The case of GFC in Australia (2008-2009)
In September 2008, Lehman Brothers, the fourth largest investment bank in the United States, collapsed leaving a huge debt. This triggered a global financial crisis that in turn had a massive negative effect on output in many countries. For example, car sales dropped by around 40% in the major economies, and world trade contracted by 25% on a quarter. What action was undertaken in Australia?
This had three main elements.
First, at the end of 2008 $10 billion was given in cash handouts to families who were receiving welfare payments and to pensioners. To the extent that these were spent, for a significant proportion were used to pay off debt or were saved, consumer spending and hence aggregate demand rose.
Second, in February 2009, a $42 billion increase in government capital expenditure was announced. Because there was clearly an inadequate number of major investment projects ‘ shovel ready’, about a quarter of the stimulus was allocated to schools by, put simply, building an extra library or gymnasium in most schools. This provided an immediate boost to the construction industry. Inevitably, given the speed with which the policy was implemented, there was some waste and duplication and the media had a field day highlighting this. The largest part of the $42 billion was spent on infrastructure – notably ports and transport. Because it takes considerable time to plan and design a new port, for example, this expenditure was spread over several years.
Third, In April 2009, each person who had paid tax in the previous financial year was sent a cheque for $900, at a total cost of $8 billion. This provided a further boost to consumer spending.
It was estimated that the total package amounted to 4.9% of GDP, making it, proportionally, one of the largest stimulus packages in the world.
The effect on the budget balance was dramatic. In the first half of 2008, there was a budget surplus of $19 billion; in the first half of 2009, there was a budget deficit of $22 billion. The budget was forecasted to remain in deficit for at least 6 years. The deficit will have to be met by borrowing and hence will be a crowding-out effect. Interest rates will be higher than would otherwise have been the case, which will have a negative effect on private sector expenditure, Fears were also expressed that the fiscal stimulus would continue even when the economy was approaching full employment again --- illustrating the problem of timing effect of the fiscal policy.
In many advanced countries, there were financial collapses and banks received large scale government support. Although this was not the case in Australia, the government guaranteed all bank deposits of less than $1 million. This was designed to prevent any panic withdrawal of the funds from the banks.
The Reserve Bank pursued an aggressive monetary policy. In September 2008 the cash rate was 7.25%. In succeeding months, the rate was reduced --- in one case by a historically large cut of 1.00% --- to reach 3% in April 2009. The banks did not pass on all of the cash rate reductions to borrowers. Nonetheless, the interest rate charged on variable rate home loans fell by 3.8%. The interest rate on business loans fell by around 3%. These reductions increased consumer spending as borrowers’ interest payments fell.
There was therefore a very large fiscal and monetary stimulus in 2008/09. It seemed (in early 2010) as if this had led Australia avoiding a recession, almost alone among advanced economies. GDP did not decline in 2008/09. Other factors were at work, however, notably the continued high rate of economic growth in China that boosted exports.
The case of COVID 19 in Australia (2020)
Impact of COVID 19 on the Australian economy (RBA)
The outlook for the Australian and global economies is being driven by the COVID-19 pandemic. The necessary social distancing restrictions and other containment measures that have been in place to control the virus has resulted in a significant contraction in economic activity, but economic conditions will improve as the pandemic is brought under control and containment measures are relaxed.
Global GDP is expected to fall sharply in the first half of 2020. The declines in the March quarter were driven by a contraction in Chinese and euro area activity as well as the rollout of containment measures elsewhere late in the quarter. A further fall in global GDP is expected in the June quarter, with many countries expected to record quarterly declines in GDP.
The Australian economy is expected to record a contraction in GDP of around 10 percent over the first half of 2020; total hours worked are expected to decline by around 20 percent and the unemployment rate is forecast to rise to around 10 percent in the June quarter. Inflation is expected to be negative in the June quarter largely as a result of lower fuel prices and free child care.
Fiscal Policy Responses
Over the past month, the Federal Government has announced an unprecedented fiscal injection of $194 billion (almost 10 percent of GDP) consisting of $39 billion directly to the business, $25 billion to households and the $130 billion Job-Keeper payment to support business and households through the COVID-19 shutdown.
Monetary Policy responses
The Reserve Bank of Australia has reduced the cash rate to 0.25%
In June quarter 2020 Australian GDP growth fell by 7%, the largest quarterly fall on record since 1959. This follows a fall of 0.3% in the March quarter. The unemployment rate rose to 7.5% in July 2020. In June 2020 the annual inflation rate was -0.3. The event is still on-going.
Complete the following 4 tasks
1.Use the ADAS model to illustrate the impact of the GFC on the Australian economy. In particular, you need to show (1) the possible outcome without policy responses, and (2) the effect of the fiscal and the monetary policy responses.
(Identification of the components leading to AD decreases 5 Marks and the impact of the fiscal policy leading to increases in AD 5 marks)
2.Use the ADAS model to illustrate the impact of COVID 19 on the Australian economy. Comment on whether the illustrations in your DADS model are consistent with the data that are available on the ABS website. In particular, you need to consider the data of C, I, G, X, M, the unemployment rate, the inflation rate, and interest rate.
3.Use the ADAS model to illustrate the possible effects of the fiscal policy responses and the monetary policy response to COVID 19 which are described in the case study above. Discuss how the policy responses will impact each component of the aggregate demand and what will be the intended effect.
4.Compared to the successful policy responses to the GFD from 2008 to 2009, what are the main differences in policy responses to the impact of COVID 19? Discuss in particular the domestic and international preconditions before the event of COVID 19, the size of the policy responses, and their effects on the outcome of the policy responses.