SAC 4: domestic Economic Goals

The meaning of the goal of strong and sustainable economic growth

• Economic growth refers to the increase in the production of goods and services (national output) in an economy over time.

• It is measured by the annual percentage change in real GDP (chain volume GDP), which removes the effects of inflation.
  

• The goal of strong and sustainable economic growth is to achieve the fastest possible rate of growth that:

  • Is consistent with low inflation,

  • Maintains environmental sustainability,

  • Supports other government economic goals like full employment.

• 3-3.5% annual real GDP growth is often seen as sustainable.
  

Measurement of the rate of economic growth in real GDP

• economic growth is mainly measured by the annual percentage change in GDP, which shows change the total value of final goods and services produced in the economy.
  
  

• GDP is calculated in three main ways (PIE):

  • GDP(P): Total value added in production,

  • GDP(I): Total income earned,

  • GDP(E): Total expenditure on goods and services.

• GDP – is the average of the three.
  
  

• Nominal GDP (at current prices) includes price changes due to inflation or deflation.
  
  

• To find the real rate of economic growth, real GDP is used,

  • Adjusts GDP for inflation

  • Focuses only on volume (quantity) changes in production.

• Allows more accurate picture of growth

Limitations of GDP as a measure

• Underestimates due to non-market production being excluded (e.g. volunteer work, black economy).

• Some values are imputed and not directly measured (e.g. farm output used on-site).

• Quality improvements may not be fully reflected.

Consequences of not achieving strong and sustainable economic growth: growth is to high:

When growth is to high:

• inflation rises: as AD grows quicker then AS, causing demand pull inflation and shortages, leading to higher prices

• External pressures increase (exchange rate): Net exports worsens, imports surge due to higher domestic demand while exports fall due to higher local prices, causing a decrease in AD

• Environmental degradation: Faster growth = more pollution/ resource depletion,

• increase global warming causing more extreme weather events, destroying resources, decreasing intertemporal efficiency, and harming Both NMLS + MLS

Consequences of not achieving strong and sustainable economic growth: growth is to low:

• higher unemployment GDP falls, as of less production, causing fewer jobs, and high unemployment

• lower wages + incomes; more ppl rely on welfare, decreasing consumption expenditure, MLS, and NMLS

• GOV finance weakens: lower GDP, means lower tax revenue, bigger deficits and therefore more debt

• Higher debt = higher interest payments limiting future spending

• results in worsened MLS and NMLS

Why strong and sustainable growth matters

• Balances economic goals, creates jobs, raises income, keeps inflation low, preserves environment, strength gov finances

Meaning and goal of full employment including NAIRU

• Full employment: using as many willing and able workers (15+) as possible, ensuring minimal unemployment while avoiding high inflation

• DOES NOT mean 0 unemployment, some is expected (seasonal/frictional)

• The goal is to maintain the lowest possible unemployment rate without accelerating inflation (NAIRU)

• NAIRU is the threshold below which unemployment is to low creating labor shortages (too many jobs not enough workers) and pushing up inflation

• As very low unemployment = rise wage cost - cost inflation - undermines price stability

• As very high unemployment = weak consumer spending - lower AD - slower economic growth - NMLS and MLS fall

Classifications within the labour force:

EMPLOYED, UNEMPLOYED, HIDDEN UNEMPLOYMENT, UNDER EMPLOYED, LONG TERM UNEMPLOYED, FRICTIONAL UNEMPLOYMENT

EMPLOYED: working for 1h per week, includes those temporary away from work

UNEMPLOYED: aged 15+, actively looking + available for work, or stood down/laid off

HIDDEN UNEMPLOYMENT: not counted in unemployment stats as they’ve given up job seeking, but would work if could

UNDER EMPLOYED: employed part time/casual, but want and are available for more hours

LONG TERM UNEMPLOYED: people who’ve been unemployed for 1+ year

FRICTIONAL UNEMPLOYMENT: ST unemployment from people moving between jobs or entering work force

Measurement of the labor force

• Labor force: Employed + unemployed (age 15+ and willing and able to work)

• Unemployed rate= number of workers 15+ who are willing and able to work but cannot secure a job

• Participation rate: a percentage of the labor force, of working age who are prepaired to work + seek employment

• a rising rate increase labor supply,

• a falling rate makes unemployment look better if jobs aren’t being created

Difference between cyclical + structural unemployment

• Cyclical: - caused by weak AD in the economy

• happens during economic slowdowns recessions when spending falls

• eg. Businesses lay off workers because consumers are buying less

• Structural: - caused by changes in tech, business closure or skill mismatches

• exists even when the economy is strong

• jobs lost in manufacturing as factories automate (tech) or if workers don’t have skills needed for new jobs

• Cycilcal: demand side, temporary, tied to business cycle

• Structural: supply side, long term, caused by changes in how and what we produce

Consequences of not achieving full employment, if unemployment is too high (above NAIRU 4%)

• Lower GDP: economy is not producing as much, therefore incomes fall

• Worse inequality: unemployed earn far less, as there often first to be laid off, leading to income gaps

• Poor wellbeing: more financial stress, mental health issues causing lower happiness

• Weaker gov budget: less tax collected + more welfare spending causing deficits

• Cuts to public services: less money for health, education and infrastructure

• OVERALL: waste of resources, low incomes, poor wellbeing

Consequences of not achieving full employment, if unemployment is too low (below NAIRU 4%)

• Inflation: labour shortages (employers compete for fewer workers), wages rises, business raise prices to protect profits

• Falling real wages: prices rise faster then wages, less purchasing power

• loss of I/C: Aussie exports to expensive, decreasing net exports, and AD

• weaker dollar: more imports, fewer exports - value of AUD drops

• OVERALL: inflation rises, harming purchasing power + trade

Meaning and goal of low + stable inflation

• inflation occurs when prices of most G+S rise over time

• Aim for low and stable inflation, within 2-3% per annum, allows for flexability while supporting other goals and maintain LS

• zero inflation is undesirable, as it would require extremely low economic activity, causing high unemployment and low growth

Distinction between INFLATION, DEFLATION, and DISINFLATION

INFLATION: when prices rise overall

DISINFLATION: when prices are still rising but at a lower rate

DEFLATION: when inflation is negative and prices are falling

Measurement of inflation using CPI

headline CPI rate of inflation

• measures quarterly changes in retail price of ‘basket’ G+S typically bought by households in cities

• Based on a regimen of about 100,000 items across 11 catagories like food/energy…

• prices are weighted - most common + expensive items have more influence

• compares changes to a base year

Measurement of inflation using CPI

Underlying CPI rate of inflation

• excludes volatile items like fruit, vegetables, fuel, energy, all that are affected by temporary events

• clearer picture of persistent inflationary pressures

• higher then headline when volatile prices fall, lower when volatile items rise

• Preffered by RBA, when deciding interest rate changes, as it reflects underlying demand driven inflation

limitations of CPI

• only covers capital cities - excludes regional and rural prices

• may not reflect specific household types (eg. vegetarian, if meat prices rise)

• only measures a fixed basket - changes in spending habits/new products may not be captured

Cause of inflation: Demand inflation

• happens when AD is too strong and the economy is close to full capacity

• causes shortages of G+S, pushing prices up

• KEY FACTORS CAUSING THIS: Increased business + consumer confidence, Increased disposable income, increased population growth, lower interest rates/bigger gov spending

• EFFECT ON LS: ST boom, but higher prices reduces purchasing power of incomes, an overall decrease of LS

Cause of inflation: cost inflation (higher C.O.P)

• Caused by rising costs for businesses, which are then passed onto consumers

• less favourable AS conditions

• KEY FACTORS: higher wages/lower labor productivity, increased utility bills, rising transport and commodity cost

• EFFECT ON LS: firms increased prices to protect profits, causes reduced real incomes and purchasing power for consumers, decreasing LS

Consequences of not achieving goal of low and stable inflation, if inflation is to high (abover 2-3%)

• reduced purchasing power: prices rise faster then wages, people can afford less, reducing MLS.

• Distortion of spending/investment: higher inflation = higher interest rates, borrowing becomes more expensive, less spending and therefore investment

• Reduced I/C: AUS goods become more expensive compared to imports - therefore AUS exports less and imports more, net exports worsen, reducing AD and increasing structural unemployment

Consequences of not achieving goal of low and stable inflation, if inflation is to low (below 2-3%)

• Higher unemployment + slower growth: weak inflation = weak economy, business dont invest causing job loss, consumer are pessimistic - less spending causing the RBA to cut rates to stimulate growth

• Differed Consumption: ppl expect prices to stay low/fall, delaying buying, asset prices like homes, fall, ppl feel poorer

• OVERALL: slower economic activity, increased unemployment, weaker confidence and living standards

AGGERATE DEMAND FACTORS (REDBIC): rates of economic growth overseas

• Slower growth in china and EU

• SSEG: hinders, as decreased export demand, therefore lower GDP

• Full employment: hinders: decreased jobs in exporting industries

• Price stability: Helps, decreased demand pull inflation pressures

AGGERATE DEMAND FACTORS (REDBIC): Exchange rates

• AUD depriciating

• SSEG: helps as increased net exports, increasing GDP

• Full employment: helps, export sector jobs

• Price stability: Hinders, increased import prices = cost inflation

AGGERATE DEMAND FACTORS (REDBIC) Disposible income

• errored by inflation, offsetting partly by government relief

• SSEG: hinders, decreased consumption = decreased growth

• Full employment: hinders, decreased demand for labor

• Price stability: Helps, decreased demand driven price pressure

AGGERATE DEMAND FACTORS (REDBIC) Business confidence

• declined due to interest rates rise + global uncertainty

• SSEG: hinders, declined investment

• Full employment: hinders: decreased hiring, fewer jobs

• Price stability, helps: decreased inflationary pressure from investment

AGGERATE DEMAND FACTORS (REDBIC)Interest rates

• RBS raised Cash rates

• SSEG: hinders, decreased AD, therefore decreased GDP

• Full employment: hinders: slows job creation

• Price stabiltiy: helps: reduces demand side inflation

AGGERATE DEMAND FACTORS (REDBIC) consumer confidence

• weakened due to cost of living crisis

• SSEG: hinders, Decreased consumption = decreased growth

• Full employment: hinders, decreased demand for labor

• Price stability: helps, reduces demand pull inflation

AS factors (APECOP) Avaliability of resources

• Skilled labor shortages due to lagging migration

• SSEG: hinders, decreased productive capacity

• Full employment: hinders, increased underemployment, increased unfilled positions

• Price stability: hinders, increased wage pressure = increased cost inflation

AS factors (APECOP) productivity rates

• stagnant/modest gains across industries

• SSEG: decreased efficiency + growth

• Full employment: hinders: decreased output per worker = increased unit labour cost

• Price stability: hinders = increased production cost = increased inflation

AS factors (APECOP) exchange rates

• depriciation of AUD raised import cost

• SSEG: hinders; increased capital input cost

• Full employment: hinders = higher cost discourages hiring

• Price stability: hinders; increased cost push inflation from imports

AS factors (APECOP) cost of production

• increased due to energy, wage pressure, and supply chain issues

• SSEG: hinders, business profitability

• Full employment: hinders, firms delay hiring or cut hours

• Price stability: hinders, increased cost push inflation across economy