4.5 The budget outcome

MC ConcerningAustralia’sNFDandliabilities,whichstatementis false? A. TheNFDistheexcessofwhatAustraliahaslentoverseasrelativetowhatwehaveborrowed. B. Theriseinofficialdebtispartlytheresultofweakereconomicactivityandhencelargerbudgetdeficits. C. Non-official,privatesectordebthasrisenduetothesavings–investmentgapandlowerinterestratesinsome overseascountries. D. Inpart,ourabundanceofnaturalresourcesandfavourableeconomicandsocialinstitutionshelptoexplain theriseinourexternalliabilities.

Question22 MC Theaggregatedemand-sideoraggregatesupply-sidedevelopment mostunlikely tocausean appreciation of theAustraliandollaris: A. ariseinworldcommoditypricesandthetermsoftrade. B. arecessioninJapan,ChinaandtheUnitedStates. C. higherdomesticinterestratesandtherelaxationofcontrolsonthelevelofforeigninvestment. D. hugenewdiscoveriesofnaturalresources. Question23 MC Whichstatementisgenerally false forAustralia? A. VerystronglevelsofdomesticeconomicactivityusuallycauseacyclicalfallintheCAD. B. AweakerAustraliandollarcanactuallyhelpimprovethebalanceofnetgoods. C. VeryrapideconomicgrowthresultinginhigherinflationcancauseafallintheTWI. D. Foreignborrowingcantendtoweakenthebalanceofpaymentscurrentaccountbyraisingtheoverallvalueof primaryincomedebitsrelativetotheoverallvalueofprimaryincomecredits. Question24 MC AlowerAustraliandollaris likely toleadtowhichofthefollowingmacroeconomiceffects? A. Highercostanddemandinflation,strongereconomicgrowthandlowercyclicalunemployment B. Lowerinflationandeconomicgrowth,withhigherstructuralunemployment C. Overallreducedcompetitivenessofdomesticmanufacturingindustriesthatexportandcompetewithimports D. AsmallernumberofoverseastouristscomingtoAustraliaandlocalstendingtoholidayabroad,slowingdown thegrowthinGDPandemployment Question25 MC Australia’sTOTwouldtendto fall andbe lessfavourable if: A. Therewasstrongerglobaleconomicactivity. B. Therewasweakerglobaleconomicactivity. C. Globaldisposableincomerose. D. Thereweregenerallylessfavourablegrowingconditionsforcropsworldwide. UNCORRECTED PAGE PROOFS

MC ConcerningAustralia’sinternationalcompetitiveness,whichstatementis false? A. Overrecentyears,ourcompetitivenesshasdeclined. B. Multifactorproductivityhasrisenstronglybutthefallinlabourproductivityhasweakenedourinternational competitiveness. C. Theprogressivecutincompanytaxforsmallbusinessesshouldhelpimproveourinternational competitiveness. D. Theabundanceofmanynaturalresourcesshouldenhanceourinternationalcompetitiveness,butourrelatively highlabourcostsundermineit.

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Digitaldocuments Multiplechoiceanswergrid (doc-34799) Multiplechoiceanswers (doc-34800)

SectionB:Extendedresponsequestions Question1(11marks)

Source: AdaptedfromVCE2021EconomicsExam,SectionB,Q4©VCAA Current account balance Percent of nominal GDP 6 Net income balance 0 –3 –6 –9 1991 1996 2001 Trade balance

Current account balance 2006 Year 2011 2016 2021

–9 –6 –3 3 6 0 % % Source: ABS;RBAChartPack,BalanceofPaymentsandexternalposition,December, 2021,seehttps://www.rba.gov.au/chart-pack/balance-payments.html a. Withreferenceto the graphabove, explain thetrendinthecurrentaccountbalanceoverthepasttwoyears. 2marks b.Explain howthe currentaccount balance over the past two yearswould have affectedthebalanceonthe capitalandfinancialaccount. 2marks c. Withreferencetothegraphabove, explain howtheperformanceinthetradebalanceoverthepasttwoyears mighthaveaffectedboth… • The achievementof the goalofstrongandsustainableeconomicgrowth • Australia’s living standards. 4marks 3 UNCORRECTED PAGE PROOFS d.Explain howachangein one structuralfactormightresultinimprovementinthecurrentaccountbalance.

3marks

Source: VCE2020EconomicsExam,SectionB,Q1©VCAA a.Describe howalowercashrateinAustraliaputsdownwardpressureonthevalueoftheexchangerateand howthismightsupportactivityacrossarangeofindustries. 4marks b.Explain thelikelyimpactofeachofthefollowingscenarios,onAustralia’s exchangerate. 6marks • Thereisafavourablemovementinthetermsoftrade. • Thereisaslowdowninglobaleconomicgrowth. c.Explain how downward pressureonAustralia’sexchangeratemightinfluenceeachofthefollowing. 6marks • Australia’sbalanceofpaymentsoncurrentaccount • Australia’smaterialandnon-materiallivingstandards

Question3(7marks)

Source: VCE2019EconomicsExam,SectionB,Q4bandc©VCAA a.Explain onewayinwhicha decline intherateofeconomicgrowthofAustralia’smajortradingpartnersmay influenceeitherAustralia’sbalanceofpaymentson currentaccount or thevalueofthe Australiandollar.

3marks

b. AssumeAustraliaexperiencesan unfavourable movementinthe termsoftrade acrossatwo-yearperiod.

Explain howthisscenariomightaffectAustralia’sdomesticmacroeconomicgoalofstrongandsustainable economicgrowth,andAustralia’s livingstandards. 4marks

Question4(3marks)

Source: AdaptedfromVCE2018EconomicsExam,SectionB,Q3©VCAA 30 20 10 –10 –20 Dec–16 Dec–17 Dec–18 Dec–19 Dec–20

Current account balance (a), main aggregates –20 –10 10 20 30 0$billion Current account balance Net goods & services Net primary income Source: GraphcopieddirectlyfromABS,balanceofpayments&internationalinvestmentposition,see https://www.abs.gov.au/statistics/economy/international-trade/balance-payments-and-international-investm ent-position-australia/latest-release 0 UNCORRECTED PAGE PROOFS a. Referringtothegraphabove, outline onefactor thatmightexplainthetrendinAustralia’s currentaccount balance during2018–19–20. 3marks

Source: AdaptedfromVCE2016EconomicsExam,SectionB,Q1©VCAA

Index Terms of trade* 2019/20 average = 100, log scale

Index

1961 * Annual data are used prior to 1960

1981 2001 2021 40 60 80 100 120 40 60 80 100 120 Source: GraphcopieddirectlyfromRBA,Chartpack,Commodityprices,seehttps://www.rba.gov.au/chart-pack/ commodity-prices.html a. Refertothegraphofthetermsoftrade. Outline onefactor thatmightexplainthetrendinAustralia’s termsof trade overthepasttwoyears. 2marks b.Analyse howan unfavourable movementinthe termsoftrade likelytoaffectAustralia’s… 4marks • balanceofpaymentsoncurrentaccount • livingstandards c.Describe howa depreciation oftheAustraliandollarmightaffecttherateof inflation inAustralia. 2marks Question6(6marks) Internationaltradeisusuallyseenasbeneficial.Explainhowinternationaltradecanresultinthefollowingbenefits: a. Lowerpricesandinflationrates. 2marks b. Greatereconomiesoflarge-scaleproduction. 2marks c. Greaterefficiencyintheuseorallocationofresources. 2marks Question7(4marks) Identify and explain how one important cyclical or aggregatedemand factorandhow one important structural or aggregatesupply factorthatislikelytohaveaffectedthesizeofAustralia’srecentcurrentaccountbalance. 4marksUNCORRECTED PAGE PROOFS

Recently,therehasbeenariseinAustralia’sNFD. a.Identify and explain oneimportantadvantageandoneimportantdisadvantageoftherecentriseinAustralia’s

NFD 2marks b.Identify and explain the two mostimportant causes ofthesubstantial rise inAustralia’sNFDinrecentyears.

2marks

c.Distinguish NFDandNFE. 2marks

Question9(14marks)

ChangesinAustralia’sexchangeratehaveimportantimpactsontheeconomy. a.Define theterm, tradeweightedindex (TWI). 2marks b.Explain howAustralia’s exchangerate isnowadaysdetermined. 2marks c.Explain howyouwouldexpectafallinAustralianinterestratesrelativetothoseintheUnitedStates, toaffecttheexchangerate. 2marks d.Explain howyouwouldexpectariseinAustralia’sTOTtoaffecttheexchangerate. 2marks e.Outline howageneral depreciation oftheA$wouldbelikelytoaffectAustralia’sachievementofkey domestic macroeconomicgoals. 6marks

Question10(11marks)

Australia’s internationalcompetitiveness isnotasstrongasitshouldbe. a.Define theterm, internationalcompetitiveness? 1mark b.Identify and outline themaincausesoftheoverall decline inAustralia’s internationalcompetitiveness?

4marks

c.Explain howan improvement inAustralia’s internationalcompetitiveness wouldbelikelytoaffect eachofthefollowing. • Thecurrentaccountbalance 2mark • Therateofeconomicgrowth 2mark • Materiallivingstandards 2mark Hey students! AccesspastVCAA examinations in learnON

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4Managing the economy

AREA OF STUDY 1 Aggregate demand policies and domestic economic stability OUTCOME 1 Discuss the operation of aggregate demand policies and analyse their intended effects on the achievement of the domestic macroeconomic goals and living standards. 4 Aggregate demand policies and domestic economic stability ......................................................... 291 AREA OF STUDY 2 Aggregate supply policies OUTCOME 2 Discuss the operation of aggregate supply policies and analyse the effect of these policies on the domestic macroeconomic goals and living standards. 5 Aggregate supply policies ...............................................................................................................................389 Source: VCE Economics Study Design (2023–2027) extracts © VCAA; reproduced by permission. UNCORRECTED PAGE PROOFS

UNCORRECTED PAGE PROOFS

4

Aggregate demand policies and domestic economic stability

UNIT 4 AREA OF STUDY 1 Aggregate demand policies and domestic economic stability OUTCOME 1 On completion of this unit the student should be able to discuss the operation of aggregate demand policies and analyse their intended effects on the achievement of the domestic macroeconomic goals and living standards. LEARNING SEQUENCE 4.1 Overview ...............................................................................................................................................................288 PART A Aggregate demand budgetary policies and the pursuit of domestic economic stability 4.2 Definition and aims of budgetary policy ...................................................................................................291 4.3 Sources of government revenue (receipts) ............................................................................................. 293 4.4 Types of government expenses (outlays) ................................................................................................ 297 4.5 The budget outcome .......................................................................................................................................300 4.6 The stance of budgetary policy — is it expansionary or contractionary? ...................................311 4.7 The roles of automatic and discretionary stabilisers in affecting the budget’s outcome and stance, and the impact on the level of government debt ..................................................................313 4.8 The effect of budget initiatives over the past two years and their likely effect on the achievement of domestic macroeconomic goals and living standards .......................................319 4.9 Strengths and weaknesses of using budgetary policy to affect aggregate demand and influence the achievement of domestic macroeconomic goals and living standards ............330 PART B Aggregate demand monetary policy and the pursuit of domestic economic stability 4.10 Definition and aims of monetary policy, and the role of the RBA ...................................................335 4.11 Conventional monetary policy and how the RBA can affect interest rates ................................338 4.12 The transmission mechanisms of monetary policy and their influence on the level of aggregate demand ...........................................................................................................................................346 4.13 The RBA’s monetary policy stance ............................................................................................................ 349 4.14 The stance of monetary policy over the past two years and its likely effects on the achievement of domestic macroeconomic goals and living standards .......................................352 4.15 Strengths and weaknesses of using monetary policy to achieve the government’s domestic macroeconomic goals and the affect on living standards ............................................ 360 4.16 Review ...................................................................................................................................................................364UNCORRECTED PAGE PROOFS

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4.1.1 Introduction Let us take a sneak preview of what lies ahead in VCE Economics Unit 4, where the focus is on the various economic policies used by the Australian government to help improve our living standards and prosperity. Earlier in Topic 2, we saw that market economies are typically unstable. They experience cyclical booms and recessions (caused by changes in AD … C + I + G + X − M, reflecting variable aggregate demand conditions), along with structural issues (relating to the influences on productive capacity and AS). At times, these two factors can undermine the simultaneous achievement of the government’s three key macroeconomic goals required for domestic economic stability: • the goal of low inflation (a slow average rise in general consumer prices averaging between 2–3 per cent a year over time) • the goal of a strong and sustainable rate of economic growth (the fastest growth in national production — perhaps around 3 per cent per year rise in GDP or a little more — that does not accelerate inflation or jeopardise the achievement of other economic and environmental goals) • the goal of full employment (the lowest unemployment rate — around 4.0–4.5 per cent of the labour force — that does not accelerate inflation). In recent years, the Australian economy has been through a recession and not fully achieved these goals. In part, this was due to the disruptive effects of lockdowns and the health crisis, brought on by several waves of the COVID-19 pandemic. As a result, living standards initially took a dive. To help moderate the severity of instability, the Australian government has used a policy mix involving both aggregate demand policies (to be covered in Outcome 1) and aggregate supply policies (to be covered in Outcome 2). This mix of strategies is summarised in figure 4.1. Referring to Figure 4.1, notice the two branches of aggregate demand policy — budgetary policy (to do with changes in the value of government receipts and outlays), and monetary policy (to do with changes in interest rates). Following basic Keynesian theory, these measures have been applied recently by the government and Reserve Bank, to help manipulate the level of AD (C + I + G + X − M) in a countercyclical way. They provided extra stimulus to spending and economic activity during the recession of 2020, and then some of the support has slowly been withdrawn as the economy was recovering during 2021–22–23. However, at the same time, the government also employed a range of aggregate supply policy measures like aspects of budgetary policy (e.g. outlays on infrastructure, education, subsidies, R&D, along with tax reforms), trade liberalisation (e.g. cutting tariff protection), and environmental policy (e.g. market-based measures to reduce CO2 emissions). These initiatives helped to boost living standards, by growing the economy’s efficiency and sustainable level of productive capacity. Over time, these policies have helped to ensure that our growing demand for goods and services has been matched by an expanding level of capacity and supply. UNCORRECTED PAGE PROOFS But for now, it’s time to find out a bit more about aggregate demand policies, starting with a closer look at the nature of budgetary policy and how this can work to improve stability and support living standards.

Outcome 1 – Aggregate demand policies ...

Unit 4: The Australian government’s key economic policies are applied countercyclically to manipulate AD and economic activity, and improve living standards. 1. Budgetary policies ... involve changes to the level and composition of receipts and outlays to help regulate aggregate demand. 2. Monetary policies ... involve conventional changes in official interest rates and perhaps unconventional measures to help regulate aggregate demand.

Outcome 2 – Aggregate supply policies ... are applied to grow efficiency, the economy's sustainable productive capacity, and improve living standards.

1. Aggregate supply budgetary policies ... involve outlays on infrastructure, education, subsidies and R&D, along with tax reforms, all designed to help grow productive capacity. 2. Immigration policies ... measures to affect the size and skills of the labour force to help grow productive capacity. 3. Trade liberalisation policies ... involve reducing protectionism to grow efficiency in the use of resources and expand productive capacity. 4. Market–based environmental policies ... involve reducing negative externalities to help make the growth in productive capacity more sustainable for current and future generations. 4.1.2 What you will learn KEY KNOWLEDGE Use each of the points from the VCE Economics Study Design below as a heading in your summary notes. • the need for aggregate demand policies, including monetary policy and budgetary policy in terms of stabilising the business cycle. UNCORRECTED PAGE PROOFS

Monetary policy • the role of the RBA with respect to monetary policy as outlined in its charter • conventional monetary policy (cash rate target) and how it affects interest rates • one example of the operation of an unconventional monetary policy tool from the past two years

• transmission mechanism of monetary policy and its effect on the level of aggregate demand, including the four channels of savings and investment, cash-flow, exchange rate, and asset prices and wealth • the stance of monetary policy: expansionary (accommodative), contractionary (restrictive) or neutral • the stance of monetary policy over the past two years and its likely effect on the achievement of the domestic macroeconomic goals and living standards • the strengths and weaknesses of using monetary policy to affect aggregate demand and influence the achievement of the domestic macroeconomic goals and living standards. Budgetary policy • sources of government revenue, including direct and indirect taxation; progressive, regressive and proportional taxes; and revenue from government businesses and the sale of government assets • types of government expenses, including government current and capital expenditure and transfer payments • the budget outcome: balanced, deficit or surplus • the underlying cash balance (budget outcome), including as a proportion of Gross Domestic Product (GDP) • methods of financing a deficit or utilising a surplus • the relationship between the budget outcome and the level of government (public) debt • the role of automatic stabilisers (cyclical component of the budget) in influencing aggregate demand and stabilising the business cycle • the role of discretionary stabilisers (structural component of the budget) in influencing aggregate demand and stabilising the business cycle • the effect of automatic and discretionary changes in the budget on the budget outcome and government (public) debt • the stance of budgetary policy: expansionary or contractionary • the effect of the budgetary policy stance and budgetary initiatives over the past two years and their likely effect on the achievement of the domestic macroeconomic goals and living standards • the strengths and weaknesses of using budgetary policy to affect aggregate demand and influence the achievement of the domestic macroeconomic goals and living standards.

KEY SKILLS • define key economic concepts and terms and use them appropriately • gather, synthesise and use economic data and information from a wide range of sources to analyse economic issues and form conclusions • discuss the operation of aggregate demand policies • analyse the effect of current factors on the setting of aggregate demand policies and living standards • predict the impact of changes in aggregate demand policies on the achievement of the domestic macroeconomic goals and living standards • analyse the strengths and weaknesses of aggregate demand policies in achieving the domestic macroeconomic goals and living standards. Source: VCE Economics Study Design (2023–2027) extracts © VCAA; reproduced by permission. Resourceseses Resources Digital document Key terms glossary (doc-34514) UNCORRECTED PAGE PROOFS