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Transcript
Debt and de)icit disaster or appropriate )iscal response? – Evaluating Australia's response to the global )inancial crisis Christopher M. Fleming Department of Accoun8ng, Finance and Economics GriffithBUSINESS Year 12 Workshop February 2015 Short-‐run economic )luctuations Economic ac8vity fluctuates from year to year. In most years, economic ac8vity increases (on average over the past 50 years economic ac8vity in Australia has increased by about 2% per annum). In some years, however, this growth does not occur. A recession is a period of declining real incomes and rising unemployment. A depression is a severe recession. Fluctua8ons in the economy are oRen called the business cycle. 2 Economic ac8vity The business cycle Peak Peak Trough Time 3 4 5 6 A new approach 7 Economic ac8vity Smoothing the business cycle Peak Peak Trough Time 8 How to smooth the business cycle There are two tools available to policymakers to smooth the business cycle: 1. Fiscal Policy – government decisions around expenditure and taxa8on. 2. Monetary Policy – Reserve Bank decisions around interest rates. Both work on the real economy through their influence on Aggregate Demand. 9 The basic model of economic )luctuations Economists use the model of aggregate demand and aggregate supply to explain short-‐run fluctua8ons in economic ac8vity around its long-‐run trend. The aggregate demand curve shows the quan8ty of goods and services that households, firms and the government want to buy at each price level. AD = C + I + G + NX The aggregate supply curve shows the quan8ty of goods and services that firms choose to produce and sell at each price level. 10 Price level Long-‐run aggregate supply Short-‐run aggregate supply A Equilibrium price Aggregate demand 0 Natural rate of output Quan8ty of output 11 Two causes of recessions 1. A decrease (leRward shiR) in aggregate demand. 2. A decrease (leRwards shiR) in aggregate supply. 12 Price level 2. ... causes output to fall in the short-‐run ... Long-‐run aggregate supply Short-‐run aggregate supply, AS A P B P2 1. A decrease in aggregate demand ... Aggregate demand, AD AD2 0 Y2 Y Quan8ty of output 13 There are two possible responses 1. Do nothing, because in the long-‐run theory suggests we will return to Y1. 2. S8mulate aggregate demand through fiscal and/or monetary policy. The Rudd Government chose op8on 2. 14 Price level 2. ... causes output to fall in the short-‐run ... Long-‐run aggregate supply Short-‐run aggregate supply, AS AS2 3. ... but over 8me, the short-‐run aggregate supply curve shiRs ... A P B P2 P3 1. A decrease in aggregate demand ... C Aggregate demand, AD AD2 0 Y2 Y 4. ... and output returns to its natural rate. Quan8ty of output 15 Price level 2. ... causes output to fall in the short-‐run ... Long-‐run aggregate supply Short-‐run aggregate supply, AS AS2 A P 3. Push aggregate demand back to where it came from… B P2 1. A decrease in aggregate demand ... Aggregate demand, AD AD2 0 Y2 Y 4. ... and output returns to its natural rate. Quan8ty of output 16 What about aggregate supply? Adverse shiRs in aggregate supply cause stagfla9on – a period of recession and infla8on. -‐ output falls and prices rise. -‐ policymakers (who can influence aggregate demand) cannot offset both of these adverse effects simultaneously. 17 Price level 1. An adverse shiR in the short-‐ run aggregate supply curve ... Long-‐run aggregate supply P2 AS2 Short-‐run aggregate supply, AS B A P 3. ... and the price level to rise. Aggregate demand 0 2. ... causes output to fall ... Y2 Y Quan8ty of output 18 1. When short-‐run aggregate supply falls ... Price level Long-‐run aggregate supply P3 C P2 3. ... which causes the price level to rise further ... A P 4. ... but keeps output at its natural rate. 0 Natural rate of output Short-‐run aggregate supply, AS AS2 2. ... policymakers can accommodate the shiR by expanding aggregate demand ... AD2 Aggregate demand, AD Quan8ty of output 19 How does )iscal policy work? Fiscal policy refers to the government’s choices regarding the overall level of government purchases or taxes. In the short-‐run, fiscal policy primarily affects the aggregate demand. When policy makers change taxes or increases transfers to households, the effect on aggregate demand is indirect – through the spending decisions of firms or households. When the government alters its own purchase of goods or services, it shiRs the aggregate demand curve directly. AD = C + I + G + NX 20 How does monetary policy work? When the Reserve Bank increases the money supply, it lowers the interest rate and increases the quan8ty of goods and services demanded at any given price level, shiRing aggregate demand to the right. When the Reserve Bank decreases the money supply, it raises the interest rate and reduces the quan8ty of goods and services demanded at any given price level, shiRing aggregate demand to the le<. AD = C + I + G + NX 21 Macro-‐economic debate # 1 Should monetary and/or fiscal policymakers try to stabilise the economy (i.e. to smooth out business cycles)? Yes -‐ The economy is inherently unstable, and leR on its own will fluctuate; -‐ Policy can manage aggregate demand in order to offset this inherent instability and reduce the severity of economic fluctua8ons; -‐ There is no reason for society to suffer through the booms and busts of the business cycle; and -‐ Monetary and fiscal policy can stabilise aggregate demand and, thereby, produc8on and employment. 22 Macro-‐economic debate # 1 cont’d… No -‐ Monetary policy affects the economy with long and unpredictable lags between the need to act and the 8me that it takes for these policies to work; -‐ Many studies indicate that changes in monetary policy have liile effect on aggregate demand un8l about six months aRer the change is made; -‐ Fiscal policy works with a lag because of the long poli8cal process that governs changes in spending and taxes; -‐ It can take years to propose, pass and implement a major change in fiscal policy; 23 Macro-‐economic debate # 1 cont’d… No -‐ All too oRen policymakers can inadvertently exacerbate rather than mi8gate the magnitude of economic fluctua8ons; and -‐ It might be desirable if policymakers could eliminate all economic fluctua8ons, but this is not a realis8c goal. 24 Economic ac8vity Lags and political business cycle Peak Peak Trough Time 25 Macro-‐economic debate # 2 Is it beier to use fiscal policy or monetary policy to stabilise business cycles? Fiscal policy -‐ Monetary policy is a very blunt instrument and may not have the desired effect; -‐ Fiscal policy can be targeted to achieve other economic/social objec8ves. Monetary policy -‐ Fiscal policy is controlled by poli8cians, monetary policy by the (more sensible) Reserve Bank. 26 Effectiveness of )iscal policy The mul9plier effect refers to the addi8onal shiRs in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending. That is, each dollar spent by the government can raise the aggregate demand for goods and services by more than one dollar. The formula for the mul8plier is: Multiplier = 1 (1 -‐ MPC) An important number in this formula is the marginal propensity to consume (MPC) – the frac8on of extra income that a household consumes rather than saves. For example if the MPC = 0.75, the mul8plier will be 4. 27 Effectiveness of )iscal policy cont’d… However….fiscal policy may not affect the economy as strongly as predicted by the mul8plier. An increase in government purchases causes the interest rate to rise. A higher interest rate reduces the rate of investment spending. This reduc8on in demand that results when a fiscal expansion raises the interest rate is called the crowding-‐out effect. The crowding-‐out effect tends to dampen the effects of fiscal policy on aggregate demand. 28 Automatic stabilisers Automa9c stabilisers are changes in fiscal policy that s8mulate aggregate demand when the economy goes into recession without policymakers having to take any deliberate ac8on. Automa8c stabilisers include the tax system and some forms of government spending. So perhaps no need for monetary or fiscal policy? 29 Questions?
