Monetary policy, an Australian
Monetary policy is a powerful tool for manipulating the economy, its capacity is heightened by the floating exchange rate used in Australia since December 1983. Fiscal policy, the other major macroeconomic force is somewhat less effective in reaching the major goals of the government including stabilisation of economic growth, unemployment, the balance of payments and inflation. The policies are simply a myriad of tools used to prevent a long period of high unemployment, inflation and prices as well as low wages and growth. Critically discuss the proposition that under a floating exchange rate (e.g. $Aus/$US) monetary policy is a powerful instrument of macroeconomic policymaking whereas fiscal policy is a weak instrument for achieving domestic macroeconomic goals.When attempting to fulfil its macroeconomic goals, governments have the choice of two major policies to use or combine. Firstly, monetary policy uses the level of interest rates to influence the economy in the short to medium term. Its major goals are to stabilise demand and inflation in the medium term and inflationary expectations and to achieve the government's objectives of sustainable growth with underlying inflation of about 2-3%. Fiscal policy is
Sustaining economic growth over a set period is more difficult under fiscal policy as growth is very much dependant on investment in the economy which is determined by the level of interest rates. Whilst floating exchange rates are helpful in respect to monetary policy, they do however have drawbacks that can offset these gains, such as the instability of the exchange rate equilibrium due to the slow changes in the short run, and thus, a floating exchange rate may fail to establish an appropriate new equilibrium in response to an external shock. Maintaining low inflation to a level of about two or three percent, is essential to fulfilling the governments macroeconomic goals, it cannot achieve sustainable growth and low unemployment without it. Government can increase growth in the short term through extra spending, but cannot continue this for extended periods of time due to the inflationary problems associated with the policy. A floating exchange rate regime makes domestic monetary policy more powerful toward domestic activity. The policy can also be used to electioneer, rather than to provide the correct guidance of the economy. As much growth as possible is desired within target range. (McCallum)Monetary policy is the act of regulating the money supply so as to keep production, prices and employment stable. A lower level of unemployment can be achieved by the government stimulating investment in the economy decreasing the interest rates and thus discouraging saving and making borrowing more financially viable, this leads to job creation and thus, a lowering of the level of unemployment. The strength of the Australian dollar is important in low inflation as it allows interest rates to be cut without a detrimental effect to the exchange rate. Governments can avoid excess deficits in the Balance of Payments by cutting back their spending and raising tax rates, this however will have a deflationary effect as the public will have less money to spend in the economy and thus, demand for goods and services will decrease leading to a slow down in the general economy in the short term. Regulating growth provides assurance in the economy and thus encourages businesses to expand. Reducing government spending will lead to a rise in unemployment in the short term due to the loss of jobs that are inevitable from the implementation of such a policy.
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