Activity 11(c)

1.  In simple terms, dubby Keynesianisn refers to a period where governments around the world were thought the best way to both counter economic downturns and to promote longer term economic growth was for the government to use its budget to deliver economic stimulus. In contrast, austere monctarism was the reverse approach where the belief was that heavily government keynesian stimulus only served to reduce economic growth over time due to burdens imposed by government debt.

2. The health pandemic caused policy makers around the world to focus less, for austerity (c.g. spending recponzibly or within certain parameters) and more to a focus more on supporting economies that were clearly entering periods of decline not seen since the great depression af the 1930s. The focus, thereafter would be on containing any risks that evolved from both the huge levels of government debt and money printing that financed the stimulus programs.

3. In Australia, the massive stimulus packages (in excess of $300 billion) provided by the federal government during 2020 resulted in a huge increase in the budget deficit (expected to exceed $200 billion in 2021) because government expenditure increaced cignificantly relative to government revenue. The large increace in the deficit resulted in higher gross government debt (expected to rise above $850 billion in 2021) because the deficit was finance by the sale of CGSs (or government issued bonds) the stock of which in the economy equates to gross government debt.

4. This Is because cash that previously was not In circulation (i.e. the money held by the RBA) enters circulation once the RBA purchases the bonds from the private sector. Accordingly, it has the same effect as the RBA printing cash to facilitate the purchase of assets (e.g. bonds) in the economy — cash that was not previously in circulation.

5. Growth in government debt will ordinatily increase (long let) interest rates because it reflects and incease in demand tor money in financial markets. Like any market, an increase in demand will lead to a higher price, where the price of money is Interest rates. It Is also true that any Increase In government debt via the sale of Commonwealth Government Securities, or bonds, increases the price of the bond and reduces the yield (interest rate) on the bond there is always an inverse relationship between the price of a bond and its yield. ihe final effect on interest rates will largely depend on who purchases the bunds. If the bulk of the bonds are purchased by foreign investors then it will have a muted cttect on interest rates compared to it the bonds were purchased by domestic investors. This is because foreign funds entering the country effectively add to the supply of many in financial markers which therefore exert downward pressure on interest rates (hence the increase in supply of money works against the increased demand for money by the government).

6. This is because governments are not concerned about the inflationary risks sssucisted with printing money that otherwise would ordinarily exict.

7. As nated by the Feonomist, law interest rates make it cheaper for the government to harrow to build new infrastructure, from research labs to electricity grids, that will boost growth and tackle threats such as pandemics and climate change. As societies age, rising spending on health and pensions Is inevitable – if the resulting deficits help provide a necessary stimulus to the economy, all the more reason to embrace them as they help to lift living standards.

8. Traditionally, governments have been loath to print excessive amounts of money because of the impact it can have on inflation and damage to the economy over time. In particular, printing money (or increasing the volume of money in the economy) at a rate that is much faster than the rate of economic growth will necessarily lead to an increase in prices if the economy is operating at oF close Lo productive capacity. So while the current stimulus programs are feasable in light of global economies producing well below productive capacity, and with interest rates close to 0 (or even negative), continuing monetary stimulus into the future is expected to increase prices (inflation) once economic recoveries take hold and economies start to produce closer to their productive capacity.

9. This is because the RBA haz made it clear it will not reduce interest rates below 0 and thot a cash rate (and medium term bond rates) of 0.1% Is the effective lower bound. It Is therefore not likely that the RBA would reduce the cash rate any further, meaning that any further stimulus that is required could not be achieved via traditional monetary policy responses. However, the RBA could further adopt non-conventional measures (e.g. quantitative easing/further long term bond purchases) as a means of reducing longer Lerim rates of interest. But ap these rates approach zero, it then makes it more difficult for moncy policy to gain any traction.

10. It expases government’s to the Influence of lobbyists and other groups thar potentially leads to ‘governments playing, favourites’ (e.g. support to some workers/businesses/industries that have political influence) and ultimately leading to the increased livelihood of government failures.

11. The RBA intervened in the cash market by raising liquidity (i.e. increasing the supply of cash in the market) via the purchase of Commonwealth government securities from cash market participants. By making it increasingly attractive for cash market participants to sell securities to the RBA, the RBA effectively injects cash into the market and cash replaces government securities that were previously held by the cash market participants. The greater supply of cash in the market exerts downward pressure on the cash rate, and the RBA ensured that supply was increased enough to force the cash rate down to the new target cash rate of 1.5% (from 1.75%). The RBA responded in this way because inflationary pressures were benign in the economy at the time (e.g. headline inflation was below 2%) and the RBA was intent on stimulating the economy via a loosening of policy (which made the monetary policy setting very expansionary).

12. Again, the RBA will have relied on a number of indicators to make its decision at the time, with the major indicator being headline inflation, followed by a host of other indicators that provided a guide as to inflationary pressures going forward,such as weak wages growth and slower rates of economic growth overseas.

13. Cost of credit channel: The lower interest rates means that the cost of borrowing has fallen (and the return on savings is reduced). This is likely to have increased the incentive for households and businesses to increase their rates of borrowing to either fund consumption and/or investment given that the cost of servicing any loan will be lower than before (i.e. the price of loans has fallen and therefore the demand for loans increases). The resulting increase in consumption and/or investment demand results in more AD and economic growth than would otherwise have been the case. Asset values channel: The lower domestic interest rates will have increased the demand for assets across the economy, including properties and shares, which increases the ‘paper wealth’ of those economic agents (including households) who have money tied up in major assets like properties and shares. This added (perception of) wealth creates incentives for these economic agents to spend more money (e.g. households might increase the size of their mortgage given that the equity in homes has increased and use the funds to spend on goods and services) which adds to AD and economic growth.

14. The fact that household indebtedness has reached a very high levels is likely to mean that any given loosening of monetary policy will have less of an impact on stimulating AD and economic growth. This is because highly indebted households will be increasingly reluctant to borrow more money and instead use any further reductions in interest rates to pay off their existing debt more quickly. This means that the flow through to AD stemming from any monetary policy loosening will be more muted.