Effectiveness of Economic Policy

Monetary Policy

Monetary policy has mostly proved to be effective in achieving its short to medium goals since the early 1990’s.

The international Monetary Fund did undertake comprehensive study of inflation targeting success and Australia’s Monetary Policy since inflation targeting (targeting a 2-3% band). Which commenced in 1993 has proven to have strong success. i.e. between 1980 – 1992 Annual inflation was 7.2% and real GDP growth of 2.8% with a variance on 2.7%

Compared to period of 1993-2004 – where Annual average inflation was 2.3% and real GDP growth 3.9% with a variance on 1.1%

Monetary policy is often referred to as a blunt instrument, i.e. a change in interest rates effect all sectors of the economy and all types of spending. Can’t target a particular group.

Monetary policy is generally more effective in implementing contractionary policy. During periods of major economic downturn, low interest rates are generally not enough to stimulate economic activity.

MP can only influence aggregate demand and not the structural causes of problems e.g. mid 2000’s when high economic activity resulted in high inflation due to the economic getting close to full capacity

Fiscal Policy 

Fiscal Policy although used for influencing AD, is largely assigned the role of achieving external stability and that the budget is kept in balance over the medium service and that higher public saving (through fiscal surpluses) can be used to reduce Australia’s call on foreign savings.

Most effective policy to stimulate the economy and for job creation. However, generally requires budget deficits which can result in crowding out effect and increase CAD.

In 2008-2010 fiscal policy was highly effective in providing economic stimulus, with Treasury concluding the stimulus added 2% to economic growth in 2009, resulting in 1.3% instead of 0.7% contraction in GDP

Overall macro policy has been successful in sustaining a twenty year period of economic growth in which Australia has progressively reduced unemployment, kept inflation low and enjoyed rising living standards

Global limitations: such as Greece, European debt crisis, limits the effectiveness of macro-economic policy on Australia’s performance, as can be seen with the ineffectiveness with a loosened cash rate of 2% being insufficient to stimulate business investment

Limitations of Economic Policy

Time Lag

Policy	Implementation Time Lag	Impact Time Lag
Fiscal	Medium Term (Annual budget)	Short Term (a few months)
Monetary	Short Term (monthly RBA meeting)	Medium Term (6 – 9 Months)
Micro Economic Policy	Long Term (a few years)	Long Term (up to 20 years)

Policy Constraints

The three year political cycle is often regarded as a constraint on long-term economic policy decision making

Furthermore, public support and loss of furture elections can put a constraint on government implementing needed but unpopular policies e.g. Carbon Tax

Furthermore, policies need to be passed through botht the House of Representatives and the Senate (i.e. a majority of votes). It is uncommon for government to have a majority in the Senate and thus they have been often forced to make compromises to win the support of the senators in porder to pass the legislation.

Global Influences

Integration with the global economy imposes great constraints on government policy.

E.g. – trade agreements, voluntary constraints on protectctioniusm policies

E.g. Interest rates – monetary policy may be constrained if we drop interest rates to encourage economic activity it may result in financial investors moving money out of Austrlaia to higher interest rate nations.

Effecitveness of government policy scaffold

Introduce Government Objectives	Including specifics of internal stability (2-3% inflation) and external stability (CAD, foreign debt, foreing liabilities, currency fluctuations), environmental sustainability etc.
Introduce Macroeconomic policies	Fiscal and Monetary. Define.  Explain Counter-cyclical, influence on AD (Y/expenditure diagram)
Monetary Policy Ø  Inflation Ø  Employment Ø  Growth	Goals How it works Successes – linked to government objectvies of growth/unemployment/inflation Limitations – time lag, current economic period, blunt instrument, structural limitations pre GFC Negative influence on external stability – increase imports when loosening monetary policy, increase flows on financial account when tightening monetary policy
Fiscal Policy Ø  The other economic objectives of the environment	Goals Processes – discretionary and non-discretionary Successions – fiscal consolidation Pre GFC, stimulus GFC (bring in multiplier benefits) – growth and unemployment -        Targeted resources – enviro/ income distribution Limitations – deficit constraints contracting current requirements (why MP is so low) -        Twin deficit constraint -        Political Constraint -        Time Lag
Conclusion	Effective but influenced by global factors

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