Question 1
Suppose that the Australian economy is at its equilibrium, and the Australian government has decided to reduce its spending on welfare supports. The government will also cut investment spending on Sydney international airport.
(a) Discuss the short-run effects of the spending cuts on macroeconomic variables – particularly on equilibrium output, inflation and unemployment rates. In your discussion, draw and use aggregate expenditure (AE) and AD-AS model to explain the process that moves the economy to its new equilibrium output.
The Australian government is considering a further interest rate cut to support the domestic economy in Australia. On the other side of the world, however, the interest rates in many other countries including Japan are on hold at the current level. If Australia cuts its interest rate further,
(b) Explain, in the short run, how the flow of funds is likely to move between Australia and Japan, and why.
(c) Discuss how the increase in interest rate in Australia is likely to affect the value of Australian dollar and exchange rate against Japanese Yen. Draw a diagram showing the movement of the exchange rate (use demand for and supply of Australian dollar). Also, discuss how the change in exchange rate is expected to influence Australia’s exports, imports and the current account balance.
Question 2
Japanese economy was at long-run equilibrium and the inflation rate was consistent with Bank of Japan’s (BOJ) target rate until early 1990s. However, economic recession caused by collapse of Japan’s property market together with worldwide economic slow-down continued to decrease household consumption and firms’ investments during the 1990s and 2000s. Assume that the BOJ maintained a stable monetary policy and everything else remained unchanged.
(a) Draw and use the AD-AS model to analyse and explain how decreases in consumption and investment expenditures would have affected Japan’s real GDP, price level and unemployment rate in the short- run and in the long-run (the long-run adjustment process). (12 marks)
(b) The two automatic stabilisers operating in fiscal policy are automatic changes in induced taxes and transfer payments. Explain how these two automatic stabilisers would work in an economic recession.
In December 2012, Japan commenced quantity expansion of money, Yen, as one of the key monetary policies. The Bank of Japan (BOJ) increased the quantity of Japanese Yen significantly every month through open market operation in an attempt to support the troubled Japanese economy. The large increase in the quantity of money was expected to have significant impacts on a range of economic sectors in Japan and global financial markets.
(c) Discuss how the quantity expansion of Japanese Yen would have affected interest rate, investment and consumption, aggregate demand, real GDP and price level in Japan. Draw AD-AS model to explain your analysis. (10 marks)
(d) Discuss how the quantity expansion of Japanese Yen would change the value of Yen, exchange rate against other currencies, and exports and imports in Japan. How would this contribute to Japan’s current account balance and the competitiveness of the Japanese economy in the global market? (5 marks)