Fiscal and Monetary Policies on Investment †MyAssignmenthelp.com

Question: Discuss about the Fiscal and Monetary Policies on Investment. Answer: Introduction Fiscal policies are government direct policies which involves either an increase or decrease in either the government spending or taxes. The monetary policy is the influence of the economy done by the government through the RBA; it involves either an increase or decrease in either money supply or the cash rate. In this case, the reduction in the government expenditure is a contractionary fiscal policy. Since this is negatively impacting the investors confidence and the government need to reduce its budget deficit, it employs a policy mix. This is where both fiscal and monetary policies are employed simultaneously. The monetary policy used is expansionary; the negative impacts of the contractionary fiscal policy are neutralized by the positive impacts of expansionary monetary policy. The major concern depicted on this paper is how the policies influence the Australian investment level. The investment level is expected to rise and impact the real GDP and the price level; this will also be discussed. Various models will be used in ensuring that the discussions are self-explanatory. There will be an increase in the Australian investment level when the interest rate falls. This is because interest rate is an important determiner of the availability of capital that is demanded for investment; it is actually the cost of obtaining capital (Ivan, 2017). A lower interest rate means that investors will pay a small extra charge on the use of money (Pettinger, 2016). This low servicing costs makes it attractive for the investors to seek loans that are used for starting new businesses and also for expanding the existing businesses. Duff (2017) noted that business watch business cycles and only consider expansions when interest rates are lower because they consider it cheaper to do so than when interest rate is higher. When the cost on acquiring capital is very high, investors are very cautious in its spending; they are not ready to risk the money on investments that are deemed to be risky. This explains why there is low investment rate in any economy whenever the interest rate is high. The other important factor that explains the changes in the investment rate from a lower interest charge is the saving rate. During a period of high interest rate, the income received from the savings is very high and thus households and investors prefer saving to investments (Fry, 2016). Investment and saving has a negative relationship; an increase in any results in a decrease on the other one. During a period of low interest rate, the income received from savings is too little to induce the households to save. In this case, they prefer investment to savings and thus the investment level goes up. According to Johnston (2017), businesses spend their money on plant expansion and buying of new equipment when the interest rate is low because there is less benefit from investing in interest-bearing accounts. Impact of Rising Investment on Aggregate Demand Curve, Price and Real GDP According to Sexton (2015), the aggregate demand curve is determined by summing up; consumption, investment spending, government spending and net exports (exports minus imports). AD = C + I + G + (X M). Whenever there is a change in any of these components, the aggregate demand curve is made to shift either to the left or right. The relationship between the economys aggregate demand and its real GDP is illustrated by using the Keynesian cross model. This model elaborates clearly how the demand curve shifts. The price level is determined by the aggregate demand level; a higher aggregate demand results in price rising whereas a low aggregate demand results in low prices The demand curve before the cut in the interest rate is AD1, the real GDP level initially was Y1 and the economy was at point A. The arrows shows the direction of change that occurs in this model. The cut will result in an increase in the investment component of the demand equation; the Aggregate demand curve rises and the initial demand AD1 shifts to a new Aggregate demand curve AD2; this is a move to the right where Aggregate demand is greater than the real GDP (Be?nassy, 2011). The graph also shows the changes is real GDP after the shift. The new equilibrium point B is associated with a higher level of real GDP; Real GDP rises from Y1 to Y2 (Mceachern, 2011). Generally, an increased level of aggregate demand results in a rise in the price level. Conclusion Investment level influence many macroeconomic indicators and thus should be maintained at a higher level. Government spending is also essential in maintaining investors confidence. A cut in government spending results in a loss on investors confidence. The improvement of government deficit requires a multiple of policies to facilitate the same; this is why most economies are being faced with the issue of increasing governments deficit. Low interest rate stimulates the economy by enabling the investors to access cheap capital which is used in boosting the investment level. When the level of investment rises, the aggregate demand also rises. The increase in investment creates many jobs, more people are employed and consumer spending rises. An increase in Aggregate demand results in an increased level of real GDP. Other than real GDP, there is also an increase in the price level. References Be?nassy, J. (2011). Macroeconomic theory. New York: Oxford University Press. Duff, V. (2017). How Do Interest Rates Affect Businesses? [Online] Smallbusiness.chron.com. Available at: https://smallbusiness.chron.com/interest-rates-affect-businesses-67152.html [Accessed 8 Oct. 2017]. Fry, R. (2016). Low Interest Rates are Hurting Growth. [Online] Forbes.com. Available at: https://www.forbes.com/sites/realspin/2016/10/04/low-interest-rates-are-hurting-growth/#44adb12db605 [Accessed 8 Oct. 2017]. Ivan, I. (2017). Do lower interest rates increase investment spending? [Online] Investopedia.com. Available at: https://www.investopedia.com/ask/answers/101315/do-lower-interest-rates-increase-investment-spending.asp [Accessed 8 Oct. 2017]. Johnston, K. (2017). The Effect of Interest Rates on Business. [Online] Smallbusiness.chron.com. Available at: https://smallbusiness.chron.com/effect-interest-rates-business-69947.html [Accessed 8 Oct. 2017]. Mceachern, A. (2011). Macroeconomics. Mason, Ohio, South-Western. Pettinger, T. (2016). Effect of lower interest rates. [Online] Economicshelp.org. Available at: https://www.economicshelp.org/blog/3417/interest-rates/effect-of-lower-interest-rates/ [Accessed 8 Oct. 2017]. Sexton, R. (2015). Exploring Macroeconomics. 7th ed. Australia: Cengage Learning.