Posted: June 25th, 2022

ECO511 Economics For Business

Question:

What can governments do to reduce unemployment by monetary and fiscal policy?

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Answer:

Introduction

To stabilize the economy, governments frequently use both fiscal and monetary instruments.

In times of low demand, the government may employ expansionary policies, such as a reduction in interest rates, tax cuts, and an increase in government spending.

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Contrariwise, governments use contractionary policies when the economy is too hot (Sloman Wride & Garratt 2015).

This article will examine how fiscal and monetary policies can be used in order to reduce unemployment.

Monetary Policy

Reduced Bank Rate

The bank rate is the rate at which money is lent by the central bank to commercial banks.

This policy is crucial in determining how much money the economy has.

To encourage commercial banks to borrow more money, the central bank lowers the bank interest rate when it wants to increase employment.

Commercial banks will lower their lending rates, which will result in a rise in borrowing by the public.

The result will be an increase in consumption and investments, as well as expansion of businesses (Mankiw 2014).

Individuals will be able to find work through the establishment and expansion of new businesses, which will result in a decrease in unemployment.

Figure 1: Source: Business Insider

Since the Global Financial Crisis (GFC) began, the Reserve Bank of Australia has seen a substantial reduction in the cash rate.

The Australia cash rate was 7.25 percent in 2007, just before the GFC.

The Reserve Bank of Australia lowered the cash rate to 3% in 2008 when the crisis started.

Together with other fiscal instruments, this policy action helped Australia avoid a recession. It also protected Australian citizens from the massive job loss experienced in advanced economies.

Current cash rate is 1.5% (Scutt 2017, 2017).

These substantial reductions in the cash rate have had a significant impact on the economy of Australia in different sectors.

Low borrowing costs are partly responsible for the boom in Australia’s housing market.

Many people are finding employment opportunities as more houses are built.

Open Market Operations is the purchase and sale by the central bank of government securities.

Government securities are purchased by the central bank when the government is trying to increase employment.

This increases the reserve of commercial banks, allowing them to lend more money out to the public.

This increases consumption and investment levels, which creates more employment opportunities for individuals.

The government of Australia buys securities during periods of low demand to stimulate economic growth.

Below is graph two which shows the economic impact of an expansionary monetary.

Expansionary policy results in increased aggregate demand and higher consumption.

The shift in the AD curve from AD1 to AD1 illustrates the growth of aggregate demand.

A rise in aggregate demand leads to a rise in real gross domestic product and employment levels.

Model AS-AD

Figure 2: Expansionary Monetary Policies

Fiscal Policies

Reduced taxes

To spur economic growth and development, governments use taxation as one of their most important tools.

Taxes that are too high can be detrimental to businesses as they discourage investment and consumption.

When the government wants to increase job creation, it lowers taxes on businesses and consumers.

Tax cuts increase incomes and therefore high consumption.

A rise in demand will lead to increased revenues for businesses, which can result in job creation and expansion.

Australia’s government has taken steps to lower the tax burden.

The tax rate for Australians with taxable income above $180 000 has been lowered by 2% since the start of the 2017-2018 financial years (Power, 2017).

For the 2017-2017 trading period, the corporate tax for small business entities was also reduced from 28.5% a 27.5%.

In the 2016-2017 Budget, Australia’s Taxation Office announced a plan to gradually reduce the corporate tax from 30% down to 25%.

These moves are intended to spur economic growth and increase government efforts to reduce unemployment.

An increase in government expenditure

Through various programs, the government can stimulate economic growth and increase job creation.

The government can finance new public works, such as roads, bridges, ports, railways, and ports.

These initiatives have been proven to increase disposable incomes and consumption, creating jobs.

The Australian government is investing in infrastructure improvements to increase job creation.

This policy was instrumental in preventing Australia from falling into a recession during the Great Depression.

The government implemented two schemes during this crisis: the Economic Security Strategy package valued at $10 billion and Nation Building and Jobs Plan valued at $42 billion (Australian Government 2017,).

The Shortcomings of Expansionary Monetary and Fiscal Policies

Expanding policies might not work, especially if the target group fails to respond.

If confidence is low, tax cuts may not be effective in increasing consumer spending as people will prefer to save than spend.

The same applies to lowering interest rates if banks are unwilling to lend or consumers are reluctant borrow (Sloman Wride & Garratt 2015).

Expansionary fiscal and monetary policies can be counterproductive if the economy is not at its full potential.

This is because increased money supply will lead to demand-pull inflation, which can be detrimental to the economy.

Low interest rates can lead to excessive borrowing and a speculative bubble in which the commodities prices rise extremely fast (Hubbard & O’Brien 2013, 2013).

In order to expand fiscal instruments, the government must borrow a lot.

For countries with high debts and rising bond yields, heavy borrowing might not be possible.

Expansive policies could lead to a loss of effect over the long-term.

The private sector may be left without funds to invest and the economy will suffer.

Conclusion

To reduce unemployment, governments often use expansionary monetary or fiscal policies.

These policies include a decrease in interest rates, the purchase and holding of securities and bonds, tax cuts, and an increase in government spending.

These policies can lead to inflation and sometimes fail when producers and consumers are not confident.

Refer to

Australian Government.

Part 2: Nation Building & Jobs Plan: Building prosperity now and supporting jobs in the future.

Australian Taxation Office.

Reduce the corporate tax rate.

Principles of economics.

Power, T. (2017 July 3rd).

Tax on income was reduced for 2017/2018 and 2016/2017 years.

RESERVE BANK AUSTRALIA.

Operation in Financial Markets

Scutt D. (2017 February 6th).

Why Australian interest rates are unlikely return to pre-GFC levels.

Economics (9th edition).

Harlow : Pearson.

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