Macroeconomic Factors and the Role of Government

Running head: MACROECONOMICS
MACROECONOMICS
Name of the student
Name of the university
Author’s note

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Executive summary
The project aims at studying the different macroeconomic factors and the role of government
intervention in the economy to bring the economy towards equilibrium. It takes example of
‘Australia’s recession’ during period of 2018 to 2019 to understand the role of government
intervention. It concludes that the fiscal and monetary policies are the crucial measures adopted
by the government and central bank to deal with the economic recession.

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Table of Contents
Introduction......................................................................................................................................3
Discussion........................................................................................................................................4
Government Intervention in economic inefficiency....................................................................4
Keynesian economic theory.........................................................................................................5
Government intervention to revive the economy........................................................................9
Conclusion.....................................................................................................................................12
References......................................................................................................................................13

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Assessment 1
Introduction
Macroeconomics is an economic branch which studies the overall performance of the
economy. It studies the reasons for major impacts on the economy, resulting in inflation,
unemployment, a decline of the production and per-capita income. Macroeconomics studies the
aggregate demand and supply variables. It studies the whole economy rather focusing on
individual business concerns. It studies the level of growth, employment, government
expenditure, the balance of payments, consumption, investment and saving functions of the
economy as a whole. The objective of macroeconomics is to maintain the equilibrium of the
economy. Managers find it difficult to consider all the macroeconomic variables at the same time
while making decisions. Appropriate decision making makes a business successful. The decision
of selection of resources, the scale of operation, location of operation as well as marketing of any
product, involves consideration of macroeconomic variables. Decisions of managers are affected
by the macroeconomic variables like inflation, interest rate, industrial policy of the country, the
trade policy of any country etc. the level of aggregate demand and supply of the economy affects
the growth of any business in the market and thus affects the managerial decisions also
(Coughlin, 2018).
The aggregate demand and the aggregate supply are used as the basic model for studying
the economic factors impacting the economy. When an economy sees a recession, then the
equilibrium falls below the potential GDP to a large extent. The pressure created by inflation can
deviate the equilibrium of the economy, and the price of the goods may rise or fall. When the

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economy sees the economic growth for the long term, it increases the production level and shifts
the aggregate supply curve towards right. However. When an economy sees recession for a short
run, the real GDP is lesser than the potential GDP of the country (Eaton et al., 2016).
Discussion
Government Intervention in economic inefficiency
Government intervene in a macroeconomic environment when it sees there is the
existence of inefficient market. The market is unable to perform at its optimum capabilities.
Recessions and inflations are an inseparable part of a business cycle. However both can have
adverse effect on the economy. Government intervenes in the economy using its policies of
subsidies and tariffs. Through subsidies and tariffs, government try to manipulate the money
supply in the market. Secondly, the government can also intervene in the market when it sees
that there is social inequality prevailing in the market. In this situation, the government come up
with their welfare schemes for improving social equality (Yagan, 2019).
The use of tariffs, subsidies, quotas for imports is used to protect the domestic industries from
foreign competitions. This is a contradiction to the free trade theory, which says economy
benefits when there are less restriction and free trade is happening between countries (Bianchi &
Melosi, 2017).
Subsidies- these are the money given to entities so that the government can lower the price of
the goods or services produced by them.
Tariffs- a tax or a duty which is payable on the imports and exports of a country. Tariffs on the
exports is an expense for the country while the tariff on the imports is an income for the country
(Jansa & Gray, 2017).

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Keynesian economic theory
This theory was developed by a British economist in the 1940s. His name was John
Maynard Keynes. He developed many types of research based on wartime economies. He is the
man who helps in the formation of the International Monetary Fund and the World Bank. He
developed an economic theory which shows the importance of government intervention for
reviving an economy which is facing the recession phase. He studied different phases of the
business cycle and observed the boom and bust phase of the economy closely. Keynes conveyed
the main elements that need major government attention through his economic theory. These
elements are tax rate, interest rate and social programs (Xiang & Worthington, 2017).
As per his theory, the major elements are discussed below:
Interest rate- The interest rate is the cost of borrowing funds. It plays a major role in the
formulating economic policy. The theory argues that the central bank of a country should
increase the rate of interest. The increasing interest rate will generate income for the lenders. It
helps the government to control the investment function of the economy during the boom phase.
It is important because if the investment is excess in the public and private sector, there is less
circulation of money and money supply will decrease (Floetotto, Kirker & Stroebel, 2016). The
theory also explains that increasing interest rate may increase the cash reserves, and it will help
the government to revive the economy at times of recession. However, lowering the interest rate
implies that the central bank wants to encourage the borrowing and increased rate of investment

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would help in increasing the production level of the economy. This will help to revive the
economy during the recession (Corsetti et al., 2019).
Tax rate – as per the Keynesian economic theory, the government should increase the income
tax rate during economic boom or growth. This helps the government to increase its revenue.
The increase in government revenue will help the government to invest in the welfare and social
projects like healthcare programs etc. During the recession, the government should decrease the
rate of personal tax and corporate tax, so that private and public sector entities can increase their
investment in various projects. This will help in increasing economic growth (Barr, 2020).
Social programs- As per the theory during the boom period, the government should lower its
investments in social upliftment projects because society does not need such spending from the
government side. There is sufficient circulation of money. Employment is at the optimum level.
There is a minimal rate of unemployment. The workforce is optimally utilized. However, during
the recession, the government should increase its expenditure on social and welfare projects. It
helps the government to increase the efficiency of the labour force so that the businesses do not
employ more labours and increase the cost of production. The economy facing recession can
easily revive with the presence of a skilled workforce (Mankiw, 2020).

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Source: Chiarella & Guilmi, 2017
In the above diagram, Eo shows the level of recession and E1 shows the equilibrium level
of GDP. The fluctuation in inflation rate in the short term recession can be influenced by the
involvement of the government. The inflationary pressure can put pressure on the demand curve
and the supply curve. The frequent inflationary pressure can raise the prices or decrease the
prices resulting in an increased level of equilibrium. The recession is generally controlled by the
government by adopting two types of fiscal policies, either expansionary monetary policy or
contractionary monetary policies. The expansionary fiscal policies help the government to
increase the consumption level by increasing the level of disposable income of the public
(Kapeller et al., 2018). The government achieves this by cutting down the personal tax rate and
diminishing the corporate tax rate. The taxable profit of the company will help to increase the
investments of the business by improving its net income after tax. The contractionary fiscal
policy is different in its approach. By adopting a contractionary policy, the government decreases
the aggregate demand and decreases the investments by the business groups. It is the level of

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aggregate demand and aggregate supply that determines the fiscal and monetary policies adopted
by the government to control the effect of the recession (Chris-Ejiogu, Emmanuel & Awa, 2019).
The fiscal policy of government expenditure, including the taxation policy, helps it to change the
economic condition. All types of government spending under the fiscal policy can change the
funds raised through taxation and lastly shifts the aggregate demand towards the right side that
moves the demand curve outward in the graph in case of expansionary policy. However, it
moves the demand curve inward in case of a contractionary policy.
In the above diagram, it is evident that in a growing economy, equilibrium moves upward. The
economy tries to produce the potential GDP, and thus the equilibrium rises from E0 TO E1 and
then E1 to E2.
Apart from using the fiscal policies government also uses monetary policy to control the
impact of the recession and revive the economy. The objective of the monetary policies is to
control the inflation in the economy, manages job opportunities and interest rate. The objective
of keeping the inflation rate is around 2% and keeping the unemployment rate between 3% to 5
%. A general difference between the fiscal policy and the monetary policy is that the monetary

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policy influences the money supply of the economy. In contrast, the fiscal policy uses the tax rate
etc. change the economic aggregate demand and aggregate supply. Government spending can
create demand in the economy and again restart the economy from a deep recession. In situations
of recession. The government cannot rely upon only the monetary policies, but it executes fiscal
policies altogether (Dell'Ariccia, Laeven & Suarez, 2017).
Government intervention to revive the economy
The continuous trade war between USA and China is having a direct impact on the
Australian economy. The result of the dispute between two major developed countries may have
impacts that can be controlled by the Australian government for the short run. However, if the
trade war continues, it can lead the Australian economy huge loses in the long run. The trade war
started between the two nations over the tariff charges of steel and iron. The increased tariff rates
by the US and china for each other impacted both the countries (Gaghman, 2020). It decreased
the demand for Australian goods in both countries. Since these two countries are the major
importer of Australian exports, the trade war affected the Australian economy adversely. The
demand for the Australian iron ore and wheat also fell as they were represented in dollars, and
the trade war inflated the price of these commodities too. Moreover, the US started competing
with most of the Australian goods that exported to Europe because it stopped exporting to china
and was searching for new buyers. This hit the Australian suppliers a lot, and they suffered a loss
(Floetotto, Kirker & Stroebel, 2016).
The Australian economy has seen a downturn in the financial year 2018-19. The main
reason for the recession in the economy was the losses suffered by the housing sector. The
reason of economic recession may be one, but the result of it was on many. It led to the loss of
employment opportunities, low per-capita income and the GDP of the country was also declined

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to a significant extent. The US-china trade dispute brought many challenges in front of the
Australian economy. There was major uncertainty in the investment in the Australian housing
business. This resulted in a decrease in the prices of housing in different overseas market in
Australia that is Melbourne and Sydney (Ezcurra & Rios, 2019). The measures taken by the
government to revive the economy are as follows:
Cut on the interest rate by reserve bank of Australia- The reserve bank of India cut the
benchmark rate of interest to 1% point which was considered to be the lowest cut by the reserve
bank of Australia in the financial records. The RBA firstly cut the rate in the year 2016 and then
continue adopting the method to deal with the economic recession. The lowest cut of interest rate
by RBA was an indicator of the slow and weak performance of the Australian economy. The
newer projects of construction reduced. The demand decreases to a significant level with the fall
in prices of houses drastically (Chiarella & Guilmi, 2017). The output level also steady decline
till March 2019. The Australian economy saw a negative growth rate in particularly this
economic recession (Yang, 2017).
Source: Australian Bureau of statistics

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Although the government intervene in a critical situation to revive the economy. The
Australian Prudential Regulation Authority (APRA) improved the credit facilities for the housing
owners and investors. One of the steps was already carried out by the RBA by decreasing the
interest rate to 25 and 50 basis points consecutively in the year 2018 and 2019. The government
of Australia brought a new scheme to increase the spending on the housing sector. The
government scheme was named as First Home Loan Deposit Scheme. In addition to it, the
government cuts the rate of taxation and also lower the repayments of mortgage lending. Due to
the cut down in the tax rates, Australians got huge tax refunds, and the lower payments of the
mortgage loans improved the level of disposable income held by the public. The increase in
disposable income helped the country in improving and increasing the consumption function of
the Australian economy. The result of the fiscal measures adopted by the Australian government
increases the consumer spending, and thus the aggregate supply of the economy soon adopted
the normal pace by March 2019. The reason for immediately taking the normal pace by an
economy which has recently seen the downturn was the young population of the country of a
developed economy. In addition to the fiscal measures taken by the government. It also increased
public expenditure. The Australian government supported the investment function of the
economy by contributing large spending on the construction sector. By adopting measures like
fiscal and monetary policies, the government of Australia helping its economy to revive and
bringing it back to the equilibrium level. though it is a long process, government intervention
helps significantly to support the domestic businesses when they face tough competition from
foreign business and get affected by any international trade war.

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Conclusion
Macroeconomics plays a significant role in managerial as well as government decisions.
The decisions of government concerning the industrial and trade policy determines the economic
health of the country. The paper concludes using Keynesian economic theory that the
intervention by the government is important during economic inefficiency. The boom phase and
bust phase of the business cycle are inseparable. The role of government is to come up with
appropriate measure to stabilize the inflation of the economy which is an effect of recession. The
paper studies the importance of tariff and subsidies and how government uses these as a measure
to revive the economy and bringing balance to it. Thus it can be concluded that government
generally uses expansionary fiscal and monetary policies in case of recession. In case of
Australian economy, the government intervene through the fiscal policy and the monetary
policies which are exactly the expansionary and the contractionary methods. The government of
Australia increased its public spending so that the disposable income of the public may increase
to increase the consumption level. In addition government used taxation policies and the central
bank used the interest rate policies to deal with the recession seen by the economy. It is evident
that government also face difficulty in deciding the exact tax and interest rate to be applicable in
these situation and continue evaluating their steps whether they are running the economy on right
path, if not they change the policies or come up with other measures.

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