Nation in denial about its challenges, says RBA governor
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Glenn Stevens made his departing speech as the Reserve Bank governor, warning that Australia was ‘in denial’ over a need to repair the budget and undergo reform to stimulate economic growth. Stevens criticised political debate surrounding policies intended to repair the budget, including the discussion on narrow notions of ‘fairness’. Monetary policy is not expected to be effective in stimulating the economy any further as households are too heavily indebted to increase consumption.
How does this relate to the HSC syllabus?
- Monetary policy operates to stimulate the economy by making credit easier to access by households and businesses so that consumption and investment increases (HSC Topic 4 – Economic Policies and Management). However, Stevens argues that households are too heavily indebted to take advantage of any further rate cuts and any additional consumption will not adequately support the economy. Considering that consumption makes up approximately 60% of aggregate demand, the fact that consumption will be less likely to increase presents concern for Australia’s short – medium term economic growth.
- Stevens was heavily critical about political constraints on the use of fiscal policy. One of the core reasons for low inflation in Australia can be attributed to low productivity growth as the last of the major reforms in Australia occurred in the 1980’s. Reforms have been relatively limited in Australia as a result of overriding political interests (Preliminary Topic 6 – Government and the Economy; HSC Topic 4 – Economic Policies and Management). Given that the election occurred recently, major policies with reform potential have been adversely affected. Furthermore, as policies do not have a ubiquitously positive effect on all groups, major groups have been arguing for ‘fairness’, driving most discussions to the fairness of policies, rather than economic expedience.
- Slowing economic growth is argued to be negative for all groups in the long term as slow growth in income will amount to slowing growth of living standards. Stevens argues for a more robust fiscal response through infrastructure investment. This means that the government would need to continue borrowing to invest in long lived assets with high yield to reduce their costs rather than fund pension and welfare which yield little return.
Understanding the real risk of helicopter money
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Much debate has surrounded the concept of ‘helicopter money’ – a direct injection of cash into households – given the potential for hyperinflation. This article argues that arguments raised against helicopter money have been underpinned by simple models which assume the economy is operating at full employment and full capacity. It is argued that monetary finance, that is, money created by the central bank, would be effective in stimulating demand which is desirable given the low interest environment the global economy currently operates in. However, this argument can be defeated if the political risks of monetary finance is too great as politician can become overly reliant on monetary financing over time rather than reverting to more traditional methods.
How does this relate to the HSC syllabus?
- Helicopter money is a form of monetary policy involving the direct transferral of funds to households which has the effect of increasing income. As a result, consumption is expected to increase, which will increase aggregate demand as AD = C + I + G + (X – M). Therefore, economic growth should theoretically increase (HSC Topic 3 - Economic Issues).
- There is been much criticism of helicopter money as it is perceived as highly inflationary. Since money is being created and injected into the economy, the extra money circulating will cause prices to increase, resulting in inflation (HSC Topic 3 – Economic Issues). Since there are limited ways to retrieve this money, the resulting inflation would be more difficult to control.
- Analyses of the effects of helicopter money make simplifying assumptions, including that the economy is at full employment. When this is the case, any additional demand caused by increased money supply would be hugely inflationary as prices in the economy increase as a result of excess demand for goods and services. However, in the current state of the economy, nominal demand is required to drive growth. As a result, if it can be argued that helicopter money would be redundant policy to address the current issues in the economy, quantitative easing and traditional monetary policy can be argued to also be unhelpful. Since low growth is a major concern in the economy at the moment, helicopter money should be an option.
- A major risk in using helicopter money is that the government will become reliant on it as a policy measure. Since helicopter money is not sourced from the budget, but from creation of money by the central bank, it does not involve worsening of the budget balance.
Theresa Dang is an economics mentor at Keystone Education. She attended Sydney Girls High and achieved an ATAR of 99.70 in 2012. She is now studying Commerce and Law at the University of Sydney. She has experience in a global technology firm and a mutual fund.
Gary Liang is the founder and director of Keystone Education. He attended Sydney Boys High and achieved an ATAR of 99.95 in 2012. He achieved 5 state ranks in Mathematics, Mathematics Ext 1, Mathematics Ext 2, Chemistry and Economics. He is now studying Economics and Science (Advanced Mathematics) at the UNSW Australia, where he is the recipient of four scholarships.