Stabilizing the Economy through Expansionary Monetary Policies

The assignment explores the concept of macroeconomic equilibrium, highlighting its role in stimulating economic growth. Expansionary monetary policy can increase aggregate demand by reducing interest rates or purchasing government securities and bonds, thereby boosting consumption and investments. Conversely, contractionary instruments can be employed when the economy is overheating. The Australian economy's ability to adjust quickly to external shocks demonstrates its stable equilibrium. Additionally, the use of fiscal and monetary policies can help the economy achieve macroeconomic equilibrium.

Running head: STABLE ECONOMIC EQUILIBRIUM
1
Stable Economic Equilibrium
Student’s name
Professor
Course
Date

STABLE ECONOMIC EQUILIBRIUM
2
Introduction
Economic equilibrium entails a condition in which economic variables are balanced. In
the absence of external shocks, the economic forces are known to remain unaffected from their
equilibrium state. Economic equilibrium is said to be stable if it recovers quickly through the
functioning of counteracting forces after the occurrence of an external shock. In an economy,
equilibrium is achieved at a point where the aggregate expenditure matches the real Gross
Domestic Product (Hubbard, Garnett, Lewis, & O'Brien, 2016). Therefore, this paper makes use
of the Keynesian cross model to analyze a stable economic equilibrium. The approaches
employed by the government to intervene in the economy are also discussed. Moreover, this
article seeks to assess whether the economy of Australia is at a stable equilibrium.
Stable equilibrium
Real Aggregate
Expenditure (EA)
Real GDP (Y)
Y=AE
AE
Equilibrium
Growing
production
Y2YeY1
Declining
production

STABLE ECONOMIC EQUILIBRIUM
3
Macroeconomic equilibrium takes place at Ye. At Ye, the aggregate expenditure equals
the real Gross Domestic Product, and it is the only level of production at where there is no
tendency to shift as the inventories remain unmoved (Blanchard & Johnson, 2013). If the
aggregate expenditure does not match the real Gross Domestic Product, then the firms in an
economy will adjust their output accordingly, and equilibrium will be attained. For example, at
point Y2, the real Gross Domestic Product exceeds the aggregate expenditure. The companies in
an economy will encounter an unplanned surge in the inventories, and therefore these firms will
respond by decreasing their production. On the other hand, at point Y1, aggregate demand
exceeds the real Gross Domestic Product. The businesses will experience an unplanned decline
in the inventories and will react by increasing their output (Boyes & Melvin, 2012).
Stabilization Policies
Stabilization policies incorporate the economic instruments employed by the government
to offset business cycles to ensure stable economic growth and low levels of unemployment and
inflation. During periods of recession and high unemployment, the government often employs
expansionary policies to accelerate economic activity (Arnold, 2013). On the other hand,
contractionary policies are deployed deal with inflationary growth.

STABLE ECONOMIC EQUILIBRIUM
4
Attaining Full Employment
Planned Aggregate
Expenditure (AE)
Real GDP (Y)
When there is inadequate aggregate demand, the equilibrium takes place below full
employment and thus the economy experience a contraction. As a result of weak demand, the
companies will reduce their workforce or freeze hiring leading to a rise in the unemployment
level. During such seasons, the government will intervene in the economy through expansionary
fiscal policies to boost the aggregate expenditure. For example, the government can increase its
spending on various schemes like infrastructure development and transfer payments (Boyes &
Melvin, 2012). Furthermore, the government can reduce the taxes to boost the net incomes of
businesses and households and thereby stimulate investment and consumption elements of the
aggregate expenditure. An increase in the total spending will direct the economy towards full
employment. On the graph above, this scenario is demonstrated by the shift in the aggregate
expenditure curve from AE1 to AE2.
Y=AE
AE2
AE1
AS
AE3
Yf
Potential GDP

STABLE ECONOMIC EQUILIBRIUM
5
When the total spending exceeds the real Gross Domestic Product, the economy will be
above the potential output. On the graph above, this situation is depicted by aggregate
expenditure curve AE3. According to basic Keynesian Model, when full employment is attained,
higher aggregate demand than real output results in higher prices in the economy. The nominal
output will rise, although it merely denotes higher prices, rather than further real output
(Blanchard & Johnson, 2013). Aggregate spending more than potential Gross Domestic Product
is inflationary. Therefore, the government can intervene through contractionary fiscal
instruments such as reduction in government expenditure or an increase in taxes to provide a
check on the excess demand.
Monetary Policies
Apart from the fiscal instruments, the government can also employ monetary policies to
stabilize the economy. During seasons of the economic downturn, expansionary monetary
policies play a major role in stimulating economic growth. For example, the government can
reduce the interest rates to encourage the households and businesses to borrow and thereby
increase both the consumptions and investments. The use of this policy was evident among many
advanced economies across the world during the Great Financial Crisis of 2008/2009. During
this Great Recession, the Reserve Bank of Australia reduced the cash rate from 7.25% to 3%, a
move that helped Australia to avoid recession (Scutt, 2017). The aggregate demand can also be
increased through the purchase of government securities and bonds. On the purchase of these
assets, the government increases the amount of money in circulation and thus a growth in
investments and consumption.

STABLE ECONOMIC EQUILIBRIUM
6
AS-AD model
Price level
Real GDP (Y)
Increase in consumption and investment due to expansionary monetary policy is shown
by the shift in the total demand curve from AD to AD1. This change results in an increase in the
real Gross Domestic Product from Y1 to Y2. The prices in the economy will also increase. On
the other hand, when the economy is overheating, the government deploys contractionary
instruments. For example, the government can either raise the interest rates or sell bonds and
securities (Goodwin, Nelson, & Harris, 2014).
Australian Economy
The Australian economy expanded by 0.8% in seasonally adjusted during the June
quarter of 2017. In the same quarter, the changes in inventory dropped to $-519 million
compared to $1476 million of the March quarter of 2017 (Australian Bureau of Statistics, 2017).
AS
P2
P1
AD1
AD
Y1 Y2

STABLE ECONOMIC EQUILIBRIUM
7
Therefore, in March quarter, the companies in Australia encountered an increase in unplanned
inventory, and they responded by reducing production, and that is why the stock fell by $1995
million. This scenario exhibits that the Australian economy is in a position to restore quickly if
disrupted and hence it is at a stable equilibrium.
Conclusion
A stable economic equilibrium is one which recovers quickly through the functioning of
counteracting forces after the occurrence of external shock. Macroeconomic equilibrium is
attained at the point where the aggregate expenditure equals the real Gross Domestic Product.
When the economy is operating below potential output, the government makes use of
expansionary fiscal and monetary instruments for stimulating economic growth. On the contrary,
when the economy is overheating, the government will employ contractionary instruments.
Ultimately, the ability of Australian economy to adjust to external shocks shows that the
economy is at a stable equilibrium.

STABLE ECONOMIC EQUILIBRIUM
8
Bibliography
Arnold, R. A. (2013). Economics. Mason, Ohio: South-Western.
Australian Bureau of Statistics. (2017, September 6th). 5206.0 - Australian National Accounts:
National Income, Expenditure and Product, Jun 2017. Retrieved September 12th, 2017,
from Australian Bureau of Statistics:
http://www.abs.gov.au/ausstats/abs@.nsf/Latestproducts/6416.0Main%20Features2Dec
%202016?opendocument&tabname=Summary&prodno=6416.0&issue=Dec
%202016&num=&view=
Australian Bureau of Statistics. (2017, September 4th). 5676.0 - Business Indicators, Australia,
Jun 2017. Retrieved September 12th, 2017, from
http://www.abs.gov.au/ausstats/abs@.nsf/mf/5676.0
Blanchard, O., & Johnson, D. R. (2013). MACROECONOMICS. Boston : Pearson.
Boyes, W. J., & Melvin, M. (2012). Macroeconomics. Mason, OH: South Western.
Goodwin, N. R., Nelson, J. A., & Harris, J. (2014). Macroeconomics in context. Armonk, New
York: M.E. Sharpe.
Hubbard, R. G., Garnett, A., Lewis, P. E., & O'Brien, A. P. (2016). Essentials of economics (3
ed.). Melbourne, Victoria: Pearson Australia, [2016].
Scutt, D. (2017, Feb 6th). Why Australian interest rates are unlikely to return to pre GFC levels.
Retrieved September 12th, 2017, from Business Insider:

STABLE ECONOMIC EQUILIBRIUM
9
https://www.businessinsider.com.au/why-australian-interest-rates-are-unlikely-to-return-
to-pre-gfc-levels-2017-2