ECON 3011: Macroeconomic Policy Assignment on Growth and Inflation

This assignment solution addresses key macroeconomic concepts, including the Malthusian growth model and the Reserve Bank of Australia's (RBA) inflation targeting framework. The Malthusian model's features, assumptions, and weaknesses are examined, along with its advantages and relevance to policies like China's one-child policy. The solution then explores the RBA's inflation targeting approach, outlining its features, benefits, and costs. The assignment analyzes the RBA's monetary policy decisions, considering the economic stimulus during COVID-19 and potential inflationary pressures. It discusses how the RBA would respond to economic overheating through contractionary monetary policy or, conversely, stimulate economic activity through cuts in policy rates. The content provides a comprehensive overview of the Malthusian model, inflation targeting, and the RBA's role in managing economic stability.

Question 1
a) The key features of Malthusian Growth Model are stated below.
 Improvements in technology would lead to higher population but would not lead to
improvement in standards of living. Thus, even if there is a sudden improvement of
technology, this would not impact the standards of living.
 The production function is based on fixed capital (K) and labour N which can be
represented using the following function.
.
 There is a relationship between population growth and standard of living as
represented by the following equation.
As a result, birth control policy plays a vital role in determining the standard of living
 The capital essentially remains fixed as it is assumed that no capital accumulation
takes place over time.
b) The one child policy adopted by China can be justified on the basis of Malthusian growth
model since in this model the population growth driven by the child policy plays a crucial
role in determining the population living standard.
An important relationship which highlights the role of population policy is indicated as
follows.
In the above equation, child policy impact is captured by the variable γ

A change in the child policy such as adoption of one child policy would lead to a decrease in
the variable γ. This in turn would imply that the right hand side of the above equation would
tend to become smaller.
This implication of this would be that Nt+1<< Nt.. There is a decrease in the steady state
population which in turn would lead to an increase in the standard of living as evident from
the following graph.
c) The key weaknesses of the Malthusian growth model are outlined below.
 Wrong assumptions – A host of assumptions which have been made by the model
have been empirically proven false.
1) The model indicates that improvement in technology does not lead to
improvement in standard of living. However, technological advancements ever
since the advent of industrial revolution has led to improvements in the standard
of living of people.
2) The model is based on the assumption that capital stock remains fixed which
infact is not true as has been empirically demonstrated over the last 200 years
where immense capital accumulation has happened. Malthius failed to consider
the impact of savings on the overall growth which essentially led to the Solow
growth model.

3) The population dynamic assumed is also too simplistic. In reality, with the
improvement of the standards of living, the birth rate has not increased but
decreased which has not been considered by the given model.
 Owing to these incorrect assumptions, the Malthusian model has limited practical
utility in the current economic realities and more superior models are used for
estimation of growth.
Despite the limitations and shortcomings of the Malthusian growth model, there are certain
key advantages which are summarised as follows.
 This was essentially the first model of economic growth which was predicted and the
subsequent models such as Solow model are essentially modifications of the
Malthusian model so as to rectify the unrealistic assumptions considered by Malthius.
 Owing to the simplistic assumptions taken in this model, the application of this model
is not difficult making it easier to understand in comparison with other models that
have more complex due to a more variables involved.
Question 4
a) The key features of the inflation targeting approach by RBA are indicated as follows.
 The inflation target for the economy has been kept between 2-3% p.a.
 The RBA does not aim to necessarily achieve this inflation on a quarterly or
monthly basis but takes a more flexible approach whereby this target has to be met
over the complete business cycle.
 The RBA uses a host of policy decisions and other tools to ensure that inflation is
met while focusing on sustainable economic growth.
 The RBA meets eleven times in a year to take suitable monetary policy decisions
which are required to ensure growth along with keeping inflation within the
declared target.
b) The various benefits of inflation targeting are indicated below.
 Since there is a defined inflation target, hence it is easier for the investors to
predict possible RBA policy decisions in the future and RBA can justify the same

 There is stability in inflation and associated targets.
 RBA can focus on the requirements of the domestic economy which would not be
possible in exchange rate targeting.
 RBA can acts credibly and maintain independence from politicians since the
decisions can be justified more easily.
 Inflation targeting has been quite successful in negating various crisis that the
Australian economy has faced over last several years.
The various costs of inflation targeting are indicated below.
 Inflation targeting results in higher focus on inflation and lower focus on
economic growth which is not correct as it violates their mandate which gives
equal importance to both.
 Asset price inflation is often ignored by RBA.
 Inflation targeting works well the aggregate demand related shock but tend to fail
in case of aggregate supply shocks.
 There may be concerns about suitable inflation rate to be targeted especially
during recessionary periods. Low inflation targets can potentially lead to higher
real interest rates.
c) In wake of the falling incomes and aggregate demand during COVID 19, there is
economic stimulus which is being provided by the Australian government. It is expected
that more income support and financial incentives would be provided in the near future.
This could potentially result in an overheating economy in the near to medium future
which can result in an inflationary environment driven by higher aggregate demand. In
order to counterbalance this, intervention from the RBA would be expected in 2020-2021.
Based on their mandate of inflation targeting, the RBA would need to consider the economic
data and inflation numbers for the recent past coupled with the likely economic scenario both
domestically and globally in order to make policy decisions. In case, the RBA sees that the
economy is overheating, it will tend to adopt a contractionary monetary policy where policy
rates would be increased so that the cost of capital may increase. On the contrary, if the
economy continue to experience deflation and lacklustre economic growth, then RBA would
need to assist with further cuts in policy rates so as to encourage the banks to lend and
thereby enhance economic activity in the country.