Monetary policy is impotent - RBA Governor

The article linked below is as much an opinion piece as a news article (so not that suitable for IA's). However there is an important message in it. Monetary policy alone won't work to manage the economy.

Ever since the idiot Costello conned everyone into believing a Budget surplus was the equivalent of good economic management Australian governments have not really distinguished themselves in fiscal (budgetary) policy planning and execution. The one exception was the Rudd governments textbook response to the GFC.

Glenn Stevens, the retiring Governor of the RBA, has given a clear message to th government. Stop obsessing about the deficit, it isn't the problem, start spending on infrastructure to boost demand and build capacity.

VCE students will recognise this as a question of the policy mix. IB students will see the liquidity trap and he ineffectiveness to monetary policy as well.

The SMH article is here

As above for VCE and IB interest.

Japan stimulates economy - again.

Japan has announced another huge fiscal stimulus package to try and boost growth in the economy. Japan has tried a succession of such measures in recent years, but the Japanese economy continues to perform poorly.

The latest package has been described as an 'old fashioned short term stimulus, based on public works.' What we might call a Keynesian stimulus package. The Aggregate Demand and Supply diagram shows the hoped for effect of the measure.

 

The  brief details of the stimulus package are that the government will spend an additional US$275billion mainly over two financial years. This will boost Aggregate Demand (AD) by raising government spending (G), a component of Aggregate Demand. The government budget deficit will rise as a result. While there will be significant infrastructure spending in the package there is also going to be cash handouts to low income families.

The main aim of the package is to boost Consumption spending, the largest component of AD, which has been very slow to grow in Japan for many years. The overall effects are also expected to be short term only, a temporary boost to AD, partly to overcome any impact of the British Brexit vote on the world economy. 

The real question is will it work? This is the second fiscal stimulus package of the year in Japan and part of the 'Abenomics' approach of Japan's Prime Minister that aims to boost economy (a link explaining Abenomics is given below).

The stimulus is being made along with the supporting policies of expansionary monetary policy and deregulation and will shift the AD curve to the right. In the diagram above this shows a very successful expansionary fiscal policy that leads to non-inflationary growth (Real output rises from 0Y1 to 0Y2 with no rise in the price level.) 

However the diagram shows a simple Keynesian model. There might be crowding out, which reduces the impact of the stimulus, or if the monetarist/new-classical model holds the rise in demand will only lead to a short term output and employment boost and then inflation.

The BBC covers the story here

Abenomics is explained here

This article is most useful to IB students. It provides and excellent example of expansionary fiscal (budgetary) policy and raises the questions of effectiveness and the nature of mutually supporting macroeconomic policies. VCE students can certainly follow the logic of the policy and apply it to Australia's situation.

A small charge for plastic shopping bags leads to massive fall.

England introduced a 5p (about 10c) charge for plastic bags in supermarkets. After six months there has been up to a 90% fall in plastic bags used.

The motive is to reduce negative externalities of consumption which have led to market failure. Not only were the bags unnecessarily up scarce resources, they are made from oil so there are negative externalities associated with production too. Also the disposal of the bags has to be in landfill because they cannot be recycled.

This example is an excellent one of regulation (it's not a tax) that internalises the externality. People are forced to consider the costs of the resources used by the imposition of a price. The PED is actually very difficult to determine as the price was originally zero, however we might at this stage suggest that there has been a highly elastic response!

The story is covered here

This is a great example for IB students and for VCE students it also illustrates the effect of using prices to correct market failure. It is unusual as it is a regulation rather than  tax, but clearly a 5p tax would have the same effect (while raising virtually no money).

South Australia places 15% tax on gambling

Australia is unusual among developed countries, it does not tax gamblers. This is unusual for two reasons, firstly gambling is a demerit good, and secondly Australians gamble a lot and it is unusual for a government not to take advantage of taxing a popular activity.

Statistically Australians are the worst gamblers in the world. The chart below shows this.

The problem with gambling is that it represents a market failure because gambling is a demerit good and an imperfect information good.

Gambling is a demerit good because:

The actions of the gambler affect third parties, such as their families. This is a negative externality of consumption.

The result of gambling can place costs on others to help gamblers rehabilitate.

Therefore there are negative external costs associated with gambling.

Gambling is an imperfect information good because gamblers rarely understand the full effects of their actions on themselves. They gamble because they hope to win  in a system where the odds are designed to ensure overall gamblers loose. While short term gains are possible over time gamblers loose in aggregate.

The market situation is shown in the diagram below.

The idea of taxing gambling is therefore a good one. Taxes will move a market towards the social optimum (MSB = MSC at Qopt in the diagram.)

The real question is, will the South Australian tax work to solve the market failure? Will those who gamble realize that the price of betting has risen? Is the demand for gambling going to prove so inelastic that there is little change in behaviour (it is an addiction). Also will taxing the firms in this way simply lower profits of bookmakers rather than affect individual behaviour.

The ABC cover the story here

RBA cuts interest rates to new record low

The Reserve Bank of Australia (RBA) has cut its cash rate to 1.5%. This means that interest rates charged and paid by banks should drop too.

The rate cut is the latest in a succession of cuts as shown by the chart below.

In the last four years the RBA has now halved its cash rate (3% to 1.5%). The aim of this expansionary monetary policy is to try and stimulate household consumption (C), business investment (I) and to some extent moderate the rise in the Australian dollar (AUD) to help maintain competitiveness in overseas markets. The rate cut will affect these variables via the monetary policy transmissions mechanism, although many doubt they will be that effective.

The reason that the RBA cut rates are given by their statement: extracts below.

"The global economy is continuing to grow, at a lower than average pace."
"Commodity prices are above recent lows, but this follows very substantial declines over the past couple of years. Australia's terms of trade remain much lower than they had been in recent years."
"In Australia, recent data suggest that overall growth is continuing at a moderate pace, despite a very large decline in business investment."
"Recent data confirm that inflation remains quite low. Given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time."

However there are some indicators that suggest that rates need not be cut. This is typical in any period and the RBA has to decide on the balance the forces to make its decision. They identify:

"Several advanced economies have recorded improved conditions over the past year..."
"Labour market indicators continue to be somewhat mixed, but are consistent with a modest pace of expansion in employment in the near term. "
"Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector."

There are several concerns about monetary policy. These include will cutting rates at such low levels actually promote any change in behaviour, i.e. will cutting rates work? There is concern that the cut in rates simply shows how desperate the economic situation is and so any influence rate cuts have is overwhelmed by lower business and consumer sentiment.

There is also criticism that the RBA have badly mismanaged the situation for years and have failed to learn from other central banks. The Guardian article below explores this.

The ABC looks at the rate cut here

The Guardian discusses RBA policy here

VCE students will be interested in the conduct of monetary policy by the RBA and how this is likely to effect the Australian economy, in particular how it might work through the monetary transmission mechanism. Also the factors that are influencing Aggregate Demand in Australia are highlighted by this decision. IB students should also be interested in the RBA overall policy that is discussed in The Guardian ad how appropriate their actions have been in recent years given the time lags involved in policy and the influence of relative interest rates.