A Comparison Of Real GDP Growth Rates, REER, And Trade Balance Between Australia And USA

Real GDP Growth Rates: A Comparison

Australia and the United States have seen tremendous growth since the year 1991. The country followed very similar trajectories of economic growth since the year 1985 for nearly up to a decade. This has led to the belief that the Australian economy is greatly affected by movements in other economies. However, Bean (2000) argues that this was a period of prosperity for most advanced countries including other countries like Japan. The economies of the two countries are linked due to trade and globalization but the two countries have differences too. These include differences in population size , geographical positions and more

Table 1Table 1 A Comparison between the Real GDP Growth Rates of Australia and USA. Source: (International Monetary Fund, 2017)

Graph 1 A Comparison between the Real GDP Growth Rates of Australia and USA. Source: (International Monetary Fund, 2017)

As seen from the above graph, there is definitely a co-relation between the trajectories of the growth rates. During the Asian Crisis of 1997, the Australian and the US economy grew further despite the odds of lower demand from Asia. However, the US economy growth seems to have hit rock bottom during the financial crisis but recovered as sharply as it fell, showing a higher growth rate than the USA and then again in 2014.. In the economic Survey of 2016, the  Organization for Economic Co-operation and Development, (2017) commended the USA for achieving better GDP growth than most countries in the OECD, including Australia. The year 2007, there was sub-prime housing crisis in the USA which then morphed into a global financial crisis. (Demyanyk & Hemert, 2009)

Recovering from a recession in the 1991, both countries have shown a growth remarkable growth between 1992-2000. Some of the reasons that led to a period of sustained growth in Australia are the deregulation of the financial sector, the removal of barriers on trade and floating the currency in the free market (Harchaoui, Jean, & Tarkhani, 2006).  At the same time, the USA with its neo-liberal trade policies, fiscal and monetary policies of allowing smaller budget deficits and progressive taxation, also underwent periods of economic boom.  (Kotz, 2003) (Jeffery Frankel, 2001) This was a period of high private sector investment and high consumer spending in USA. (Jeffery Frankel, 2001)  During this period, asset prices in advanced economies were beginning to bubble. (Bean, 2000) This helps establish that are linkages between the various economies of the world.

The Role of Exchange Rates

Following the period of sustained growth, there is a sudden sharp dip in the year 2008. The Financial Crisis of 2008-2009 was one of the biggest economic crises that the world has experience since the Second World War. (Bean, 2000) The economy of USA took a serious hit and went into a recession with a Real GDP growth rate of -3%  but the Australian economy did not take such a sharp dip.

The US economy also seems to have been more volatile following the crisis, than the Australian economy. According to Organization for Economic Co-operation and Development, (2017), the US economy still seems to be reeling from the after-effects of the financial crisis despite a sustained growth for the seven years following the crisis.

The graph above shows that co-relation between the US economy and the Australian economy starts to weaken during the crisis as the Real GDP growth rate is largely better than the real US growth rate at the tail end i.e. in the post financial crisis period.

In the post- crisis period, the US economy has expanded, although this expansion is nothing like the previous economic expansions that the country has seen, such as the economic boom of 1990s.

According to Organization for Economic Co-operation and Development, (2017), the US economy has surpassed the peak –crisis output levels which would indicate its recovery. According to the OECD, the recovery has been largely due to profit margins in the private sector of the economy, especially the technology sector. On the other hand, the commodity boom has been responsible for the buoyant Australian economy between 2012 and 2016. Both the countries have also has fiscal policies of allowing greater budget deficit and this seems to have off for the two countries.

In this case, we have taken the Real Effective Exchange Rates (REER) to measure the macro-economic performance since REER accounts for inflation and is largely free from distortions of currency market speculation.

“REER is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs.” (International Monetary Fund, 2017) Exchange rates are related to terms of trade since a better exchange rate implies better relative prices. “Growth in REER implies that exports became more expensive while it became cheaper to import goods. This is an indicator of the loss in ‘trade competitiveness’ (International Monetary Fund, 2017) The graph shown below depicts that the Australia REER followed more or less the trajectory of the USA REER, until 1995. Following that during period of 2000 – 2005, the Australian trade competiveness has grown comparatively with a sharp dips in the REER. This implies that Australia outperformed USA in competitiveness during this period. However, between 2010 and 2016, the Australia REER was greater than that of USA. This implies a sharp dip in the competitiveness which goes hand in hand with the GDP growth.

The Role of Trade Balance or Net Exports

The co-relation between REER and trade balances is not one sided. It has been observed that REER in Australia, is significantly influenced by the terms of trade, thereby confirming that the volume of trade has a significant impact on exchange rates.

 (Tarditi, 1996)

Table 2: Real Effective Exchange Rates Source: ( The World Bank, 2017)

Graph 2: REER Comparison for Australia and USA . Source ( The World Bank, 2017)

The graph shown above has similar movements to the Real GDP Growth Rate graph, indication a direct relationship between REER and Real GDP Growth Rate.

Australia is a country with large mineral resources and agricultural commodities and these are some of the major exports of the country. The USA is the second largest importer of goods from Australia. (Depratment of Foreign Affairs and Trade, Australian Government, 2017)

Table 3: Trade Balances or Net Exports of USA with Australia as a trading partner

 In the table above, the net exports (exports- imports) also known as trade balance have surged since 1985, implying that the growth rate of the net exports from USA to Australia has surged continually with a single dip. Overall, Net exports for USA have remained positive throughout. As seen in the table above, the exports from USA to Australia grew at a faster rate than the imports from USA to Australia. This growth has been continuous with the only decline seen during the four year period following the Asian crisis. A decline in the exports to Australia from USA signifies lower demand. However, domestic demand surged during the same in Australia. An excess of exports to imports affects the exchange rate of the country. This could also imply, that the USA industries rely more on Australia than on the Australia markets rely on the USA.

Assuming that USA’s imports from Australia are the Australia’s exports to USA, we could draw the following chart.

 Graph 3: Bi-lateral trade between Australia and USA in 1985. (United States Census Bureau, 2017)

Graph 4: Net Exports of USA from Australia (in millions USD). These figures reflect the corresponding negative balance of trade for Australia (negative net Exports) (United States Census Bureau, 2017)

Given below, in the table, is a comparison of the short term interest rates. These are the annual average interest rates (here represented by Cash rates for Australia and Federal Fund’ rate for USA,) Interest rates are important tool in stabilizing the economy. (Sachs, 1989).

In the early 1990s, Federal banks for both countries lowered the interest rates, accompanied by other reforms. For example, at the beginning of 1990, both the Cash Rate for Australia and Federal Funds rate for USA were over 13.00. Thereupon, began a period of sustained lower interest rates for both countries.

Good monetary policy has been the hallmark of Australia’s performance since the 1997 Asian crises. (Harchaoui, Jean, & Tarkhani, 2006). The Reserve Bank of Australia lowered the cash rate as soon as the Asian crisis struck which fuelled domestic demand. During the crisis, the Australian Dollar fell nearly 20% against the US Dollar, yet this did not seem to affect the Australian economy. (Bean, 2000) A fall in exchange rate of AUD would imply cheaper exports for Australia. This could explain the growth in exports to the USA and reduction in imports. A period of better trade balance and a growth in domestic demand following the period of Asian crisis may have been the reason for the GDP growth in Australian economy despite the Asian crisis.

Similarly, during the financial crisis of 2008, aggregate demand dropped drastically. Central Banks all over the world had to drop interest rates to fuel demand and some Central Banks were not averse to zero percent interest rates. (Blanchard, Dell’Arricia, & Mauro, 2010)  (McDonald & Morling, 2011)  This is reflected in the chart and table below.

 Table 4 The Lending Rates of Reserve Bank of Australia and Federal Reserve Bank. Source: (Organization For Economic Co-operation and Development, 2017)

The period of low interest rates trend has continued. The post-crisis low interest rest have led to greater mortgage borrowing in Australia, which could partially explain the expansion of Australia’s economy during this period. (Organization for Economic Co-operation and Development, 2017) The interest rates in the US compared to Australia is even lower and near to zero, although it started to move upward. This implies that there are some fundamental differences between the two economies.

Interest rates could also been seen as an indicator of economic strength. Long Term Bond Yields. According to Gruen & Shrestha (2000), the increase in Australia’s competitiveness could be gauged from the fact long term bond yields for Australia reached the level of yields of German and American bonds, implying a trust of investors in the bonds.

Graph 5  A Comparison Between Bank Lending Rates Between Asutralia and USA

Conclusion

There is plenty of evidence to suggest that ups and downs in the Australian economy are co-related to ups and downs in the US economy. Foreign economic developments since 1998 have been noted to have a contractionary policy on the Australian markets, the USA in particular. This could simply be a result of the globalization of the Australian economy and banking system. Advanced economies, generally, have a greater demand for Australian manufactured goods than the developing countries. (Organization for Economic Co-operation and Development, 2017). It is, therefore, easy to conclude that the changes in the real economy seem to have an effect on the Australian economy

Gruen & Shuetrim, (1994) proved the existence of a long term equilibrium relationship

between the Gross Domestic Products of Australia and USA. However, this analysis was from before the 1997 sub prime crisis, following which Australia seems to have taken its own path.

This, however, does not imply that there are no linkages between the economic performances of the two economies.

There is a strong link between the real economy of the USA and Australia is due to trade and globalization of Australian financial and banking system since 1985. These reforms that took Australia towards a more globalised system, essential have ensured that there are no limits on the number of subsidiaries or branches that any bank could establish in the country. (Bean, 2000) Even though banks and financial institutions are more of monetary entities, it is possible that problems in the banking system could set of a “real” crisis.  The Australian economy has very strong global linkages and hence, the most powerful risk to the economy is from the global contagion, spillover effects of increases in global asset market prices credit growth, especially those in the USA. (Organization for Economic Co-operation and Development, 2017)

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