How do we measure the health of the economy?
Explain the main macroeconomic objectives and the indicators used to measure economic performance in Australia.
Growth, low unemployment, price stability and other goals, plus the ABS and RBA indicators such as GDP, the CPI and the unemployment rate.
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What this dot point is asking
Macroeconomics studies the economy as a whole. Governments and the central bank pursue several objectives at once, and they track progress using indicators collected mainly by the Australian Bureau of Statistics (ABS) and the Reserve Bank of Australia (RBA).
Economic growth
Economic growth is an increase in the real output of goods and services over time, measured by real Gross Domestic Product (GDP). Real GDP removes the effect of inflation so we see genuine changes in output. Sustainable growth is the goal: fast enough to lift living standards and create jobs, but not so fast that it fuels inflation or harms the environment. Australia generally targets real GDP growth of around 3 per cent a year. GDP per capita, which divides output by population, is a better guide to average living standards.
Full employment
Full employment means everyone willing and able to work at the going wage can find a job, which still allows for some frictional and structural unemployment. The unemployment rate is the number of unemployed as a percentage of the labour force:
The labour force is the employed plus the unemployed actively seeking work. The participation rate measures the share of the working-age population in the labour force. Economists also watch underemployment, where part-time workers want more hours. The lowest sustainable rate of unemployment, the NAIRU, is the level below which inflation tends to accelerate; in Australia it is generally estimated around 4 to 4.5 per cent.
Price stability
Price stability means low and steady inflation. Inflation is a sustained rise in the general price level, measured by the Consumer Price Index (CPI), which tracks the price of a representative basket of goods and services. The RBA targets inflation of 2 to 3 per cent on average over time. Both high inflation and deflation are harmful.
External stability and other goals
External stability concerns Australia's economic relationships with the rest of the world, measured by the current account balance, net foreign debt, the terms of trade and the exchange rate. Other widely cited goals include a fair distribution of income (often shown with the Gini coefficient) and environmentally sustainable development.
Conflicts between objectives
Objectives can clash. Pushing growth and very low unemployment can drive up inflation, while squeezing inflation may raise unemployment, a short-run trade-off illustrated by the Phillips curve. Policymakers must balance competing goals.
Knowing each objective, its indicator and how the indicators interact is the foundation for analysing fiscal and monetary policy later in the course.
Exam-style practice questions
Practice questions written in the style of TASC exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
2022 TASCExplain the government economic objectives of full employment and price stability.Show worked answer →
Full employment. The objective is to have the lowest unemployment rate that does not accelerate inflation, that is, to eliminate cyclical unemployment so that everyone willing and able to work at the going wage can find a job. In practice it corresponds to the natural rate (NAIRU), commonly estimated around 4 to 5 per cent, because some frictional and structural unemployment always remains. It is measured by the ABS unemployment rate.
Price stability. The objective is to keep inflation low and stable so that the purchasing power of money is preserved and economic decisions are not distorted. In Australia the RBA targets consumer price inflation of 2 to 3 per cent on average over the cycle, measured by the CPI.
A good answer notes why each goal matters (full employment uses resources fully and supports living standards; price stability protects real incomes and supports investment) and that the two can conflict in the short run.
2023 TASC8 marksDiscuss the challenges of achieving the two (2) macroeconomic goals of low unemployment and price stability.Show worked answer →
Explain each goal, then discuss why pursuing both at once is difficult (an 8-mark discuss question, so cover both sides).
The conflict. There is often a short-run trade-off (the Phillips curve relationship). Policies that lower unemployment by boosting aggregate demand can generate demand-pull inflation, while policies that reduce inflation by slowing demand (such as higher interest rates) tend to raise unemployment. So pushing hard on one goal can move the economy away from the other.
Challenges:
- Policy lags mean monetary and fiscal policy take time to work, risking over- or under-shooting.
- Cost-push shocks (for example energy-price rises) can raise inflation and unemployment at the same time (stagflation), so demand-side policy cannot fix both.
- Estimating the NAIRU is uncertain, so policymakers may not know how much spare capacity exists.
Discussion. In the long run supply-side and microeconomic reform that lifts productivity can ease the trade-off, allowing lower unemployment without higher inflation. Conclude that the two goals are achievable together over time but frequently conflict in the short run, forcing governments to balance them.