6355 Lecture Notes - Lecture 12: Inflation Targeting, Official Cash Rate, Real Interest Rate

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redcockroach788

20 Jun 2018

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University of Canberra

Department

University of Canberra

Course

6355

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all

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Week 12- Fiscal Policy and International Trade

Fiscal Policy

Policy objectives;

Economic growth

Full employment

Stable price level

Policy Instruments

Fiscal policy

Monetary policy

Fiscal Policy

Fiscal policy is changes in federal taxes and purchases that are intended to achieve

macroeconomic policy objectives, such as high employment, price stability, and

healthy rates of economic growth.

Fiscal policy refers to the actions of the federal government, and not state, territory,

or local governments.

Using fiscal policy to influence aggregate demand

Aggregate Demand: the total demand for goods and services within a particular market.

Expansionary fiscal policy

Increases in government purchases and/or decreases in taxes in order to increase

aggregate demand

An increase in government purchases will increase aggregate demand directly

A reduction in taxes has an indirect effect on aggregate demand through the affect

on disposable income.

The goal of expansionary fiscal policy is to increase aggregate demand by more than

what it would have increased without policy

Appropriate when the economy is in equilibrium, below full-employment, e.g. during

an economic contraction or recession

Leftward shift

Contractionary fiscal policy

Contractionary fiscal policy: decreases on government purchases and/or increases in

taxes in order to reduce aggregate demand

Appropriate when the economy is above full employment equilibrium and the

inflation rate is high.

Rightward shift

Automatic Fiscal Stabilisers

They work to stabilise the economy without the need to change policy

Examples:

Progressive personal income tax rates and transfer payments

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When GDP rises, taxes increase and transfer payments fall

When GDP falls, taxes received fall, and transfer payments rise

The Limits of Using Fiscal Policy to Stabilise the Economy

There are two main problems associated with fiscal policy effectiveness

1. Timing lags

2. Crowding out

What is monetary policy?

Monetary policy: the actions taken by the Reserve Bank of Australia to manage

interest rates in the pursuit of macroeconomics

Since 1993 the RBA has focused on monetary policy on achieving price stability

Inflation targeting: conducting monetary policy so as to commit the central bank to

achieving a publicly announced level of inflation

Inflation: a general increase in prices and fall in the purchasing value of money.

The RBA's target inflation is between 2% and 3% per annum on average over the

business cycle

Bonds

Bonds are a method of raising finance available to businesses and governments

Bonds are a legal promise to repay a loan, usually including a principle amount and

regular interest payments. On issue, the agreed interest rate is called the coupon rate

and the interest payments are called the coupon payments

Supply of Money and Equilibrium

The money supply is influenced by the RBA and consists of notes and coins in

circulation plus deposits in the banking system

Does not depend on interest rates, so money supply curve is vertical with respect to

interest rates

Equilibrium interest rate occurs where monetary demand and supply curves

intersect

Monetary Policy and Open-Market Operations

An increase in the supply of money leads to a decrease in the interest rate

Equivalently, if the central bank wants to raise the interest rate, it must decrease the

supply of money

Open market operations, which take place in the 'open market' for bonds, are the

standard method central banks use to change the money stock in modern economies

Monetary Policy

RBA no longer targets the money supply to conduct monetary policy

Cash rate: the interest rate on loans in the overnight money market

The cash rate is determined by the interaction of demand for and supply funds in the

overnight money market

RBA Targets the Cash Rate

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Document Summary

Fiscal policy is changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives, such as high employment, price stability, and healthy rates of economic growth. Fiscal policy refers to the actions of the federal government, and not state, territory, or local governments. Aggregate demand: the total demand for goods and services within a particular market. Increases in government purchases and/or decreases in taxes in order to increase aggregate demand. An increase in government purchases will increase aggregate demand directly. A reduction in taxes has an indirect effect on aggregate demand through the affect on disposable income. The goal of expansionary fiscal policy is to increase aggregate demand by more than what it would have increased without policy. Appropriate when the economy is in equilibrium, below full-employment, e. g. during an economic contraction or recession. Contractionary fiscal policy: decreases on government purchases and/or increases in taxes in order to reduce aggregate demand.

Related Questions

In an effort to move the economy out of a recession, the federal government would engage in expansionary economic policies. Respond to the following points in your paper on the actions the government would take to address expansionary fiscal and monetary policies:

Expansionary Fiscal Policy:

Explain the actions the federal government would take while engaging in expansionary fiscal policy in terms of the following:

The necessary change in taxes and government spending,

The effect on aggregate demand, GDP, and employment.

Expansionary Monetary Policy:

The three tools the Federal Reserve Bank (The Fed) uses when conducting monetary policy are the required reserve ratio, the discount rate, and open market operations.

Explain the actions of the Fed in regard to the three tools.

When the required reserve ratio is increased or decreased

When the discount rate is increased or decreased

Buying or selling government securities when conducting expansionary monetary policy

Explain how these actions would affect the money supply, interest rates, spending, aggregate demand, GDP, and employment.

raspberrygoose799

Important policy objectives of the federal government include economic growth, high employment, price stability, and a balance in international transactions. The achievement of these objectives is the responsibility of monetary policy, fiscal policy, and debt management carried out by the Federal Reserve System, the President, the Congress, and the U.S. Treasury. Describe the responsibilities of the various policymakers in trying to achieve the four economic policy objectives.

turquoiseferret953

Fiscal policy is carried out primarily by

A) the Federal government.

B) state and local governments working together.

C) state governments alone.

D) local governments alone.

Fiscal policy refers to the:

A) manipulation of government spending and taxes to stabilize domestic output, employment, and the price level.

B) manipulation of government spending and taxes to achieve greater equality in the distribution of income.

C) altering the interest rate to change aggregate demand.

D) fact that equal increases in government spending and taxation will be contractionary.

Expansionary fiscal policy is so named because it:

A) involves an expansion of the nation's money supply.

B) necessarily expands the size of government.

C) is aimed at achieving greater price stability.

D) is designed to expand real GDP.

An appropriate fiscal policy for severe demand-pull inflation is:

A) an increase in government spending.

B) depreciation of the dollar.

C) a reduction in interest rates.

D) a tax rate increase.

29. The amount by which government expenditures exceed revenues during a particular year is the:

A) public debt.

B) budget deficit.

C) full-employment.

D) GDP gap.

30. If actual GDP is greater than potential GDP, we have

A) a negative GDP gap

B) a positive GDP gap

C) minimum GDP gap

D) maximum GDP gap

31. Money functions as:

A) a store of value.

B) a unit of account.

C) a medium of exchange

D) all of the choices

pinkhedgehog911

6355 Lecture Notes - Lecture 12: Inflation Targeting, Official Cash Rate, Real Interest Rate

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