Examining The Interconnectedness Of Economic Indicators In Australia

Overview of Australian Economy

Discuss about the Macro Financial History And The New Business Cycle.

Australia being one of the fastest growing developed nations has always attracted attention of the economy. This service dominated economy has successfully maintained a steady growth path over past several decades. Economic state of a nation depends on overtime performance of the nation in various dimension. Growth of real GDP is the primary indicator of a nation well-being. Being an aggregate measure of output growth in GDP is likely to have a relation between other variables such as inflation and unemployment. The volume of trade varies with movement of exchange rate (Mendes, 2017). In a globalized world, policies undertaken in one country influences policy of other countries as well. Change in fund rate of US thus has an impact on the movement of cash rate in Australia. The paper examines performance of Australia in terms of different economic indicators and their interconnectedness.

Gross Domestic Product is one key indicators of measuring performance of a nation.  It measures value of goods and services in the nation that are marketed in a year.  As GDP is a quantitative measure, value of goods and services are represented in terms of their respective market price. GDP quantifying goods and services using market price of present year is called nominal GDP or GDP at current prices. Values of goods and services can also be expressed in terms of price of a fixed year. The fixed year is called base year and GDP computed through this method is called real GDP or constant price GDP. Constant price GDP is an output estimates that is adjusted for inflation.  Economic growth of a nation is reflected from the growth of GDP.  In this regard, percentage change in real GDP s taken into consideration to present the economic growth. GDP being a complete measure of output, it is related with several other indicators as well (Goodwin, et al., 2015). Unemployment and inflation are the two such variables having close relation with GDP. Unemployment represents a condition of labor market where some fraction of labor force cannot find jibs suitable for them. A higher growth rate of GDP indicates faster expansion of output. This in turn means more job opportunities and hence a low rate of unemployment. As output expand price level might be increase or decrease depending on the position of aggregate demand and aggregate supply. Movement of price level is expressed in the form of rate of inflation. As real GDP takes into account the inflationary pressure a higher inflation means low real GDP growth and vice versa. The proposed relation between GDP growth and that of inflation and unemployment is verified using the relevant data for Australia economy.

Gross Domestic Product (GDP)

Trend in GDP growth and that of other indicators are examined for a time frame ranging from 1990 to 2016. During this period, GDP grows on an average by 3.10 percent.  The average unemployment rate is quite high with the rate being 6.72 percent. The accounted GDP growth in 1990 was 3.53. The economy that was growing at a rate of 3.53 had an unemployment rate of 6.90.  At the late 1990s, Australia experienced a recession that lowered GDP growth to -0.38 percent.  With a negative rate of growth unemployment rose to 9.60 percent. Economic growth was only 0.44 in 1993. The low growth rate was associated with a very high unemployment rate of 10.70. in the next year, growth rate though increased to become 4.06 but unemployment remained almost same at 10.90 (ABS, 2018). This implied economic growth during this year was unable to reduce the incidence of unemployment. From 1995 onwards, unemployment reclined sharply along with GDP growth validating the inverse relation between unemployment and economic growth. As a consequence of global financial crisis in 2008, GDP growth in 2009 fell to 1.81 percent. This though raised unemployment rate slightly from 4.20 in 2008 to 5.60 in 2009, but unemployment was never as high as that in 1990s.  After the crisis unemployment started falling along with recovery of economic growth. Rate of unemployment though fluctuates along with fluctuation in the growth rate but it remained around 5.5 percent on an average, a rate much lower than that in 1990s but higher than that prevailed in between 2005 and 2008. The figure below shows trend movement of GDP and unemployment in Australia.

As discussed above, GDP growth and unemployment moved in the opposite direction. Staring initially from a very high level, unemployment rate gradually declines with an increase in economic growth rate.  A very narrowed gap exists between unemployment and GDP growth from 2000 to 2008. As economic growth declined after 2008 the gap increases not as much as that in the decade of 1990s. Unemployment in recent years has increased slightly in response to a slow pace of economic growth.

Average inflation rate in Australia from 1990 to 2016 is estimated to be 2.68. The rate of inflation in 1990 was 7.27 percent corresponding to the growth rate of 3.53 percent Both inflation and unemployment fell in the next year. This is due to the recessionary effect of 1990s. The low inflation rate was unable to pull up GDO growth because of an overall decline in national output. Fir the next two or three years both GDP growth and inflation were recovering together. With economic expansion, as growth recovered inflation started to influence real GDP negatively. With a growing nominal GDP, a low level of inflation implies a higher real GDP and therefore a higher growth (McCombie and Thirlwall, 2016). A 5.01 percent growth in 1999 was associated with a relatively low level of inflation. The rate of inflation in 1999 was only 1.47 percent. The price level increased by 4.48 percent in 2000s. This dragged real GDP growth again to 3.87 percent. GDP growth was even lower in 2001 with the economy growing only at a rate of 1.93 percent.  The corresponding inflation rate was 4.38 percent.  Growth gradually recovered till 2008 and inflation continued to fall (Blanchard, Cerutti and Summers, 2015).  Again in 2009, followed by a recessionary hit both growth rate and inflation settled at a low level of 1.8 percent. The economic growth in recent years has relatively slowed as compared to that in the previous decade while inflation is stabilized around 2%.

Unemployment and Inflation

The graph shows sharp fall in inflation for the chosen time frame. Economic growth on the other hand though increases or remained stable except during phase of recession. The objective of Reserve Bank of Australia is to attain a stable economic growth with a targeted low level of inflation. In general, an inverse relation is observed between inflation and GDP growth.

The relation between real GDP growth and unemployment and inflation can be further confirmed from the result of correlation matrix for the chosen variables

Economic growth of a nation is unlikely to constitute a steady upward or downward trend. Every economy undergoes with stages of economic fluctuations. The theory of business cycle attempts to explain the point of fluctuations. There are two extreme phases of business cycle called peak and trough indicating the highest and lowest point of growth. In between the two extreme there are phase of economic recession and expansion (Agénor and Montiel, 2015).  In context of Australian economy, there is evidence of business cycle. One way to frame business cycle is to examine the movement of GDP growth overtime.

Staring from 1990s the period of 1991 was identified as a period of trough as growth rate fell to its lowest level of -0.38.  The phase of expansion began after that and the peak reached during 1994 with growth rate being 4.05. The economic slowdown in the next few years can be identified as phases of recession as growth rate fell till 1997. Again expansion started and attained a peak growth rate of 5.01 percent in 1999. Growth rate again reached to the lowest level in 2009 with a rate of growth being only 1.81. The phase however short lived as the economy made a quick recovery. Reaching somewhat peak in 2013, growth gain slowed down due to internal and external shocks. From 2009 onwards, the economy has experienced a slow expansion (Jorda, Schularick and Taylor, 2017). Many feared that the economy is going to enter a recession as expansion does not stay much long period.

Australia actively participate in international trade. Trade has growing share in GDP of Australia. Australia ranked 23^rd in the list of export economy. The value of export and import of Australia during 2016 were $159 billion and $181 billion respectively. Australia mainly export iron ore, gold, petroleum gas, coal and crude petroleum. China, Japan, South Korea, United State and United Kingdom are the five major export partners of Australia. The imports of Australia include Computers, medical equipment, automobile and refined petroleum. China, United State, Japan, Germany and Singapore are the top import origins of Australia (Kenyon and van der Eng, 2017).

Trend in GDP Growth and Unemployment

In international trade, as goods are exchanged in the global market, the balance of trade depends on the exchange rate between two countries. The net export of Australia is thus subject to value of Australian dollar against currency of its major trading partners. The US dollar is used as a standard medium of presenting values of goods and services. United States also is one of the major trading partners of Australia both in terms of export and import (Cole and Nightingale, 2016). The exchange rate between Australia and United State is therefore has an important role in determining trade volume of the Australia

Australia had a positive trade balance in 1990. The exchange rate then was stabled at 1.28. Exchange rate continued to increase till 2001. The rate of exchange between AUD and USD in 2001 was 1.93. This indicates during this time 1.93 AUD dollar needs to be exchanged for every USD. The high exchange rate indicates a relatively weak currency (Bernanke, Antonovics and Frank, 2015). This is favorable for export as Australian exportable seemed to be cheaper in the international market. This has the positive effect on trade balance. Throughout this period, Australia enjoyed a considerable surplus in its balance of trade account. The domestic currency started strengthening from 2003.  With this the net export started to decline. A trade deficit occurred in 2008 following a small exchange rate of 1.19 (World Bank, 2018). This was the time when US severely hurt by the financial currency. The weak US dollar strengthens AUD and the trade deficit continued. With recovery of United State, the currency value again increases. This contributed to a reduction in trade deficit which converted to a trade surplus in 2016 with an exchange rate of 1.35.

Fund rate and cash rate are instrument of monetary policy used by the central bank to stabilize economic growth and inflation (Heijdra, 2017). The Federal government in United State adjust its fund rate to control lending of commercial banks and influence economic activity.  In Australia, the same is done by Reserve Bank of Australia. Following an interconnected between USA and Australia in terms of trade and investment change in interest rate of one nation influences the decision in other nation. If Federal government lowers its fund rate, then thus reduces value of US dollar. A relatively weak US dollar in turn implies a strong position of Australian dollar. This hurts Australian export worsening its trade balance. The RBA then needs to make downward revision of its cash rate. An increase in fund rate on the other hand indicates a strong position of US economy which is beneficial for Australian economy (Hamilton, et al., 2016).

Inflation and Real GDP Growth

The figure above clearly indicates that both fund rate and cash rate reduced drastically over time. This implies an ease monetary policy for both the nations.  In 1990 the RBA set cash rate at 14.83 implying a tight monetary policy. The fed fund rate was 8.10 (FRED, 2018). After 1990s, cash rate and fund rate both started to fall. From 2003 to 2007 cash rate and fund rate were increased indicating a prosperity for both the nation. The housing bubble burst in USA in 2008 causing severe recession. Federal government needs to take an expansionary monetary policy by reducing fund rate to promote economic growth. RBA during this time also lowered its cash rate but not as much as Federal government did. Fund rate was only 0.09 in 2014 while cash rate was around 2 percent (RBA, 2018). With economic recovery, Fed has made a slow increase in fund rate which increased to 0.40 in 2016 while cash rate remained constant at 1.5.

In last two or three years Australia though has experienced a slow growth rate but still there remain optimistic view about future of the economy. The slow growth contributed from slowdown in mining and construction is likely to be offset by the gain in productive investment in other areas of the economy. Household consumption is gaining slowly and is expected to increase further stimulating GDP (Metcalfe, 2018). The growth of investment in non-mining sector will improve economic growth and will help the nation to back to its previous growth pace. RBA however should not decrease cash rate any further as the low cash rate by encouraging housing investment moves the economy towards a housing bubble and future recession.  

Conclusion

The analysis of trend performance shows that real GDP growth has a favorable impact on level of unemployment. With economic growth employment opportunities expands and unemployment falls.  High level of price is like to reduce growth in real GDP. However, in recent years in response to counter inflationary policies taken by RBA both the inflation and real GDP growth has remained considerably low. United State being one of the major trading partners of Australia, an appreciation of Australian dollar results in a trade deficit by lowering export largely. The economy has experienced different phases of phase of business cycle with recording time to time fluctuation in GDP growth rate. Both and cash rate and fund rate have settled to a significantly low level as compared to that in 1990s. The fund rate however has reduced at a much faster pace after global financial crisis. Lastly, there is an optimistic outlook regarding future growth of Australia following expansion of service and non-mining industries.

References

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