Understanding Unemployment, Inflation, Fiscal Policy, And Money Creation Is Essential For Writing An Essay.

Discuss about the BUECO5903 Business Economics. Demand-pull inflation happens when total demand and output are increasing at an unmaintainable rate and bring about intense pressure on limited resources and a positive output gap.

Unemployment Data Collection in Australia

Unemployment data is an essential indicator of labor market performance. The Australian Bureau of Statistics assesses unemployment levels by gathering data from periodic surveys of about 27,000 houses other than a range of hospitals, hotels, colleges, schools, prisons, and native populations in Australia (Abs.gov.au, 2018). Generally, data is gathered from about 53,000 persons, which forms a representative sample of the Australian populace (Abs.gov.au, 2018). Participants are not questioned whether they are without a job. Preferably, the Australian Bureau of Statistics utilizes trained interviewers or self-guided online survey tool to whether a person is without a job, based on the three criteria; aggressively looking for employment, presently available for work and without work. The Australian Bureau of Statistics then scales up the individuals in the survey sample, using the most current population statistics, to give a picture of the whole population. The unemployment information is printed monthly from the Labor Force Survey in Labor Force, Australia and is obtainable by many features including sex, age, marital status, country of birth, geography, and duration of job search. Whereas this method is widely used in other nations to determine unemployment rates, it has been criticized heavily for giving misleading statistics. First, there is a sensation that governments in some way influence the very definition of unemployment. Second, individuals who work one hour per week are categorized as employed whereas they should be counted as without a job. Third, many people work fewer hours than they would love to and this circumstance does not get calculated.

Q2 (b)

Shumon (2018) defines frictional unemployment as unemployment that results when people move from one job to another. In an economic structure where individuals are at liberty to change their works and where businesses may sack redundant or inefficient workers, it is t impossible to eliminate frictional unemployment, and can even be desirable. Nonetheless, friction unemployment can be reduced to a certain magnitude by conveying better information regarding available workers and job opportunities, and by human resources planning to facilitate workers to have the skills that are deemed essential by the economy.

Q3 (a)

Inflation is a continued upsurge in the overall price level that results in a fall in the purchasing power of money (Tutor2u.net, 2018). Inflationary gravities most of the times originate from external and domestic causes and both the demand and supply side of the economy. According to Schwarzer, (2018), cost-push inflation transpires when industries react to mounting costs, by raising their prices to shield profit margins. On a graph, cost-push inflation can be demonstrated by an upward (inward) shift of the SRAS. The fall of short-run aggregate supply curve leads to shrinkage of GDP in conjunction with increased price levels. A notable danger of cost-push inflation is recession.

Types of Inflation - Cost-Push, Demand-Pull

Demand-pull inflation happens when total demand and output are increasing at an unmaintainable rate and bring about intense pressure on limited resources and a positive output gap. When the demand in an economy is excess, manufacturers can increase prices and realize higher profit margins as they are aware that demand is increasing more than supply (Schwarzer, 2018). Demand-pull inflation is a threat to an economy especially when it has witnessed a great boom with GDP swelling at a rapid rate than the long run trend growth of possible GDP. The figure below illustrates demand pull vs cost pool inflation.

Q3 (b)

According to Schwarzer (2018), cost-pull inflation could occur for many reasons. First, due to a rise in raw materials and components prices. This could be catalyzed by an increase in global product prices such as copper, agricultural products and oil and gas products. Second, rising labor costs resulting from increase wages that surpass enhancements in productivity. Salary and wages cost frequently increase when unemployment is at minimal levels (leading to labor shortages) and when the public expect inflation and they end up bidding for greater remunerations to cushion their real incomes. Finally, cost inflation is also driven by greater indirect levies imposed by the government.  For instance an increase in the standard rate of Value Added Tax or an increase in the duty on cigarettes, alcohol, and diesel/ petrol. Based on the price elasticity of supply and demand, merchants can pass on the tax burden to the consumers.

On the other hand, the rise in aggregate demand that brings about demand-pull inflation can ensue from several economic undercurrents. For instance, a surge in government expenditure can intensify total demand, thus pushing up prices. Devaluation of local exchange rates is another cause of demand pull inflation. For foreigners, currency devaluation lowers the price of exports and increases the price of imports. Consequently, the purchasing of exports rises while the buying of imports falls, thus increasing the aggregate demand level. Rapid growth in overseas income can also flare up an upsurge in demand as exports consumed by foreigners increases. Lastly, reduction in government levies leaves consumers with more disposable income at their hands pockets. Accordingly, this raises consumer spending, thus pushing up aggregate demand and ultimately bring about demand-pull inflation.

Q4 (a)

Keynesians are critical on the reasonability that fiscal policy can play in stabilizing the economy. Specifically, the Keynesian model proposes that increased government outlays in a recession can support a more rapid economic recovery (Pettinger, 2018). On the other hand, Monetarist put emphasis on the significance of regulating the money supply to regulate inflation. On the other hand, Monetarists emphasizes on the expansionary fiscal policy supposing that brings about crowding out or inflation and consequently is not useful.

Keynesian and Monetarist Debate on Fiscal Policy and Aggregate Supply

Q4 (b)

The supply-side macroeconomic discussion between monetarists’ and Keynesians has continued all through our post-modern time. The monetarists presume that the aggregate demand is fairly elastic, whereas the aggregate supply is inelastic concerning the expansion of price level and money supply (Chand, 2018). The monetarists plot the aggregate supply as a vertical straight line, inferring that the changes in the quantity of money (M) produce no effect on real output or the level of employment. In contrast, Keynesians theorize that the aggregate supply is fairly more elastic, “even more than the elasticity of the aggregate demand to the price level” (Chand, 2018). Accordingly, when the government spending (G) or the money supply (M) rises through deficit financing or otherwise, it will yield a healthy effect on output and employment level, as unutilized resources would be triggered into productive usages till the economy attains the full employment level. Fig. 1 (a) and (b) clarifies these argument.

Q6 (a)

The axiom banks create money conveys an erroneous picture of the role of banks in the money creation process. Basically, banks play an intermediary role between sellers and buyers, for instance, a transaction concerning the purchase of a house (Vivian, 2018). Notwithstanding, the Reserve bank of Australia introduces typically new monies into the system by printing new money to buy products from member banks (Vivian, 2018). The central bank can buy whatsoever it chooses. It naturally buys government bonds. Upon receiving the new currencies, backs can loan the cash out. A minimum reserve ratio stipulates how much money a bank has to possess on hand (Vivian, 2018). For instance, a reserve ratio of 15% implies that the bank must keep $15 for every $150 in loans.

Q6 (b)

 Creation of credit money is the most essential role of a commercial bank. Money creation or Credit creation denotes the ability of the commercial banks to contract or expand demand deposits by creating more investments, loans and advances (Vivian, 2018). Through giving out loans, a bank may receive the cash as new deposits and lend out this cash to generate more revenue and loans and so on. This becomes a basis for the creation of new loans and continuous new deposits, and the process is repeated till a bank cannot lend anymore. In our current scenario, given the cash by another bank to be deposited on a personal account gives room for the receiving bank to issue multiple loans using this money hence increasing money creation and eventually money supply in the economy (Vivian, 2018). A commercial bank, accordingly, can be appropriately defined as a producer of credit, which is capable of multiplying investments and loans and therefore deposits. Banks are thus able to create extra purchasing power to a substantial degree with less cash at the disposal. Through this process, banks are able to create credit.

Role of Banks in Money Creation

Q6 (c)

When an individual deposits $1,000 in his personal bank account, his or her bank does not retain all the amount but only a specific according to the standard reserve ratio in this case 10%. Therefore, the bank keeps $ 100 and loans out $900 to another person say A by creating new a credit account in her name. In addition, retaining 10% as minimum reserves as required by the central bank, the bank lends the rest $ 810 to person B; still keeping 10% to meet the standard reserve rate. 729 to C and so on, till $1,000 are exhausted. Thus, a primary deposit of $ 1,000 brings about extra deposits of $ 900 plus $ 810 plus $ 729 and so on. By summing up all the deposits, the bank gets total $9000. In this context, the cash reserve ratio was 10% or 0.1. Thus, the credit is $ 9,000. Thus, the credit amount that a bank can create is dependent on the reserve ratio. Briefly, the credit creation multiplier can be expressed as:

1/1-(1-rr) = 1/rr where rr is the reserve ratio

If the reserve ratio is 0.1, credit creation multiplier is 10, a reserve ratio of 1/8 will give the credit creation multiplier is 8.Based on these deductions, and the maximum amount that Westpack bank can lend from an original deposit of $ 1000 is $9000

Q7 (a)

No. The sales of government securities to commercial banks through central bank is meant to reduce money supply in an economy. This is because, the households are usually expected to deposit money with the commercial bank. Accordingly, commercial banks deposit this money with the central bank which can decide either to freeze thus regulating money supply.

Q7 (b)

Yes. An increase in government spending backed by borrowing from the banking industry increase money supply because government when the loan matures, the money is expected to accrue some interest rates. Besides, government expenditures creates a room for depositing and lending of new loans assuming that the entire money is spent on government projects.

Q7 (c)

Yes. A purchase of government securities by central bank is meant to increase money supply as commercial banks have large amounts of money to create loans. This is as a result of earned interest rates that the security usually attracts and the fact that households are highly expected to deposit the realized income with commercial banks.

Q7 (d)

No. The move would reduce money supply as the central bank through the commercial banks will be able to collect and freeze excess money in the market.

Reference List

Abs.gov.au. (2018). 6105.0 - Australian Labour Market Statistics, July 2014. [online] Available at: https://www.abs.gov.au/ausstats/[email protected]/Latestproducts/6105.0Feature%20Article53July%202014 [Accessed 29 May 2018].s

Chand, S. (2018). Controversy between Keynesian and Monetarist Views | Money Economy. [online] Your Article Library. Available at: https://www.yourarticlelibrary.com/economics/money/controversy-between-keynesian-and-monetarist-views-money-economy/26003 [Accessed 30 May 2018].

Pettinger, T. (2018). [online] Economicshelp.org. Available at: https://www.economicshelp.org/blog/1113/concepts/keynesianism-vs-monetarism/ [Accessed 30 May 2018].

Schwarzer, J. (2018). Retrospectives: Cost-Push and Demand-Pull Inflation: Milton Friedman and the “Cruel Dilemma”. Journal of Economic Perspectives, [online] 32(1), pp.195-210. Available at: https://www.aeaweb.org/articles?id=10.1257/jep.32.1.195 [Accessed 30 May 2018].

Shumon, Z. (2018). Why frictional unemployment is inevitable in the economy? Explain with argument.. [online] Zulfekarshumon.blogspot.co.ke. Available at: https://zulfekarshumon.blogspot.co.ke/2010/08/why-frictional-unemployment-is.html [Accessed 29 May 2018].

Tutor2u.net. (2018). [online] Available at: https://www.tutor2u.net/_legacy/blog/files/Revision_Causes_of_Inflation.pdf [Accessed 30 May 2018].

Vivian, R. (2018). Do banks really create money out of thin air?. [online] World Economic Forum. Available at: https://www.weforum.org/agenda/2015/06/do-banks-really-create-money-out-of-thin-air/ [Accessed 30 May 2018].