital, increasing demand for $A and causing an appreciation of its value This reduces the competitiveness of export firms and of import competing firms resulting in a decrease in output An increase in interest rates also decrease consumption and imports, which decreases the supply of $A increasing $A

Limitations Interest rates cannot target specific parts of the economy A blunt instrument since an increase in interest rates affects all sectors of the economy irrespective of other government policies Can adversely affect all types of spending, even if the problem is excessive spending in only one area, such as housing

Interest rates cannot deal with cost-push inflation Monetary policy can influence demand-pull inflation, inflationary expectations and imported inflation, but is not good at dealing with cost push inflation Higher interest rate = higher repayments higher costs = higher inflation

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Investment is based upon other factors Stock levels, excess capacity, sentiment, future expectations The transmission from the cash rate to interest rates Increase in cash rate by 0.25% saw Westpac increase I.R by 0.4% due to overseas costs

The main advantage is the relatively short time lag Normally takes 6-9 months for an interest rate increase to affect aggregate demand and the level of national income, whereas fiscal policy can take 24months Fiscal Policy Fiscal policy refers to the use of the sixe and pattern of taxation and government spending A key component of the current policy mix is its extensive deficit in the fiscal balance Contractionary stance Increased budget surplus (T>G) or a decreased budget deficit Blanced Budget Occurs when G =T Exanisiornary Stance Increased Budget deficit (G > T) or a decreased budget surplus Fiscal policy can be broken down into two key components structural and cyclical Expenditure AD1 = C + I + G1 + X-M AS

AD = C + I + G + X-M Expansionary AD2 = C + I + G2 + X - M Contractionary Income The effect of budget stimulus can be seen in the above figure A budget deficit leads to an increase in aggregate demand from AD to AD1 This leads to increasing demand for resources and income via the multiplier effect until a new equilibrium is achieved at a higher level of national income, which indicates growth An increase in NY sees and increase in investment in new productive capacity and therefore an increase in output

Economic Notes

All the while, the injection attempted to improve confidence which sought to enhance the multiplier

Structural component refers to the deliberate changes in government spending or taxation (discretionary policy) Budget has two objectives Macro (medium term) to bring about a change in the level of aggregate demand in the economy Through the multiplier change economic growth and employment Micro (long term) to bring about a structural adjustment, through a relocation of land, labour, capital and enterprise to increase efficiency and productivity Structural change, changes income distribution For instance the 2010-11 budget, the government has increased funding on infrastructure by $5.6 billion. As well as $2.2 billion for a national health care system as well as $653 million in a renewable energy future fund.
1. 2. Cyclical component This refers to the automatic stabilizers, which offset the extremes of the business cycle. Aim to stabilize the economy in order to remove the peaks and troughs of the business cycle. These include a progressive taxation system Greater proportion of incomes taxed in boom containing growth in aggregate demand Lower proportion of income taxed in a recession. Maintains aggregate demand to achieve activity and employment Transfer payments Increase when the rate of unemployment increases in a recession This increases GE which helps raise AD Automatic stabilizers are counter cyclical, that is, they operate to reduce or cap the peaks of economic activity. Therefore, reducing inflationary pressures Rate of economic growth For instance when economic growth declines, the demand for labour decreases leading to falling wages and greater unemployment levels. The provisions of a social security payment act to ensure that these people can maintain a minimal level of consumptions.

The effect of the automatic stabiliser When considering these conditions, the 2009-10 budget saw $57.6 billion deficit which included $338.3 billion of expenditure. However, following the twin deficit theory, such has aided in crowding out private sector debt and adding to the Cad. The priorities of fiscal policy have changed over time. Between 1998 and 2008, the primary objective was external stability (reducing deficits) as the private sector was taking care of growth and employment This dramatically changed with the onset of the GFC. Economic growth, was sought through automatic stabilizers and discretionary demand Budget Policy and effects

Economic Notes Resource Allocation: The budget offers growth through supply side management The budget uses taxation and government expenditure to send price signals and allocate resources to ill-resources sectors of the economy $ 5.6 billion in a new infrastructure find allocates resources to roads, rails, ports etc. Investment in new productive capacity attempts to overcome structural constraints to growth. Highlighted by the constrained ability to export coal to China. Framework for long term growth $4.5 billion clean energy, which stresses solar cells has allocated income and resources to sustainable power source

Inflation: Demand pull inflation Aggregate demand chases aggregate supply as the sale of resources goods and services are auctioned upwards

Income Distribution: Income reallocated towards low income earners who spend a greater proportion of their income Pensions Carers payments

Unemployment: The budget has also stressed structural, frictional and cyclical unemployment Cyclical: Employment is a derived demand Structural (skills shortage): Training 18,000 nurses (2009 2013) Apprenticeship subsidies in over 500 occupations Frictional Programs such as the $4.9 billion Job services Australia, seeks to better connect job seekers with opportunities e.g. writing resumes Also attempted to remove waiting periods Throughout the GFC, unemployment peaked at 5.8%, which is much lower than the previously predicted 10%p.a it is currently at 5.4%. However, reduced full employment was offset by increasing part time

Environmental Sustainability: $4.5 billion clean energy find, which stresses solar cells, has reallocated income and resources to a sustainable power source

Current Account Deficit: Increase in Public sector debt through the crowding out effect of Australian savings CAD has deteriorated from a low of 3.4% to 4.9% in March 2010 Funding a deficit Deficit financing

Economic Notes Borrowing funds from the private sector by selling new commonwealth government securities in domestic financial markets Deficit financing is undertaken by the federal government selling treasury bonds Advantages No change in money supply No increase in the new foreign debt as the government has not borrowed overseas to fund the budget deficit Disadvantages May cause a rise in interest rates and crowding out of private investment Higher interest rates may increase capital inflow, raising the exchange rate, which reduces the international competitiveness of Australian export and import substitutes Leads to the accumulation of national debt by government and sets up future obligations in the form of public debt interest

Monetary financing (Also known as printing money) it can borrow from the RBA by instructing the RBA to simply print money to cover the shortfall in budget revenue Advantage No change in interest rates and no accumulation of public debt Disadvantage An increase in the money supply and a danger of rising inflation if the economy is at full employment

Borrowing from overseas It can borrow funds in overseas financial markets by getting the RBA to sell new government securities in return for foreign currencies Advantage No increase in domestic interest rates Disadvantage The government accumulates foreign debt and this adds to the size of the CAD Microeconomic Policy Microeconomic policy is supply side management which aims to maximize the allocation of resources between firms and industries in order to maximise the output of scarce resources The underlying motivator of microeconomic policy is structural change: changes in the economys patterns of production over time, as evidence by the reallocation of land, labour, capital and enterprise. Microeconomic policy accelerates structural change through sending price signals to enterprise which in turn reallocates resources and income to achieve technical, allocative and dynamic efficiency, which subsequently achieves the six economic objectives Long term aim to trigger a reallocation of resources and structural change Structural change: a change in the resource reallocation and patterns of production in an economy over time caused by changing technology, government police, the price mechanism, competition and globalization Microeconomic policy is required due to the inadequacies of macro policy. The stimulation of AD is infallible in raising resource consumption and promoting growth,

Economic Notes However, as evidence by the short run Philips curve, there is a trade off between inflation and unemployment. Also, macro-policy cannot address structural problems. For instance in Australia, patterns of production were built behind protection, which in no way promoted comparative advantage and blocked any attempt to yield the fruits of globalization Supply side economics can reduce NAIRU, improve international competitiveness and manage inflation Industry Sector % of % of Total % of gross Employm Exports domestic ent of goods product and (GDP) services 1989 2008 1989 2008 1989 2008 Agriculture 4.0 2.3 5.7 3.2 26.0 13.0 Mining 4.4 7.6 1.3 1.2 40.0 50.0 Manufacturing 15.4 9.7 16.1 9.8 14.0 15.0 Services 76.2 80.3 76.9 85.5 20.0 22.0

Three types of efficiencies Allocative efficiency: Patterns of production to maximize the overall utility and reduce opportunity cost through a shift in the allocation of resources Technical efficiency: Firms producing at the lowest cost possible (technical optimum) Dynamic Efficiency: Ability to change from producing one product to another Requires that firms be innovative by introducing up-to-date technology and by responding to the changes in the needs of their customers.

Product market: final goods and services are sold Factor market: productive inputs such as land, labour, capital and enterprise are sold. Role of microeconomic policy reform Economic rationalism clearing obstacles and allowing market forces to induce structural change Increased competition Reducing the inefficiencies which result from distorted price signals Price signals causes increase in productivity Firms will need to be more innovative in the face of competition Improved productivity Assists in the international competitiveness of local firms from import competition Is more resistant to inflation Reduction in price distortions (created by the tax system and government subsidies) In the past government business enterprises were sheltered from competition Meant that they had higher prices and a lack of competitiveness

Economic Notes

Moving may business activities out of the public sector and into the private sector Less resistance to the market forces encouraging structural change Technological advances, changes in income or consumption patterns, increasing global specialization as well as resource discovery or depletion can trigger changes in the output patterns in the Australian economy The benefits and costs of microeconomic reform Benefits Productivity growth Increased national income, and improved living standards Increased productivity is often triggered by increased competition in the goods and factor markets Controlling inflation By promoting competition, firms are less able to increase prices and so will be less willing to grant excessive wage rises Allocative efficiency Competition makes firms more flexible and responsive to change in consumer demand Costs Job losses Structural unemployment Lower wages Increased inequality in the distribution of income Labour market deregulation ay mean workers relying n safety net wage rises will fare worse than those able to negotiate enterprise agreements Unilateral Tariff reform Tariff reductions: engaged by historic government 1975 Whitlam government: 25% across the board protection cuts Hawke Government industry statements (1988, 1991) By 2005, average maximum 5% excluding TCF, PMMV at 10% Premise: intense competition sent price signals to domestic industry Foreign resources and incomer are reallocated domestically To remain competitive firms must raise productivity to reduce costs Not always the case: in this way, resources are allocated towards their most efficient use as per the principles of comparative advantagAlso promotes economies of scale, innovation Long Term growth GDP (National Income) Benefits indicated in figure 1 Productivity gains shift aggregate supply to the right New equilibrium: reduction in inflationary pressures whilst retaining real GDP Low inflationary growth This causes a lower costs of production, expansion in output ad income Hence, there is higher GDP and employment without an increase in inflation This causes a shift in NAIRU to the left

Economic Notes Benefits are not purely domestic: international competitiveness raises exports CAD improvements However, structural unemployment

Example smaller more productive industry PMV tariffs fell 40% -10% 1990-2005 Entered niche large passenger vehicle market Resources allocated to competitive industry Economies of scale: per employee 12-18 cars per year between 19902005 Turnaround of $AU 224 million loss to $AU 372 million profit (export middle east) Reduced inflationary pressures International competitiveness and productivity gains create long term framework for growth Improve CAD through greater exports However structural unemployment misallocate government income

Taxation reforms Goods and services tax, Decrease in the marginal tax rate and the streamlining of tax through pay as you go Decrease in company tax rates from 36% to 30% Raises incentives to work, save and invest Through making it more efficient and equitable it increases productivity, savings and investment.

Competition Policy Competition policy is about bringing about workable competition that will produce the best structure, conduct and performance in an industry The ACCC seeks this workable competition The best level of competition in a market that maximizes consumer choice and utility and allow firms to ahcievea satisfactory level of economies of scale 9 Perfect competition is not always possible or desirable.

Trade Practices Act 1974 Price collisions and fixing agreements are illegal Outlawed price discrimination Resale price maintenance Restricted mergers with or takeovers of rival firms Competition Policy reform act (1995) Outlawed anti competitive behaviour, collusion, exclusive dealings, price discrimination

Economic Notes Achieve maximum workable competition (perfect competition or monopoly) To remain competitive firms must raise productivity to reduce costs Resources are allocated towards their most efficient use as per the principles of comparative advantage Also promotes economies of scale, innovation Low inflationary growth Telstra: enforced through ACCC. Provided second part y access to Telstra infrastructure Raised competition sent price signals to Telstra to reduce cost structures, enhance productivity and achieve technical efficiency Price signals of profit potential further allocated resources into Services communication industry, reducing opportunity cost Competition Policy Act : Framework for long-term growth. Productivity commission estimates GDP raised by 5.5% Low inflationary with $AU 9 billion in consumer gains Structural change creates unemployment Long run benefits of competition policy Lower cost structures as there is greater productive efficiency leading to lower prices, lower cost-push inflation and greater international competitiveness Increased choice for consumers at lower prices leading to greater consumer utility and therefore greater allocative efficiency, which improves living standards More productive use of resources, freeing up for resource reallocation Public Sector Reform Hilmer Report 1973 recommendations of microeconomic reform in the form of privatisation and corporisation Corporisation Public companies become profit driven Privatisation Formerly government operated enterprises opened to natural, unassisted, profit driven markets exchange of ownership Qantas (privatisation combined with two airline policy): Reduced cost structures to remain competitive and enhance productivity Dynamic: Innovative product differential and encourage technological update e.g. Airbus acquisition Profit: 2008: $AU 618 million, Profit: 2009: $AU 210 million Low inflationary pressures Structural unemployment Financial deregulation (not for structural change) 1985 RBA opened the baking sector releasing 16 new licenses This increased competition and reduced the cost of finance, facilitating innovative product differential in capital markets. Enhanced technical and dynamic efficiency Permitted investment led growth (cheaper, malleable loans) Floating the Australian dollar raised the competitiveness and productivity of Australian exports: enhancing technical efficiency Improved exports enhance BOGS

Economic Notes Labour Market The decentralization of the labour market through certified agreements. Accords in 1980s Break wage price spiral through tying wage growth to productivity gains Eliminated wage indexation Through Workplace Relations Ac, collective agreements and AWAs were standard wage agreements. Although, Rudds fairness with fairness policy disbanded the latter. Certified agreements (enterprise bargaining): Collectively bargained at the enterprise level (usually through unions, but not always) in relation to wage adjustments, working conditions, work practices and productivity gains Awards: minimm standards of employment LMR has rewarded workers who seek to improve their skills via wage increases Multi-skilled workers are more dynamically and technically efficient, but also, multi-skilled workers can also move industries more readily, enhancing allocative efficiency In this way patterns of production have been directed towards firms with the greatest capacity to pay Low inflationary growth International competitiveness Advantages and Disadvantages of Decentralised Wage Determination Advantages: Increased flexibility more efficient allocation of labour Increased productivity greater incentive to increase skills training and education Decreased likelihood of cost push inflation Disadvantages Market determines wage outcomes based on productivity and skills increased wage and income inequality Greater labour market segmentation those with greater bargaining power have higher wages Fed government has no wage control Environmental Regulation Carbon pollution reduction scheme Garanaut report 2008 demanded immediate action Rudd proposed a carbon pollution reduction scheme. However, as of yet delayed by liberals and greens Proposition: give property rights to carbon Various enterprises given fixed permit number for pollution. Failing to adhere requires payment of a fine Internalise the externality If costs exceed price of new capital, may promote research and development QP represents income reallocation to Government for research and cleaning

Economic Notes Business may pass on costs (inflation). Reduce real income or cut workers to remain competitive Environmental regulation challenges Australias resource based growth Framework for the future

Labour Market Reform Labour is an input in the production process Represent upwards of 60% of firms costs Objectives Improve the operation of the labour market Reduce unemployment Reduce cost-push inflation Raise productivity Responsive to changing economic conditions Flexibility and increases in international compettitivness Achieved through Deregulation reducing the role of the AIRC De centralization moving power away from central government bargaining to enterprise bargaining Problems Prior to 1996 Inadequate differences in wages were not providing clear price signals on the demand for particular skills, occupations and industries High minimum wages were contributing to high unemployment among youth Unfair dismissal laws were harming the unemployed it was claimed that they were discouraging employers from hiring new employees Lack of incentives for the unemployed and other welfare recipients to seek employment The accords (MKI-VIII) 1983-1993 Broke the wage price spiral and wage indexation. Wage increases were matched to productivity increases.

Workplace Relations Act 1996 Introduction of Australian Work Place agreements (AWAs) and Certified Agreements (CAs) Encouraged labour market flexibility and promoted workplace level wage bargaining An industrial award system developed for workers unable to negotiate enterprise agreements These reforms were designed to reduce unemployment and increase labour market responsiveness to structural and cyclical shifts in the product market Industrial Awards: Applies to workers not covered by enterprise bargaining Legal documnet setting out the minimum wage and working conditions for employees in an industry or job classification Centrally administered

Economic Notes

Awards were simplified so that only 20 allowable matters were enforceable Annual safety net increase only Benchmark against which employment contracts will be judged

Certified Agreements: An agreement collectively bargained at the enterprise level (usually through unions, but not always in relation to wage adjustments, working conditions, work practices ad productivity gains (Non wage benefits include superannuation, sick leave, holiday leave, long service leave etc.) They exist in addition to the award and are renegotiated periodically The AIRC certifies the agreements provided they satisfy a no disadvantage test which requires that the agreement reached is at least as favourable to workers as was the appropriate award

Australian Workplace Agreements (AWAs): Individual employment contracts Maximises the individual employees ability to create flexible working conditions in a negotiated agreement with their employer. The agreement is reviewed by the Employment advocate to ensure that it does not breach the no disadvantage test.

The Workplace Relations Amendment (work choices) Act 2005 Reforms: Allowable matter 20 allowable matter reduced to 16 for awards and 45 for collective agreements and AWAs Unfair dismissal Regulations on unfair dismissal will be significantly weakened Firms that employ 100 or fewer persons will be exempt from unfair dismissal claims Businesses employment more that 100 persons must wait 6 months before they can pursue an unfair dismissal claim Union involvement: Collective bargaining will be hampered by tough restrictions on unions over their rights to enter workplaces and the right to strike Reduction of third party scrutiny of individual contracts: The no disadvantage test is removed and replaced by the Fair Pay and Conditions Standard This means that lodgment of the individual contracts (AWAs) with the office of the employment advocate is all Assessment of Labour Market Policy At the heart of the reforms decentralization improves labour market flexibility Wage increases are tied to productivity gains: greater flexibility in wage outcomes Reward multi-skilling: dynamically efficient Underperforming workers pressured to improve But also, labour is allocated towards the capacity to pay, which offers a more optimal allocation of resources about the economy

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Raised productivity reduced RULC (real unit labour costs): which makes enterprise more technically efficient, but it also improves price stability GDP (National Income)

Ultimately achieves low inflationary growth: indicated in figure 1 Productivity gains shifts aggregate supply to he right New equilibrium: reduction in inflationary pressures whilst raising real GDP Low inflationary growth Benefits not purely domestic: international competitiveness raise exports CAD improvements Also though, productivity produces greater environmental sustainability to current production methods As touched on earlier, productivity and real income are linked Real income improves with productivity gains (also from growth dividend) Increased average living standards Greater employment opportunities (particularly for women, teenagers and the unskilled) due to fewer restrictions Lower levels of industrial disputation that before the introduction of enterprise bargaining through reduced union influence and defined disputation periods. It increased the labour market flexibility; Disadvantages Increaed income inequality especially for those not successful in obtaining an enterprise agreement Possibility of employees and employers not having equal bargaining power Loss of rights and erosion of minimum standards Partly due to less union movement Very difficult to sustain a system that links productivity with wage gains Pattern bargaining potentially replaced true enterprise bargaining where one certified agreement with one employed becomes the model of other certified agreements Erosion of job security Increased causalisation of the workforce Multiple authorities in industrial relations: each IRCs/ industrial which increase complexity

Wokplace relations Amendment (A stronger safety net) Bill 2006 Introduced Fairness Test and workplace ombudsman A balance between decentralisation and right s protection Forward with Fairness Policy and Fair Work Act 2009 Disbanding AWAs Re instated collective agreements and enterprise bargaining as the primary wage determination mechanism

Economic Notes Minimum standards increased from 5 to 10 Reduced exploitation of workers and promote equality Increased casualisation of workforce Reduced productivity and international competitiveness Wage increases may outstrip productivity gains. If firms are unable to absorb high labour costs, they will be passed on consumer, causing inflation and a potential wageprice spiral Fair work Australia ministers the certification of CAs applying the better off overall test

Structural (skills shortage): Training 18000 nurses (2009 2013) Apprenticeship subsidies in over 500 occupations (bridging school and employment). Enhances allocative efficiency in moving workers to their best use Frictional: Programs as the $4.9b Job Services Australia better connect job seekers with opportunities e.g. writing resumes. Enhances dynamic efficiency and capacity to shift Removing caps and waiting periods, job seekers can get into the right training or get back into the workforce faster and employees can fin the staff they need.