Macroeconomic Policy

What are macroeconomic policies?

Counter-cyclical, demand-side tools (fiscal and monetary policy) that smooth the business cycle to achieve internal (and external) stability.

What are the 3 internal objectives of macro policy and their targets?

(1) Full employment at NAIRU (RBA estimate ~4.5%) (2) Price stability: 2–3% CPI (3) Sustainable growth: ~2.5–3%, roughly potential

What are the key limitations of macro policy?

(1) Cannot fix supply-side problems (productivity, imported energy shocks) (2) Policy conflict: expansionary FP and contractionary MP offset each other (3) Time lags: MP impact lag, FP implementation lag (4) Political constraints (5) Exogenous global shocks

What are the time lags of MP and FP?

(1) MP: impact lag, transmission takes 12–18 months (2) FP: implementation lag, tied to the annual Budget

How does macro policy act across the business cycle (Fig 1)?

(1) Expansion (t1): contractionary MP/FP flatten the peak to keep growth sustainable (2) Contraction (t2): expansionary MP/FP lift the trough

What is fiscal policy and what does it aim at?

The government's use of the annual Budget to pursue (1) internal stability: activity, employment, resource allocation, income distribution (2) external stability

What is the multiplier formula and how is it drawn (Fig 2)?

(1) ΔY = k × ΔAD, where k = 1/(1 − MPC) (2) An injection shifts AD1 → AD2, then the multiplier carries it to AD3

What are the two components of the Budget balance?

(1) Structural (discretionary) component: Budget decisions (2) Cyclical (non-discretionary) component: automatic stabilisers, as tax revenue and welfare move with the cycle

What is monetary policy?

The RBA's influence over the cost and quantity of credit by setting the cash rate target (CRT).

Why does the 2–3% inflation target matter?

It anchors expectations, so firms and households can make long-term decisions without short-term distortion.

How does the interest rate corridor work (Fig 3)?

(1) RBA deposit rate = floor (2) RBA lending rate = ceiling (3) No bank lends overnight below the floor or borrows above the ceiling (4) So the cash rate settles at the CRT inside the corridor

What are open market operations?

Buying/selling second-hand CGS to add or drain liquidity (shifts supply in Fig 3) and hold the cash rate at target.

What are the 4 unconventional MP tools and when are they used?

Used when the CR hits its lower bound: (1) QE (2) QT (3) Forward guidance (4) Term Funding Facility

What are the 4 transmission channels of a cash rate cut?

(1) Savings & investment: less saving, more borrowing (2) Cash-flow: borrowers (higher MPC) gain more than savers lose (3) Asset & wealth: asset prices rise, wealth effect lifts C (4) Exchange rate: lower returns cut demand for AUD, depreciation lifts competitiveness

How does QE work?

Steady CGS purchases raise bond prices, lower yields along the curve and push banks to lend.

COVID-19: how severe was the shock?

GDP −6.3% y/y (June quarter 2020); first recession in nearly 30 years; shows vulnerability to exogenous shocks regardless of policy

COVID-19: what was the fiscal policy response?

(1) Over $311bn of stimulus (2) $130bn JobKeeper ($1,500/fortnight) (3) JobSeeker doubled with a $550/fortnight supplement (4) ~$2.5bn HomeBuilder; net debt rose from ~19% to ~29% of GDP

COVID-19: what was the monetary policy response?

(1) CR cut 0.5% (Mar 2020) → 0.1% (Nov 2020) (2) CPI still hit −0.3% (June 2020): liquidity trap (3) QE of $5bn/week (4) $200bn Term Funding Facility (cheap fixed-rate funding for banks to on-lend)

COVID-19: what stats show macro policy was effective for internal stability?

(1) Growth rebounded 3.4% q/q (Sept quarter 2020) (2) Unemployment peaked at 7.5% (July 2020), far below the 13% Treasury feared without JobKeeper (3) Inflation rose from −0.3% to 1.1% (Q1 2021), still below target

COVID-19: what was the effect on external stability?

Mixed: deficits raised NFD, but record-low rates cut interest owed abroad, shrinking the NPY deficit to −$4.5bn (Dec quarter 2020).

Post-COVID (2021–23): how strong was the V-shaped recovery?

Unemployment hit 3.5% (lowest since 1974); growth reached 4.3%

What caused post-COVID inflation and where did it peak?

Peaked at 7.8% (Dec 2022), mostly supply-driven: (1) Russia–Ukraine war energy shock (2) Global supply-chain disruptions (3) La Niña floods on the east coast

How did the RBA respond to post-COVID inflation?

Abandoned forward guidance (rates on hold "until 2024") and hiked 13 times (May 2022–Nov 2023) from 0.1% to 4.35%.

What cost-of-living FP support ran alongside the rate hikes?

(1) $3.5bn Energy Bill Relief ($300 per household, 2024–25 Budget) (2) $3.5bn to triple the bulk-billing incentive (3) 15% rise in Rent Assistance

What did inflation and unemployment recover to after post-COVID macro policy?

Inflation fell to 3.6% (Q1 2024); unemployment rose back toward NAIRU

What are the 3 limitations of post-COVID macro policy (with evidence)?

(1) Policy conflict: transfers went to high-MPC households, so the multiplier added demand against MP (2) Wrong tool: MP cannot fix supply-side inflation (3) Cost of juggling objectives: growth slowed to 0.1% q/q (Q1 2024)

What happened to MP in 2025?

With trimmed mean back inside the band, the RBA cut three times (Feb, May, Aug 2025) to 3.60%.

2026: what are the latest headline macro indicators?

(1) GDP +2.1% y/y (June quarter 2026) (2) CPI 4.0% headline, 3.6% trimmed mean (Aug 2026) (3) Unemployment 4.6% (Aug 2026), highest since late 2021

2026: what is the Strait of Hormuz shock?

US–Iran war (from 28 Feb 2026) effectively closed the Strait, which carries ~20% of world oil and LNG; Brent rose ~60% in the first month; fuel prices rose 14.8% in August 2026 alone

2026: what has the RBA done?

Reversed its 2025 cuts with four hikes (Feb, Mar, May, Sep), 3.60% → 4.60% (29 Sep 2026), highest since 2011; Board will hike further "if needed" (forward guidance as a contractionary tool)

2026: what is the fiscal stance (2026–27 Budget, 12 May 2026)?

(1) Deficit $31.5bn (1.0% of GDP), roughly neutral (2) $2.9bn fuel excise cut of 32c/L for three months from 1 April 2026 (3) Bottom tax rate 16% → 15% from 1 July 2026 (14% from July 2027)

Why is macro policy relatively ineffective in 2026?

(1) Imported cost-push inflation is beyond demand management (2) FP partly offsets MP (3) Productivity is unaddressed (4) Stagflation risk (5) External stability weakened

2026: what stats show inflation is imported/cost-push?

Housing (+5.7%) and transport (+5.6%, driven by fuel) were the two largest contributors to 4.0% CPI (Aug 2026); higher rates mainly cool the domestic economy

2026: what stats show FP working against MP?

Fuel relief and tax cuts add demand: the deficit widens from $28.3bn (2025–26) to $31.5bn (2026–27) in the year the RBA is hiking

2026: what productivity stats show macro policy can't fix the supply side?

GDP per hour worked ~5% below its peak; fell 0.2% over the year to June 2026; unit labour costs +3.6%, adding to inflation

2026: what stats show a stagflation risk?

Over the year to Aug 2026: unemployment 4.2% → 4.6%; growth slowed from 2.6% (Dec 2025) to 2.1%; CPI rose to 4.0%

2026: what stats show external stability has weakened?

CAD widened to $27.2bn (~3.7% of GDP) in the June quarter 2026; fuel imports jumped 42.5%; BOGS fell into its first deficit since 2017