The Impact of Fiscal and Monetary Policies on Investment in Australia

This report analyzes the impact of Australian fiscal and monetary policies on investment levels, focusing on the relationship between interest rates, aggregate demand, real GDP, and the overall economy. The introduction explains that fiscal policies involve government spending and taxes, while monetary policy is influenced by the Reserve Bank of Australia (RBA) through the money supply or cash rate. The report highlights how a reduction in government expenditure (contractionary fiscal policy) can negatively impact investor confidence, prompting a policy mix. The discussion emphasizes the effects of low-interest rates on investment, arguing that lower rates make it cheaper for investors to acquire capital, thus stimulating business expansion and reducing the incentive to save. The report also uses the Keynesian cross model to illustrate how rising investment shifts the aggregate demand curve, affecting real GDP and price levels. The conclusion underscores the importance of maintaining investment levels and the role of government spending in sustaining investor confidence, while low-interest rates encourage investment, increase aggregate demand, and boost real GDP and price levels. The report provides several references to support the analysis.

Running Head: Australian Macroeconomic Policies
The Impact of Australian Fiscal and Monetary Policies on Investment
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Australian Macroeconomic Policies 2
The Impact of Australian Fiscal and Monetary Policies on Investment
Introduction
Fiscal policies are government direct policies which involves either an increase or
decrease in either the government spending or taxes. The monetary policy is the influence of the
economy done by the government through the RBA; it involves either an increase or decrease in
either money supply or the cash rate. In this case, the reduction in the government expenditure is
a contractionary fiscal policy. Since this is negatively impacting the investors’ confidence and
the government need to reduce its budget deficit, it employs a policy mix. This is where both
fiscal and monetary policies are employed simultaneously. The monetary policy used is
expansionary; the negative impacts of the contractionary fiscal policy are neutralized by the
positive impacts of expansionary monetary policy. The major concern depicted on this paper is
how the policies influence the Australian investment level. The investment level is expected to
rise and impact the real GDP and the price level; this will also be discussed. Various models will
be used in ensuring that the discussions are self-explanatory.
Impact of Low Interest Rate on Investment
There will be an increase in the Australian investment level when the interest rate falls.
This is because interest rate is an important determiner of the availability of capital that is
demanded for investment; it is actually the cost of obtaining capital (Ivan, 2017). A lower
interest rate means that investors will pay a small extra charge on the use of money (Pettinger,
2016). This low servicing costs makes it attractive for the investors to seek loans that are used for
starting new businesses and also for expanding the existing businesses. Duff (2017) noted that
business watch business cycles and only consider expansions when interest rates are lower
because they consider it cheaper to do so than when interest rate is higher. When the cost on
acquiring capital is very high, investors are very cautious in its spending; they are not ready to
risk the money on investments that are deemed to be risky. This explains why there is low
investment rate in any economy whenever the interest rate is high. The other important factor
that explains the changes in the investment rate from a lower interest charge is the saving rate.
During a period of high interest rate, the income received from the savings is very high and thus
households and investors prefer saving to investments (Fry, 2016). Investment and saving has a
negative relationship; an increase in any results in a decrease on the other one. During a period of
low interest rate, the income received from savings is too little to induce the households to save.

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In this case, they prefer investment to savings and thus the investment level goes up. According
to Johnston (2017), businesses spend their money on plant expansion and buying of new
equipment when the interest rate is low because there is less benefit from investing in interest-
bearing accounts.
Impact of Rising Investment on Aggregate Demand Curve, Price and Real GDP
According to Sexton (2015), the aggregate demand curve is determined by summing up;
consumption, investment spending, government spending and net exports (exports minus
imports). AD = C + I + G + (X – M). Whenever there is a change in any of these components,
the aggregate demand curve is made to shift either to the left or right. The relationship between
the economy’s aggregate demand and its real GDP is illustrated by using the Keynesian cross
model. This model elaborates clearly how the demand curve shifts. The price level is determined
by the aggregate demand level; a higher aggregate demand results in price rising whereas a low
aggregate demand results in low prices
Fig: Keynesian cross model illustration of the shift in Aggregate demand curve.
AD
AD = Y
B AD2 = C + I + G + (X – M)
AD1 = C + I + G + (X – M)
A
45o
Y1 Y2 Real GDP
The demand curve before the cut in the interest rate is AD1, the real GDP level initially
was Y1 and the economy was at point A. The arrows shows the direction of change that occurs in
this model. The cut will result in an increase in the investment component of the demand
equation; the Aggregate demand curve rises and the initial demand AD1 shifts to a new
Aggregate demand curve AD2; this is a move to the right where Aggregate demand is greater

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than the real GDP (Bénassy, 2011). The graph also shows the changes is real GDP after the shift.
The new equilibrium point B is associated with a higher level of real GDP; Real GDP rises from
Y1 to Y2 (Mceachern, 2011). Generally, an increased level of aggregate demand results in a rise
in the price level.
Conclusion
Investment level influence many macroeconomic indicators and thus should be
maintained at a higher level. Government spending is also essential in maintaining investors’
confidence. A cut in government spending results in a loss on investors’ confidence. The
improvement of government deficit requires a multiple of policies to facilitate the same; this is
why most economies are being faced with the issue of increasing government’s deficit. Low
interest rate stimulates the economy by enabling the investors to access cheap capital which is
used in boosting the investment level. When the level of investment rises, the aggregate demand
also rises. The increase in investment creates many jobs, more people are employed and
consumer spending rises. An increase in Aggregate demand results in an increased level of real
GDP. Other than real GDP, there is also an increase in the price level.

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References
Bénassy, J. (2011). Macroeconomic theory. New York: Oxford University Press.
Duff, V. (2017). How Do Interest Rates Affect Businesses? [Online] Smallbusiness.chron.com.
Available at: http://smallbusiness.chron.com/interest-rates-affect-businesses-67152.html
[Accessed 8 Oct. 2017].
Fry, R. (2016). Low Interest Rates are Hurting Growth. [Online] Forbes.com. Available at:
https://www.forbes.com/sites/realspin/2016/10/04/low-interest-rates-are-hurting-growth/
#44adb12db605 [Accessed 8 Oct. 2017].
Ivan, I. (2017). Do lower interest rates increase investment spending? [Online]
Investopedia.com. Available at: http://www.investopedia.com/ask/answers/101315/do-lower-
interest-rates-increase-investment-spending.asp [Accessed 8 Oct. 2017].
Johnston, K. (2017). The Effect of Interest Rates on Business. [Online] Smallbusiness.chron.com.
Available at: http://smallbusiness.chron.com/effect-interest-rates-business-69947.html [Accessed
8 Oct. 2017].
Mceachern, A. (2011). Macroeconomics. Mason, Ohio, South-Western.
Pettinger, T. (2016). Effect of lower interest rates. [Online] Economicshelp.org. Available at:
https://www.economicshelp.org/blog/3417/interest-rates/effect-of-lower-interest-rates/
[Accessed 8 Oct. 2017].
Sexton, R. (2015). Exploring Macroeconomics. 7th ed. Australia: Cengage Learning.