Using the AD-AS model, explain the possible effects of a sustained appreciation of the local currency on the government's macroeconomic objective.

Assume that initially the economy is at the equilibrium level of output where aggregate demand equal to aggregate supply and this is shown diagrammatically below.

Aggregate demand is the quantity of total output demanded at a given price level and comprises total of all the consumption and investment goods and services as well as the required goods and services of the government and net exports. A sustained appreciation of the local currency would bring about negative effects to the economy in the short and long term. In the short term, the price of local goods and services would be relatively expensive to the goods and services of other countries which would consequently lead to a fall in demand of Australian goods and services. Therefore, the exports of Australian goods and services would fall accordingly as this phenomenon implies the reduction of Australian competitiveness. Simultaneously, the imports of overseas goods and services would rise to maintain the constant supply of the goods and services. Hence, this could lead to a possible external imbalance with a falling Australian dollar value and worsened Current Account Deficit (CAD). As for the firms in Australia, they will start to cut down their production of the goods and services to remove the surplus of their goods and services because in such condition, producers find it less profitable to produce. In addition, there would be a fall in foreign investment inflow as firms are motivated by profit motive and private initiative. Thus, the level of investments of the firms in Australia would decrease. When the level of investments decrease, the level of employment would fall and this would bring to a decrease in the level of disposable income. A fall in the level of disposable income would then reduce the total consumption of household due to the cut in their earnings. These three factors would result in a decrease in aggregate demand.

In the long term, a decrease in aggregate demand is not desirable because it could lead to a recession in the business cycle or the economic activity. This phase is characterized by such conditions such as a fall in the rate of economic growth, decreasing employment and higher levels of job vacancies and a reduction in the rate of prices or wages growth. There are four major macroeconomic objectives that each government would strive to achieve. They are price stability, full employment, economic growth and external balance in equilibrium. In order to improve the economic activity, there are two options for the government to undertake. They are the expansionary policies which are demand management policies or microeconomic reforms of the supply management policy.

Expansionary policies such as fiscal and monetary policies indeed can stimulate the aggregate demand but they have destabilizing side effects that may impose more problems to the economy. For instance, expansionary fiscal policy like lower direct and indirect taxes may experience higher consumption fairly shortly after implementation. This however, may affect its productivity adversely if the increase in aggregate demand leads to an increased interest rates which are contractionary. As for expansionary monetary policy which is of attempts like lowering the interest rates, ease of obtaining credit facilities and increasing the issue of credit card applications is time-consuming and this can help to reach the full employment objective but also, worsening the price stability objective.

On the other hand, supply management policy is directed towards improving producers' ability to reduce costs of production and to increase efficiency or productivity thus lifting the competitiveness of suppliers goods and services on the world market. Microeconomic reforms include competition policy, deregulation of markets, infrastructure reforms, trade initiatives, industry policy, corporatisation and privatization of Government Business Enterprise. These policies improve the quality of Australian workforce by vocational skills training sessions and also improve external balance and levels of employment and growth as well as the Australia's level of foreign debt after the implementation of deregulation of the financial system. This side of management not only increase potential output but it also improve the standards of living over time as shown in the production possibilities curve below.

By weighing the effects of the demand and supply management policy to boost the level of economic activity due to sustained appreciation of local currency, it is more desirable to implement the supply management policy as it does not only bring benefits to the local producers but also to the government and country. As a consequence, there would be a shift to the right for the short term supply curve where the government is still able to achieve the full employment level, external balance and higher economic growth with lower prices. These changes are clearly shown in the diagram below.

As a conclusion, a sustained appreciation of the local currency may bring constraints to the government to achieve the major macroeconomic objectives. These constraints however could be resolved by adopting supply management policy stimulates the economy to increase productivity and efficiency as well. Demand management policies are less preferable as these policies involve conflicts in macroeconomic objectives and could cause severe effects on business profits, confidence and future expectations as well as uneven effects on different sectors of the economy.