Policy Impact

Full Employment

One of the charter goals of the RBA is to maintain full employment. As such, it is very important that we are able to assess how successful they have been at achieving this goal. The impact on full employment is similar to the impact on economic growth.

Interest rates represent both a supply and demand factor affecting full employment. When interest rates fall, the discretionary income of individuals and businesses will increase, and a percentage of this will be spent. This will lead to an increase in aggregate demand. Interest rates also represent a common cost of production for many businesses, and as such can affect the level of aggregate supply in the Australian economy. It is important to recognise that as the increase in aggregate supply will come about due to a fall in the cost of production (rather than an increase in productivity) this allows for the possibility of falling unemployment. Some employers may use their surplus funds to expand their businesses by employing more people.

However, it is also very important to recall that the impact on aggregate demand is likely to be stronger than the impact on aggregate supply. As such, it becomes possible that the Australian economy will experience inflation. As the RBA will always seek to minimise the incidence of inflation in the Australian economy, it is very likely that they will tighten monetary policy as soon as inflation becomes a possibility, even if the goal of full employment is not currently being achieved.

With the beginning of the global financial crisis in late 2007, the RBA began to realise that it was no longer necessary to focus their attention on the possibility of increasing inflation. Although the Australian economy was stronger than most others in the world, in early 2008 the IMF predicted that unemployment in this country could climb to 10%, and even the most optimistic forecasts from our own government suggested that a figure of 8.5% was likely. This was the prediction that was announced as part of the federal treasurer's budget speech in May 2009.

These predictions failed to realise the effectiveness of the RBA in implementing monetary policy in this country. Unlike the USA or Japan, the central bank in this country had worked hard to increase the cash rate to a "neutral" setting after earlier economic shocks. When the financial crisis was at its peak, the RBA had room to be very aggressive with the monetary policy setting. The cash rate was cut by 425 basis points; after peaking at 7.25% it was cut to a 49 year low of 3.0% during 2009. Combined with extra spending by the Australian government, this helped to stimulate both consumption and investment spending. Overall aggregate demand seemed to increase at this time, rather than fall as it did in almost every other developed economy. Unemployment peaked at 5.8% - well below the forecasts. While unemployment continued to climb in the United States, the effective use of monetary policy helped the Australian economy to avoid the worst of the global financial crisis.

Current Page: Full Employment