Modern Monetary Messaging
Updated: Jul 28, 2021
So it's Unit 4, you're working through Area of Study 1, you get up to Monetary Policy and you learn that the RBA always aims to 'fight inflation first'. Then because you're a student that is wise beyond their years, you go to the RBA's website and you read the recent statements on monetary policy and find out 'hey, wait a minute! They're not targeting inflation at all at the moment! They lied to us through our curriculum!'
If Monetary Policy is supposed to fight inflation first as it is seen as a pre-condition to achieving the other domestic macroeconomic goals, then why are the RBA currently turning their focus to unemployment?
As you've either learned or will soon learn, one weakness of monetary policy is that although it is incredible at slowing down economic activity in a peak or boom, it is far less effective at stimulating economic activity during a contraction or downturn. There are a couple of reasons for this; firstly, the household indebtedness ratio in Australia is high with an average of 185% debt to income for households. Secondly, due to the nature of the pandemic being so unpredictable, households are too scared for the future to borrow any more money as they don't know if they're have the means to pay it off in the future.
It is for these reasons that record low interest rates have not been able to stimulate inflation, because it does not have the impact on borrowing and private consumption spending which the theory would lead you to believe.
So why target full employment next rather than economic growth? Well by maintaining or decreasing the unemployment rate, it creates or maintains income levels which can maintain levels of aggregate demand and therefore also growth. This works by either lowering the cost of production for businesses with existing business loans or by decreasing the cost of investing and expanding (therefore increasing private investment spending and aggregate demand). These then work to either keep the currently employed workers in jobs, or increase the derived demand for labour and decrease the unemployment rate (which is currently at 4.9%).
My thoughts on the Government and Treasurer proudly boasting about the 4.9% unemployment rate? Well that'll have to wait for another time, but let's just say that the PM for NSW may have gotten a bit ahead of himself on that one considering the lagging nature of unemployment statistics. Hey there, do you like tips about VCE Economics or would you like the whole curriculum explained to you in a 3 hour window? Then think about signing up for The Running Economy's Unit 3&4 Revision Lecture in September below. Or maybe you you'd like to check out more Practice Tests.