As NSW and Victoria continue to face COVID lockdowns, the role that fiscal and monetary policy play in supporting the economy is once again highlighted. This gives us another great opportunity to look at the implications of the government’s policy response to the ongoing economic situation.
1. Monetary Policy woes
The RBA has continued to play an extremely important role in supporting Australia’s economy through the pandemic as well as in its recovery. However since the lockdowns began, monetary policy has been unsuccessful in stimulating aggregate demand. This is because at 0.10%, there is little opportunity for the RBA to lower the cash rate any further.
What this also means is that monetary policy will likely be similarly ineffective in stimulating aggregate demand and economic activity across the board in the near future, perhaps all the way to 2023.
Prior to this lockdown, the low interest rates combined with large amounts of government stimulus, for example the increase to the first home-buyers’ rebate, contributed to double-digit growth in the average price of houses and apartments in NSW, a bright spot for growth in the property and construction industry. However, after the state was plunged back into lockdown, low interest rates have been unable to stimulate any particular industry.
It appears that consumers are again holding back from spending as their expectations of the economic future darken in the face of further COVID-related challenges.
With interest rates so low, yet ineffective, RBA head Phillip Lowe mentioned his concern about the impact of further lockdowns on the future of Australia’s economy. Furthermore, the RBA has already mentioned that it is unlikely to increase interest rates for the next three years meaning that if economic stagnation and heavy inflation occur at the same time, the current state of aggregate demand in the economy mean that it’s unlikely that raising the interest rate will be able to combat inflation.
This begs the question: what other tools can the RBA and Australian government rely on to stimulate the economy while keeping inflation steady?
HSC application:
- The interest rate bound is likely to limit monetary policy effectiveness
- The RBA is unlikely to be able to keep inflation up, and may struggle with public opinion if it needs to lower the inflation rate
2. Labour market and Fiscal policy
The ever expanding Sydney lockdown and the refusal of the government to reinstate Job-Keeper has Australia looking at an American-style covid response, where the government opts to let unemployment rise, while providing significantly increased fiscal stimulus via unemployment benefits to try and support the economy.
In the medium term, this strategy will likely see real unemployment stay high and cause wage growth in labour markets to become disconnected from changes to demand. This is a situation called “sticky unemployment”, and we’ll likely see the impacts of this on the economy’s recovery as this wave of lockdowns conclude.
Firms will struggle to rebuild the workforces they gathered over many years, and will be forced to spend much of their funds training new workers to fill in the gap left by experienced workers who were fired or permanently resigned.
Overall this will reduce employment as firms simply do not have the funds and resources to train new workers and replace experienced workers that will never fully come back.
Moreover, it is a process that drives away from investment into expansion in business operations and therefore the efficiency of our economy. This will lower our aggregate supply in the long term, signalling the potential beginning of serious structural issues impacting future economic growth.
HSC application:
- In NSW, sales fell by 2 per cent with the lockdown in Greater Sydney starting late in the month.
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This series of weekly articles aims to compile the important economic news of the week into bite-sized summaries with HSC-specific takeaways.
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