Discuss about the Evolutionary Macroeconomic Explanation System.
Through the implementation of macroeconomic policy framework the government setup broad objectives for the betterment of the entire economy as well as the policy frameworks are used in order to achieve the desired objectives of the government. The macroeconomic objectives which are generally set by the government through the policy framework generally includes the establishment of full employment within the economy, avoidance of inflation, ensuring equilibrium in the balance of payments (Jordà & Taylor, 2016). The main policy instruments which are used in this regard are the supply side policies, monetary policies and fiscal policies. The following assignment will shed light on the macroeconomic policy implemented by the government of Australia and how this policy is affecting the economy of United States. Presently it has been observed that emergence of the excessive inflationary pressure has compelled Australia to strengthen its macroeconomic policy framework. In order to cope with the situation there are certain reform oriented economic policies as well which have been enacted by the government of Australia (Argy & Nevile, 2016). The economic policy of the country has always been a major determinant of the growth of the country. The present economic scenario of the country is quite in favor of the country and has also depicted significant expansion since the past sixteen years. However certain changes in the economic system and policies of the country also leaves an impact over certain other countries as well. In this context the same will be evaluated how these recent changes in the economic policy affected the United Kingdom.
It is a matter of fact that the developed as well as the developing country’s macroeconomic policies have mostly focused on eliminating the fiscal deficit and taking control of the rate of inflation. However, presently the economists have put a thrust on using the macroeconomic policies for enhancing the development and growth of the countries (Baffes et al., 2016). The chief economist of the IMF, Olivier Blanchard opined that the macroeconomic policies have got several targets and numerous instruments and presently it is the high time that the macroeconomic policies should shed the light beyond inflation stability.
In other words the pendulum is swinging from the orthodox policies towards the more heterodox policies. Simply by orthodox it is meant that the policies which are derived from the key theoretical frameworks of efficient and rapid adjustment in order to utilize the available resources efficiently (Johnson & Mitchell, 2017). As per this theory if an economy already possess a tendency to achieve full employment automatically within a time period which will seem viable to the policymakers there is no need of macroeconomic policies. It is noteworthy that if the economy can obtain the unique full employment level of output provided the other parameters of the economy to be constant then any macroeconomic intervention is unnecessary. In such a situation the monetary and fiscal policies of the government should be neutral and the adopted exchange rate should be floating without any intervention on the part of the government (Heindl & Löschel, 2015).
In the context of the heterodox policies it can be stated that these policies are derived from the imperfect market clearing. These imperfection manifest itself in various forms incomplete clearing as can be observed in the labor market with a constant level of unemployment or market clearing with multiple prices (Foster, 2015). At the macroeconomic level inefficient clearing of the market imply that an economy could not adjust automatically to the full potential output. These inefficiencies of the economy sometimes justify the public interventions particularly for every country.
In order to understand the macroeconomic policy framework of the different countries it is necessary to develop a basic understanding of the nooks and corners of the macroeconomic policy frameworks (Barlow et al., 2017). As a result of this in this section the basic outlines of the economic policies in general has been discussed. It is expected that it will further help in understanding the macroeconomic policy framework of Australia and how it has affected the economy of United Kingdom as well.
The Australian government has recently aimed at achieving a few objectives through macroeconomic policies. These objectives are economic growth, external balance of the economy and the internal balance as well. Moreover, these three objectives taken together acts as the key factor for achieving the sustainable national growth level while controlling the level of inflation and limiting the size of the foreign debts and liabilities at the same time (Cornwall & Colander, 2016). It is a noteworthy fact that the growth rate prevailing within a country is never constant over time and is highly influenced by the ups and downs in the international business cycle. The macroeconomic management on the part of the government is carried out in order to minimize these fluctuations through influencing the demand. This in turn makes it possible to achieve sustained growth, maintain lower level of inflation and unemployment. Hence, it is quite evident that because of the demand side characteristics of the monetary policies it cannot be used alone and hence is used in conjunction with the supply influencing macroeconomic reforms (Weale et al., 2015). The government of nation mainly uses two measures namely monetary and fiscal policies in order to influence the demand.
The fiscal policy framework is a macroeconomic policy also which makes use of the budget of the government for influencing the economic objectives through adjusting the amount of spending on the part of the government and the revenue of the government as well. This in turn changes or alters the extent of economic activities through fiscal deficits or fiscal surplus or with the help of implementing a balanced budget (Duval & Furceri, 2018). It is a matter of fact that the budget can influence the economy in turn the economic performance can also influence the budgetary outcomes as well. This outcome of the budget is generated with the help of both the cyclical component and structural component. The cyclical component in this context amalgamates the automatic stabilizers like tax receipts of the government’s spending through transfer payments which adjusts itself in accordance with the state of the economy (Afonso et al., 2018). The structural component on the other hand, incorporates the discretionary proposed by the government for instance reduced spending on the part of the government changes the economic activities.
The automatic stabilizers also play a crucial counter cyclical role within the budget however are strong quite often to influence the full effects of the business cycle and hence the discretionary fiscal policies are used more frequently (Baker, 2015). When the government of Australia is willing to stimulate the growth rate of the country it uses an expansionary fiscal policy. It is generally carried out by increasing the expenditure on the part of the government, reducing taxation which in turn causes an increase in the level of consumption with a multiplier effect through the Keynesian Multiplier mechanism. Analogically a contractionary fiscal measure is undertaken when there is a need to slow the economy down and control the foreign liabilities as well as the current account deficit (Fagiolo & Roventini, 2016).
The monetary policy incorporates the action of the Reserve Bank of Australia implemented to influence the availability and cost of money as well as credit within the economy. Technically the objective of the monetary policy is to establish the internal balance within the economy through influencing the rate of interest through open market operations which involves the buying and selling of government bonds along with the correction of surplus or shortage of funds in the short-run money market. In order to implement an expansionary fiscal policy the Reserve Bank of Australia will certainly buy bonds which will increase the liquidity, bring down the rate of interest which in turn will boost up the spending on the part of the consumers and increase the investment spending and thereby lower the unemployment rate (Bhattarai & Trzeciakiewicz, 2017). Contractionary monetary policy on the contrary is implement to counter the rising inflationary pressure and under tis policy the Reserve Bank of Australia will sell the bonds which will soak the funds from the economy as a result the rate of interest will rise and the expenditure will get reduced. Over the passage of time, the reserve Bank of Australia implements contractionary and expansionary monetary policies and thereby controls the rate of inflation and maintains it at a level of 2- 3% (Wu & Xia, 2016). Certain times the Reserve Bank influences the exchange rate so as to maintain stability without changing the monetary policy stance. This is basically achieved through systematic interventions in this case the Reserve Bank of Australia would be required to buy or sell bonds which will be equivalent to the amount of Australian Dollars purchased or sold for maintaining a constant amount of cash within the market.
This assignment will mainly focus on the monetary component of the macroeconomic policy and depict the changes in the aggregate demand and aggregate supply model which is caused by the demand supply of money. Hence in order to understand the method of operation of the money market it would be required to understand how the money demand and money supply can be controlled and the underlying factors affecting these two (Bhattarai & Trzeciakiewicz, 2017).
In the context of money demand it can be stated that while deciding the amount of money one will hold people generally decide how to hold the wealth and in which form they should hold it. The demand for money is defined as the amount of money that people are willing to hold and the underlying factors which are affecting that. Economists argued that people generally hold money for two purposes. For transaction purposes and precautionary purposes. Transaction demand for money is that component under which people hold the money for purchasing goods and services or for anticipated expenditures. On the other hand, the precautionary demand for money is that amount which is held by the people for mitigating any future consequences or for precautionary purposes. There is another component of the demand for money which is termed as the speculative demand for money. People hold money for the speculative purposes in the money market and this component of the money demand is determined by the rate of interest prevailing in the market.
The amount of money people will be willing to hold will again in turn be dependent on their income and the interest rate prevailing in the market. Different average amount of money held by the individuals can satisfy their precautionary and transaction demand for money. The speculative demand for money is related with the rate of interest (Baker, 2015). When the rate of interest is low then bond prices are high and then the financial investors becomes very much concerned about the fact that the bond prices may fall. Hence it can be stated that higher bond prices and lower level of interest rate would certainly increase the amount of money held by the investors for speculative purposes (Cornwall & Colander, 2016). On the other hand, while the rate of interest is high and the bond prices are low the investors will not expect that the prices will fall further and therefore will hold lower balance in their hand for speculative purposes. Hence it can be stated that the speculative demand for money is inversely related with the rate of interest.
As it has been observed that the demand for money is negatively related with the rate of interest as the transaction, speculative and precautionary demand for money are inversely related to the rate of interest. Incorporating all these three sources within the demand schedule the demand curve for money can be derived which will depict the relationship between the rate of interest and quantity of money demanded while the other factors are considered to remain unchanged. The money demand curve as shown below is a downward sloping curve, as the rate of interest increases the amount of money demanded reduces and vice versa.
On the other hand it is necessary to mention that there are a few factors which can shift the money demand schedule. A rise in the level of real GDP, rise in the price level of changes in the transfer costs. For instance an increase in the level of GDP at a given rate of interest r will increase the demand for money and will shift the demand curve towards the right. Similarly the opposite of the aforesaid event if takes place will shift the money demand curve towards the left a given interest rate.
Now the supply curve of money traces out the relationship between the quantity of money supplied and the rate of interest prevailing in the market while keeping all the other supply determining factors unchanged. The supply of money in the economy is controlled by the central bank through performing open market operations which also determines the amount of reserves to be kept with the banks. It is assumed that the supply of money is increased in a fixed proportion with the bank reserves (Cornwall & Colander, 2016). The supply curve of money is hence drawn in the figure below and it is found to be a vertical line which is determined by the monetary policy makers. Drawing a vertical line as the supply curve of money strictly ensures that money supply is not affected by the interest rate and the changes in the quantity of reserves will reflect a change in the supply of money.
Now as the Australian government which has implemented an expansionary monetary policy, the government will increase the demand for money in the market. This may take place because of the positive expectations or for transaction costs which will compel people to hold more money in hand at each interest rate (Foster, 2015). In this case the money demand curve will shift to the right and the demand for bonds will shift towards the left. The higher rate of interest will lead to a lower amount of investment. Moreover, higher rate of interest will also implement a higher level of exchange rate and will reduce the net exports. As a result the aggregate demand curve will shift towards the left and the level of real GDP and price level will fall.
From the figure above it can be stated that after the implementation of the expansionary monetary policy the demand for money increases and the curve shifts to the right in panel A. As a result the price level has also increased and the supply of money has also shifted towards the right and as a result the aggregate demand curve shifts towards the right and the real GDP and price level increases.
The expansionary monetary policy of Australia has also effected the economy of United Kingdom largely. This is because both the countries share a trade relationship between them. This is because the lower level of interest rate induces the level of investment and reduces the amount of net export. Due to the reduction in the level of net exports the economy of United Kingdom has faced certain issues as it no longer remained to access the Australian products and the currency of United Kingdom also became cheaper in comparison to the price of the Australian currency (Jordà & Taylor, 2016). However, the Australian economy is in such a shape that it was in dire need to rectify its macroeconomic policies so that it can cope up with the given situation.
Conclusion
On a concluding note it can be stated that the assignment has focused successfully over the macroeconomic policy of Australia and how it has affected the economy of United Kingdom. In order to understand the macroeconomic policy a complete overview of the macroeconomic policy framework and the key techniques which are used for implementing the monetary policies have also been discussed. Furthermore the macroeconomic policy guidelines of the country have been discussed in detail where it has been observed that initially the macroeconomic policy was only focused over controlling the rate of inflation and unemployment. However, presently these policies have become so designed that these play a crucial role in enhancing the performance of the country and plays a major role in enriching the growth rate of the nation as a whole.
Reference List
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