RBA cash rate trends and changes
Figure 1: Trend in monthly cash rate in Australia
(Source: rba.gov.au 2020)
The trend in monthly cash rate target of Australia shows that there is an overtime declining trend. In order to give the economy necessary stimulus through monetary policy, Reserve Bank of Australia continuously lowered the cash rate with cash rate declines sharply from 14.00 in August 1990 to 0.75 in January 2020. RBA adjusted the cash rate with economic upturn and downturn to ensure a stable economic performance. The trend shows some big drops in the cash rates each associated with event that could cause a significant economic downfall. The period since middle October 1990 to January 1992 was experienced a series of big cuts in the cash rate. Monetary stimulus through lowering cash rates were given during this time in order to rescue to the economy from severe recession started since September 1991 resulted from international stock market crash. Cash rate again followed a series of decline during the period October 2008 to May 2009. Cash rate during this time was lowered in order to counter the impact of Global Financial Crisis in 2008. RBA again took the decision of lowering the cash rate in May 2012 due to a decline in mining activity, tight labor market condition and fall in retail sales. Cash rate reached to 3.00 percent which was the lowest since 1990 (Kwek 2012). With expectation of a lower global economic growth RBA lowered cash rate from 3.00 in April 2013 to 2.50 in October 2013 till January 2015. In response to weak domestic demand, decline in commodity price and slowdown in China’s growth RBA cut Cash rate by 0.5 basis point in 2015 (rba.gov.au 2019). Because of a below average growth rate of Australian economy RBA since June 2019 continuously lowered the cash rate until it reached to 0.75 percent in November 2019 and remained unchanged till January 2020.
Figure 2: Trend in inflation and unemployment rate
(Source: Abs.gov.au. 2020)
Figure 3: Relation between inflation and unemployment rate
(Source: Abs.gov.au. 2020)
The trend in inflation and unemployment and that of scatter graph between inflation and unemployment rate reveals an overall inverse relationship between inflation and unemployment. From the period since 1980 to 2019, low unemployment rate is mostly associated with high inflation and vice versa. The negative correlation between inflation and unemployment can be explained with the theory of Phillips curve. This explains with increase in labor demand, unemployment rate falls. Higher demand of labor however increase wage resulting in wage push inflation (Heijdra 2017). Similarly, in Australia with increase in economic growth unemployment decreased which increased price level. However, because of inflation targeting policy of RBA since 1991, inflation remained within the targeted range of 2 to 3 percent while unemployment declined continuously.
Inflation and unemployment rate trends and their relationship
The Keynesian Cross Model explains macroeconomic equilibrium of an economy using the aggregate expenditure function and the 450 line showing actual expenditure or income. Aggregate expenditure function of the model represents sum of consumption expenditure, investment expenditure, government expenditure and net export. Changes in any one of the expenditure components changes aggregate expenditure function and equilibrium. Because of coronavirus outbreak, cross country exchange of goods and services have ceased. This has caused a significant decline in trade volume. Now assuming Australia enjoy a current account surplus restriction on trade reduces trade balance of Australia. Decline in net export lowers aggregate expenditure. Interruption in supply chain due to disruption in import lowers production activities in the economy (De Vroey 2016). This increases possibility of unemployment in the economy. Outbreak of Coronavirus, also hurt confidence of consumers and investors lowering consumption and investment spending. The likely recession because of coronavirus outbreak thus lowers aggregate expenditure. Accordingly, aggregate expenditure function shifts downward. At the new equilibrium real GDP falls as illustrated in the following figure.
Figure 4: Impact of Coronavirus Outbreak on Australian economy
The upward slopping relatively flat line shows aggregate expenditure of the economy. Equilibrium occurs at the intersection of aggregate expenditure function and the 450 line. Because Coronavirus outbreak, as aggregate expenditure lowers, aggregate expenditure function shifts down to AE1. Equilibrium moves from A to B. Real GDP of Australia declines from Y* to YE.
Figure 5: Impact of bushfires on Australian economy
The figure above explains macroeconomic equilibrium in Australia. Suppose, the economy initially at the stable equilibrium at point A as obtained from intersection of aggregate demand, short run aggregate supply and long run aggregate supply. Now, bushfires in the economy has a destructive impact on productive capacity of the nation. It destroys capital stock of the economy in form of destruction of factories, equipment, land resources, property, roads and other assets (Butler 2020). Decline in productive capacity of the nation shifts the short run aggregate supply curve to the left to SRAS1. Short run equilibrium now shifts to B. At this point real GDP declines to Y1 and price level increases to P1. As real GDP falls below the potential GDP at Y*, there is a recessionary gap in the economy.
For stimulating the economy, government should use expansionary monetary and expansionary fiscal policies. Expansionary monetary policy can be taken by lowering cash rate, reducing reserve requirement or through open market purchase of government securities and bonds in order to inject more money in the economy. Expansionary monetary policy by lowering interest rate increases investment and boost aggregate demand. This helps to counter recessionary pressure and moves economic output towards potential output.
Impacts of Coronavirus outbreak on the economy and stimulus policies
Considering expansionary fiscal policy government should give fiscal stimulus to business and other affected areas. Tourism industry is one of the most affected industries due to bushfires and realized a significant hit because of decline in number of tourists. Therefore, government to give stimulus package to rebuild the industry (Heijdra 2017). Expansionary fiscal policy targeting particular areas are considered to have a more effective impact in rescuing the economy.
Besides demand side policy, government can also take supply side policies to stimulate economy’s output. This includes investment in infrastructure, rebuilding capital stocks and such other to boost output.
The impact of monetary and fiscal stimulus has been illustrated in the figure below.
Figure 6: Impact of fiscal and monetary policy stimulus
The immediate impact of fiscal and monetary policy stimulus is to shift the AD curve outward to AD1. Real GDP moves toward the potential GDP and price level further increases to P2
The impact of supply side policies is shown in the following figure
Figure 7: Impact of supply side policies
The fiscal policy stimulus however can affect long run output due to its impact on the saving rate. National saving is the sum of private and government saving. Fiscal policy expansion reduces government saving meaning less fund available for investment. This can reduce potential output in the long term. Monetary policy though has not the impact of lowering national saving like fiscal policy, it however is associated with a higher inflation. However, since bushfires creates a recessionary pressure the impact the inflationary impact will be less than expansionary effect on output (Ehnts 2016). The demand side policies though move economic output towards potential output these however have some unintended consequence in the long run. The supply side policies however do not have such unintended consequences.
References
Abs.gov.au. (2020). 6401.0 – Consumer Price Index, Australia, March 2020. [online] Available at: https://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/6401.0March%202020?OpenDocument [Accessed 17 May 2020].
Abs.gov.au. 2020. 6202.0 – Labour Force, Australia, Apr 2020. [online] Available at: https://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/6202.0Apr%202020?OpenDocument [Accessed 17 May 2020].
Butler, B. 2020. Economic impact of Australia’s bushfires set to exceed $4.4bn cost of Black Saturday. [online] the Guardian. Available at: https://www.theguardian.com/australia-news/2020/jan/08/economic-impact-of-australias-bushfires-set-to-exceed-44bn-cost-of-black-saturday [Accessed 17 May 2020].
De Vroey, M., 2016. A history of macroeconomics from Keynes to Lucas and beyond. Cambridge University Press.
Ehnts, D.H., 2016. Modern monetary theory and European macroeconomics. Taylor & Francis.
Heijdra, B.J., 2017. Foundations of modern macroeconomics. Oxford university press.
Kwek, G. 2012. RBA lowers rates to GFC levels. [online] The Sydney Morning Herald. Available at: https://www.smh.com.au/business/banking-and-finance/rba-lowers-rates-to-gfc-levels-20121204-2aslb.html [Accessed 17 May 2020].
rba.gov.au 2019. Statement by Philip Lowe, Governor: Monetary Policy Decision | Media Releases. [online] Available at: https://www.rba.gov.au/media-releases/2019/mr-19-29.html [Accessed 17 May 2020].
rba.gov.au 2020. Statistical Tables. [online] Available at: https://www.rba.gov.au/statistics/tables/ [Accessed 17 May 2020].
Order an Essay Now & Get These Features For Free:
Turnitin Report
Formatting
Title Page
Citation
Outline
