RMIT Classification: Trusted ECON 1016 – Macroeconomics1 Final Assessment ✓ Solved

This is an individual piece of assessment. For each question, explain whether the given statement is true, false or uncertain. Start your answer by selecting one of the options – “True”, “False” or “Uncertain” and then provide arguments to justify your selection (be brief and concise and present your arguments in 100 or less words).

Question 1: The world price of oil has risen recently. For Australia (which is a net exporter of oil), this development will imply that the CPI will increase by much more than the GDP deflator.

Question 2: Susan negotiated a wage contract where her salary was indexed to rise by 1% each year. In 2019, actual CPI inflation turned out to be 2%, negatively affecting Susan’s purchasing power.

Question 3: Suppose the negative shock of the pandemic has pushed the economy far below its potential GDP. The government has decided to expand government spending (G) but should exercise caution as this may crowd out private spending.

Question 4: If the government provides a tax rebate to small businesses, this policy is likely to have a positive effect on household saving, assuming no change in budgetary position.

Question 5: In 2011, Australia’s saving rate was 15% while the investment rate was 25%, resulting in a net outflow of capital.

SECTION B - Scenario-based questions. All questions have 3 subparts.

Question 1: Coronavirus pandemic led to contraction in the US economy in 2020. The Fed followed expansionary monetary policy, cutting down interest rates to restore the economy to potential by 2021. Show the events using the AD-AS model, and explain (100 or less words).

b) How does the expansionary monetary policy affect aggregate demand components? State ‘increase’, ‘decrease’ or ‘no effect’ on each component.

c) Suggest two unconventional monetary policy measures the Fed could undertake if conventional measures fail.

Question 2: Discuss the effects of active fiscal policy on the economy.

a) If a demand shock affects Singapore, should the government increase spending (G) equivalent to the decline in net exports (NX)? Explain your reasoning (50 words or less) and discuss crowding out concerns.

b) If the Australian government boosts spending when the economy is in good shape, how will this affect interest rates? Will crowding out be a concern? Explain without a diagram.

c) Discuss how effectiveness of fiscal policy may be affected if the public is cautious and not spending much.

Question 3: In Janine Dixon's article, what are the shortcomings of GDP highlighted? Discuss long-term repercussions of bushfires on Australia’s productive capacity using production function.

c) What is the main problem of aggregated measures and how can economic analysis be modified according to the author?

Paper For Above Instructions

The economic attributes of Australia's involvement in global oil markets present a compelling case for the relationship between world oil prices and domestic inflation metrics, such as the Consumer Price Index (CPI) and the Gross Domestic Product (GDP) deflator. In understanding the dynamics of this relationship, it's essential to establish that when world oil prices rise, net exporters like Australia typically weather the impact differently than net importers. Therefore, I classify the statement as True. The CPI tracks the price level as it affects final consumption, leading to a heightened sensitivity relative to the GDP deflator, which encompasses a broader spectrum of price changes including investments and net exports. Hence, it can be expected that an increase in oil prices would inflate consumer-related costs significantly more than it would affect production costs reflected in the GDP deflator.

In question 2, regarding Susan's wage indexing amidst rising inflation, I assert that the situation is True, as a 2% inflation rate effectively dampens her purchasing power. In economic terms, real income is assessed by adjusting nominal income according to the inflation rate. Given Susan's wage increase is only 1% against a 2% inflation, she is essentially experiencing a loss of purchasing power, resulting in diminished ability to maintain her standard of living. Her income fails to keep pace with the cost of living, thus warranting a negative outlook on her economic condition.

In the third question, I select True regarding the fiscal expansion and potential crowding out effect of government spending. While increasing government expenditure may provide necessary short-term boosts, if not well-calibrated, it risks elevation in interest rates due to heightened demand for loanable funds. Such an effect could dissuade private sector investments as they compete for financial resources. The government should consider implementing fiscal policies judiciously, ensuring they strike a balance between stimulating growth and not undermining private sector confidence.

Question four relates to tax rebates for small businesses and is True in its assumption about fostering household savings. Tax rebates effectively increase disposable income, enabling households to save more as businesses are likely to pass on cost reductions to consumers. Assuming a balanced budget, this mechanism opens avenues for enhanced private savings as households respond favorably to improved financial conditions.

Lastly, the statement in question five regarding Australia's capital flow indicates True as well. Australia’s notable outflow of capital against a backdrop of diverging saving and investment rates signals outbalance. The investment to saving rate, juxtaposed with international capital mobility indeed suggests that the country was susceptible to net capital outflows in pursuit of greater investment returns overseas.

Moving to Section B, in light of the catastrophic impact caused by COVID-19, I would illustrate the effects on the American economy in context through the AD-AS model by plotting shifts in aggregate demand reflective of fiscal and monetary response mechanisms. The expansionary measures, critical to restoring equilibrium amid economic turmoil, can be visualized with the Aggregate Demand curve right-shifting to restore potential GDP Y. It presumes the economy was effectively at Y prior to the disturbance; thus, the representative model would demonstrate the extent of shifts occasioned by stimulus measures.

As for the components of aggregate demand subject to change due to the Fed's monetary policy in lowering interest rates, I would state effects as follows: consumption (increase), investment (increase), government spending (no effect), and net exports (increase). Lowering interest rates rationally translates into more accessible credit for consumers and businesses alike, subsequently lifting overall demand.

In contemplating unconventional monetary policy, if traditional methods prove futile, the Fed might consider quantitative easing (buying financial assets to inject liquidity) and negative interest rate policy (charging banks for holding excess reserves). Both options aim to further stimulate economic recovery by circumventing conventional limitations in cases of near-zero interest rates.

Concerning Singapore’s economic issue due to declining export demand, it’s rational to argue that increasing government spending may not require an equivalently proportional adjustment to the fall in NX. A fiscal multiplier indicates the government’s capacity to amplify economic activity, suggesting that the infusion of funds can potentially elicit a more substantial overall impact. However, crowding out might indeed emerge as interests rates hike to attract capital to cover deficit spending.

The Australian fiscal landscape, even in a pre-electoral context, reveals possible upticks in interest rates as increased government spending may exert upward pressures on funds demand. This is particularly relevant if market confidence anticipates unsustainable financial commitments, thus heightening crowding out concerns.

Lastly, the effectiveness of expansionary fiscal policy can be undermined under circumstances where consumer confidence is low and spending remains stagnant, as the multiplier effect diminishes with a non-responsive populace. If the public remains reticent, any increase in government spending may fail to stimulate requisite economic recovery.

As discussed in Dixon's article, the inadequacy of GDP as a perfect measure of economic health is evident as it neglects subtleties of social wellbeing footprints left by disasters, including infrastructure destruction and lost employment which contribute intangible losses beyond monetary values. Moreover, long-term productivity capacity is curtailed as vital production factors like labor and capital suffer degradation post-disaster restoration difficulties. Furthermore, discrepancies in aggregated measures illustrate the flaws in single metric reliance. Dixon posits that improved economic analysis can be achieved by factoring in qualitative assessments of wellbeing to counterbalance conventional GDP-centric frameworks.

References

• Dixon, J. (2020). Take care when examining the economic impact of fires: GDP doesn’t tell the full story. The Conversation.
• Blanchard, O. (2017). Macroeconomics. Pearson.
• Mankiw, N. G. (2018). Principles of Economics. Cengage Learning.
• Krugman, P. & Wells, R. (2018). Economics. Worth Publishers.
• Bernanke, B. S. (2020). The Federal Reserve and the Financial Crisis. Princeton University Press.
• Romer, D. (2018). Advanced Macroeconomics. McGraw-Hill Education.
• Friedman, M. (2016). A Theory of the Consumption Function. Princeton University Press.
• Keynes, J. M. (1936). The General Theory of Employment, Interest, and Money. Harcourt.
• Stiglitz, J. E. (2015). Economics of the Public Sector. W.W. Norton & Company.
• Garrison, R. W. (2012). Time and Money: The Macroeconomics of Capital Structure. Routledge.