VCE Economics Headstart Notes areas.

The figure may therefore not be representative of the purchasing habits of regional households, leading to meaningless data for these households. Inaccurate Weighting Every household spends differing proportions of their income on particular goods and services. Therefore the weighting used in the CPI may not be reflective of actual spending habits of the majority of consumers. Volatile Events One-off volatile events such as wars and natural disasters can result in a higher Headline CPI (e.g. Cyclone Larry, war in the Middle East, floods, droughts etc.). The impact on living standards of failing to meet the goal of low inflation Local Producers are at a Competitive Disadvantage A high rate of inflation undermines local producers competitiveness overseas. Local g/s become relatively more expensive for consumers, and so they may turn to cheaper imports. Higher imports and lower exports will result in a worsened international trade deficit, and may also lead to closures in export industries (rise in structural unemployment). Inflation Undermines Economic Growth When inflation occurs, consumer and business confidence is eroded (lower C + I). Tightening of monetary policy associated with higher rates of inflation will increase interest rates. Higher interest rates will also slow C and I. Inflation Undermines Efficiency in Resource Allocation Higher inflation may reallocate resources away from industries that require heavy investment in capital items towards high return areas such as shares, property and art. Resources are pulled away from productive long-term uses in the pursuit of short-term gain. This will result in a lower long-term rate of economic growth, again undermining living standards. Inflation Affects Income Distribution in Arbitrary Ways 1. Persons with fixed incomes (pensioners, welfare dependent) will become worse off as their incomes fail to increase at a rate corresponding with higher prices. 1. Conversely, people with flexible incomes (rich) can use the rise in prices to increase their incomes via speculation on various assets. 2. Exporters become worse off as they lose their international price competitiveness and face lower living standards. 2. Importers may gain due to stronger sales and higher incomes. 3. Home-owners with mortgages (with a variable loan) will be required to use a higher proportion of their income to finance their debt. As their discretionary income falls, their living standards are lowered. 3. Lenders may have higher incomes as a result of the higher interest rates. 4. The business closures would mean the unemployed face decreased incomes and lower living standards.

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VCE Economics Headstart Notes Economic Growth and Employment Growth Higher exports would see economic growth rise (via an increase in X in AD). In contrast, a fall in exports or a rise in imports would see economic growth and employment fall. This could occur due to an appreciation of the $AUD. Inflation A fall in the exchange rate may see our exports rise in demand, causing shortages and price rises here (demand inflation). Imports would therefore become more expensive and importers would pass this on as higher prices (cost inflation). Efficiency and Resource Allocation High levels of business investment are important for efficiency but to finance this is relies on borrowing. Unfortunately Australia has low savings so borrowing occurs from overseas. Repayments tend to lower our disposable income and living standards. Income Distribution If the exchange rate falls then the value of exports would rise as would incomes and living standards of exporters relative to importers. The nature of free trade and protection including advantages and disadvantages, methods of protection, and the effects of free trade on domestic and global trade and living standards Free Trade: is a situation where no barriers to trade exist between trading partners. Protection: refers to tariffs (tax on imports), producer subsidies (cash payments to local producers), import quotas (limit the quantity being imported), foreign ownership restrictions (laws to prevent foreign ownership in some industries). Advantages of Free Trade: Greater efficiency leads to higher growth and incomes, increased international trade leads to higher exports, more jobs, more choice and lower prices Advantages of Protection: Help for infant industries to get started, defence reasons (inability to trade with countries during a war), local employment Aggregate Demand and Aggregate Supply factors that may have influenced international transactions The CAD is trending upwards and is much higher than the target of 3-4% of GDP, averaging 5.7% over the last 4 years. The exchange rate has been volatile over the last few years. Recently, it dropped in value by 10% in less than a month. NFD has continued to rise despite there being favourable repayment conditions for borrowers (i.e. higher $AUD) and now is over 54% of GDP (caused by increases in public sector borrowings). The terms of trade (export prices/import prices) rose significantly to record levels due to Chinese and Indian demand for domestic minerals. Factors Affecting External Stability 36 Connect Education 2012

VCE Economics Headstart Notes 2011/12 Federal Budget Expansionary Stance - $44 billion deficit Economic Growth Removing tax impediments to infrastructure investment $36 billion in infrastructure investment

Low Inflation $22 billion in savings on the path to a budget surplus serves to decrease demand inflation within the economy

Full Employment $558 million for the National Workforce Development Fund

External Stability $36 billion in road/rail and port infrastructure

Equity in Income Distribution Increasing the Family Tax Benefit Part A for teenagers to $4,208 per year

2010/11 Federal Budget - Expansionary Economic Growth Company tax rate to be cut to 29% from 2013-14 and 28% from 2014-15

Low Inflation $5.6 billion for a new infrastructure fund and $1 billion to renew rail networks

Full Employment $661 million for Skills for Sustainable Growth

External Stability 50% tax discount for first $1000 of investment income promotes savings

Equity in Income Distribution A $500 standard tax deduction in 2012-13 for about 6.4 million Australians.

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VCE Economics Headstart Notes Persuasion: the RBA could issue a statement to the public asking them to slow their level of spending, and alluding to the fact that interest rates will be raised if excessive spending continues. Promoting the Goals of Strong Economic Growth and Full Employment In times of weak aggregate demand and recession, where economic growth is too slow, cyclical unemployment rising and living standards deteriorating, the RBA would probably adopt an expansionary monetary policy stance (countercyclical) to accelerate growth and stimulate AD. Other Instruments to Increase Economic Growth and Full Employment Dirty Float: The RBA could attempt to decrease the price of the $AUD by becoming a seller in the Forex market and increasing supply. This would decrease the relative price of our exports, and increase the price of imports, having a favourable effect on AD. Persuasion: the RBA could issue a statement to the public asking them to increase their spending by a presenting a positive outlook for the economy. THE RELATIONSHIP BETWEEN MONETARY AND BUDGETARY POLICY IN MANAGING AGGREGATE DEMAND Compatible Relationships Reducing Inflation (2005-2008): Tightening of monetary policy via increases in interest rates and contractionary budgetary policy stance via an increase in the budget surplus or decrease in deficit. GFC (weak economic growth, cyclical unemployment): The RBA cut its cash rate target from 7.25% to 3% and the government used an expansionary budgetary policy stance and switched its projected surplus of $21.7 billion into a deficit of $32.1 billion. Conflicting Relationships Reducing Inflation (2005-2008): Certain aspects of budgetary policy undermined the policys overall contractionary stance. While the RBA was increasing its cash rate target to counter inflation, there were discretionary cuts in PAYG tax in three consecutive budgets. These tax cuts reduced the effectiveness of monetary policy and worked in a cyclical manner (not counter-cyclical). Higher Inflation (2009-2010): As the economy recovered inflation began rising towards the top end of the RBA target. As a result, the RBA tightened monetary policy, raising interest rates from 3.00% to 4.50%. At the same time, the government had a budget deficit outcome, expanding the economy and contributing to rising inflation. Crowding Out and Crowding In: When the government runs several budget deficits to stimulate the economy, it is forced to borrow from either overseas or within Australia. With limited savings or credit available, upward pressure could unintentionally be exerted on domestic interest rates. Theoretically, this could crowd out private sector borrowers, thus 71 Connect Education 2012

VCE Economics Headstart Notes contradicting the original expansionary aims of budgetary policy. In reverse, contractionary surplus budgets may tend to cause interest rates to fall or rise less quickly than otherwise (e.g. perhaps 200508). This may result in crowding in by borrowers and increase spending, undermining the RBAs contractionary monetary stance. Conflict due to different priorities: A further instance of possible conflict between these two policies can arise if they have different priorities or goals in mind, rather than the same one. For instance, monetary policy has low inflation or stability of the currency as its most important goal. It is possible, however, that budgetary policy might have other important things in mind such as creating more jobs through tax cuts or infrastructure spending.

2005 2008 HIGH INFLATION RBA Government

INTEREST RATES: 5.25% - 7.25% SURPLUS BUDGETS: $15.8B - $19.7B

2008 2009 LOW ECONOMIC GROWTH (GFC) RBA INTEREST RATES: 7.25% - 3.00% Government DEFICIT BUDGETS: $21B Surplus - $32B Deficit

2005 2008 HIGH INLFATION RBA Government

INTEREST RATES: 5.25% - 7.25% INCREASING PAYG TAX CUTS

2009 2010 RISING INFLATION RBA INTEREST RATES: 3.00% - 4.50% Government DEFICIT BUDGETS: $32B Deficit - $57B Deficit

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