Analysis Of Real GDP Growth, Inflation, Unemployment, Business Cycles, Net Export, And Exchange Rate In Australia

Gross Domestic Product and Its Significance

Relation between real GDP growth and inflation and unemployment rate 

One of the most important macroeconomic indicators of a nation is its gross domestic product. Gross domestic measure is a measure of aggregate output produced in a nation. As GDP is a representative measure of aggregate valuation of produced goods and services market prices are used to quantify the volume of output in terms of its market price. In GDP computation use of current year market price gives nominal GDP while the use of a certain base year market price provides GDP at constant price. In order to measure economic growth of a nation percentage change in GDP is taken into consideration (Mankiw, 2014). Use of real GDP growth rate considers as a more useful measure of economic growth as is free from the effect of inflation. The growth rare in real GDP thus expected to have a relation with rate of inflation. As a rising real GDP growth is an indicator of economic expansion it influences unemployment rate through creation or contraction of job opportunities.

Real GDP growth and inflation

The average real GDP growth rate in Australia from 1990 to 2016 is estimated as 3.08%. The real GDP growth rate in 1990 was around 3.53% with an associated rate of rate of inflation of 7.27%. Following a recession at the late 1990s growth has slowed down to -0.38%. With a decline in growth rate inflation rate declined to 3.22%. The economy started to recover from 1992 with a positive growth rate of 0.44% (ABS,2018). The price level however continued to fall was 0.99%. For rest of the periods of 1990 the growth was moderate moving around 3 to 4 percent with reaching a peak rate of 5.01% in 1999. Except in 1995 the inflation remained at a relatively low level. For the next two periods of 2000 and 2001, rate of inflation increased to 4.48 percent and 4.38 percent. As real GDP is an inflation adjusted measure of GDP, a higher price level is associated with a low real GDP growth rate and vice-versa.  The real GDP growth in 2001 was 1.93 percent associated with a high inflation rate of 4.38% (data.worldbank.org 2018). Real GDP growth reached to a significantly low level in 2009 with growth rate being only 1.81 percent. During this year, the rate of inflation fell to 1.82%. Both the low level of GDP growth and inflation indicates that there were factors other than inflation that were at play in determining real GDP growth rate. The real GDP growth rate gradually improved but has not yet reached to the rate prevailing during 1900s or early years of 2000s. The average rate of inflation throughout the entire sample period is 2.68%. The trend in real GDP growth and associated rate of inflation can be understood with the help of following time series graph.

Real GDP Growth Rate Trends and Patterns

As discussed above there is a general inverse relation exists between inflation and real GDP growth rate. Formal definition of real GDP suggests that real GDP is obtained by diving real GDP with GDP deflator. A higher level of price is thus associated with a small real GDP and vice versa. In context of Australian economy, the negative relation between inflation and GDP growth is found to be valid for most of the years (Svensson, 2015). However, there are some exception years where both real GDP and inflation declined simultaneously. These are the period of entire economic slowdown. Such periods include late 1990s to 1991 and in 2009.

Real GDP growth and unemployment rate

The average unemployment rate between 1990 and 2016 is 6.73%. The moderate growth rate of 3.53% in 1990 is associate with an unemployment rate of 6.90%. The negative growth rate of -0.38% in 1991 led to an increase in unemployment rate of 9.60%. The slow growth for the next two three years marked a high unemployment rate of 9-10 percent. As growth recovers, the unemployment rate gradually declined. The movement of real GDP growth rate and associated unemployment rate indicates a negative relation between the two macroeconomic indicators.

The above paired graph between economic growth and unemployment rate showed an inverse relation between GDP growth and unemployment. A higher GDP growth implies more job opportunities and hence, a low rate of unemployment. As shown from the graph, from 1991 onwards as GDP growth started to increase there is a sharp is a sharp fall in prevailing unemployment rate. The gap between GDP growth and unemployment rate narrowed down from 2000 to 2008 (Andersen, Malchow-Moller and Nordvig,  2015). After 2008, following a slowdown in economic growth unemployment rate gradually moved up.

Business cycle

The business cycle theory provides a useful insight to understand the fluctuation in economic growth. The economic growth of a nation is unlikely to constitute a smooth trend over time. There are several factors that contributes to fluctuation in the growth rate. These fluctuations are identified as different phases of business cycle (Jiang, et al., 2017). A complete business cycle includes four phases namely recession, expansion, peak and trough. As indicated from trend growth rate there are notably three years when the economy experienced a significant slowdown. These three phases include 1990-91, 2000-2001 and 2009 (Kent, 2014). In these three phases, a considerable recessionary pressure was realized resulting in a slow movement of price level and high rate of unemployment. After experiencing recession in 1991, the economy gradually entered the phase of expansion and achieved the highest growth rate of 5.01% in 1999. Then again growth slowed down indicating beginning of another business cycle. After the recessionary pressure during 2008-09 following global financial crisis of 2008, the economy currently is a phase of economic slowdown with growth rate being lower than the expected growth rate. The end of mining boom indicated some major differences between mining and non-mining sectors, which are important to understand the state of current business cycle.  Like every other economies Australia has also experienced phases of business cycle followed by fluctuation in economic activity (Halling,Yu and Zechner, 2016). Decline in mining investment, slowdown of household spending, slow wage growth and unstable state of external sector are some of the factor explaining on going phases of business cycle in the economy.

Inflation Trends and Patterns

Relation between net export and real exchange rate between Australia and USA

One of the important components of GDP is net export. The term net export indicates net earnings from external sector and obtained as a different between export and import (Keynes 2016). International trade constitutes a steady proportion of Australian GDP. The share of trade is Australia has increased steadily since 1980s reaching peak at 2008 when trade accounts for about 23 percent of GDP. Estimates suggest that almost one third of Australian produced and services are exchanged internationally. The main exported commodities of Australia include iron ores and concentrates. Coal, education and travel service, natural gas, gold, crude petroleum, aluminum, wheat, professional services and others. The op export destinations for Australia are China, Japan, United States, South Korea, India, Singapore, New Zealand and others.

The main imports of Australia are cars, computers, refined petroleum and packaged medicament. The top five export partners of Australia are China, Japan, United State, Singapore and Germany (Parliament of Australia, 2018). In determining volume of export and import the relative price of currency play an important role. Real exchange rate is a measure that present value of one country’s currency in terms of another. A higher exchange rate implies a higher relative value of currency. This is known as the deprecation of currency. A depreciated currency helps to improve the trade balance by stimulating export volume because of a lower relative price of export in the international market. The appreciation of currency on the other hand worsens the trade balance by reducing volume of export. As most of the exported goods in the international market is measured in terms of US dollar the exchange rate between Australia and USA are crucial in determining the extent of net export (Zhang, Dufour and Galbraith, 2016). The movement of real exchange rate and net export of Australia is shown in the figure given below.

The AUD/US exchange rate during 1990s was 1.28. This implies Australia need to pay AUD 1.28 to purchase one unit of US dollar. In 1992, the exchange rate rose to 1.36 AUD per unit of US dollar. This marked a depreciation of Australian dollar. Following a currency depreciation, the nation experienced a gain in export which resulted in an increases in net export (Dauvin, 2014). Until 2008, Australia maintained a positive trade balance. In the phase of global financial crisis, the relative value of US dollar has declined significantly. This caused Australia dollar to appreciate. The trend decline in exchange rate continued till 2012 with Australia accounting a sizable trade deficit. The US dollar gradually recovered after overcoming the shock of financial crisis. In 2016, the recorded exchange rate is 1.35. With this, the external account of Australia has experienced a trade surplus after a long period of trade deficit.

Unemployment Rate Trends and Patterns

Australia’s cash rate and Federal Reserve’s fund rate

Fund rate and cash rates are the interest rate at which central bank of the nation lend money to other financial institution. The Reserve Bank of Australia and Federal Reserve of United State adjusts the two rates depending on condition of the economy. US and Australia share a strong relationship in terms of trade and investment. Therefore, economic state of one nation likely to affect decision of the other (Ihrig, Meade and Weinbach, 2015). The interest rate also influences exchange rate between the two nations. When Federal Reserve raise the fund rate then that signals a strong position of the economy which a good news for Australian economy. The summary statistics of cash rate and fund rate are presented in the table given below.

The average fed fund rate is obtained as 3.04 as against the average cash rate of 5.83. The relatively higher cash rate helps to strengthen Aussie dollar against that of US dollar. The relatively low average fund rate in US is contributed from continuation of a very low fund rate especially after the global financial crisis.

In 1990, Federal fund rate was 8.10. During this year, corresponding cash rate was 14.83. The Federal government reduced its fund rate to 5.69. The Reserve Bank of Australia in response to recessionary shock in 1990 lowered the interest rate to 10 (rba.gov.au 2018). Cash rate reduced to 5 basis point in 1993. Fed also continued to reduce the cash rate to 3.02 in 1993. As shown from the above graph, cash rate and fund rate are moving almost in the same direction. However, after the financial crisis the fund rate is set a very low level (Goodfriend, 2016). RBA though has reduced the cash rate but it is above that of fund rate. In 2016, the fund rate has slightly increased from 0.13 in 2015 to 0.40 in 2016. The cash rate stabilized at a historically low level of 1.50.

Despite a relatively slow growth rate in recent years, the economic outlook for Australia remained positive. It is expected that investment outside construction and mining will increases bringing a greater opportunity of economic growth. Export will increases following arrival of new resource sector (Mercer, de Rijke and Dressler, 2014).  Household income will increase gradually along with a growth in consumption. A considerably cash rate by encouraging business investment will help to pick up inflation and wage growth.  However, the RBA needs to stop any further lowering of the cash rate. Persistently long period of low cash rate contributed to an increase in housing price in metropolitan areas. This leaves the household in a highly indebted condition. The highly concentrated baking sector in Australia exposes the economy to the risk of future financial crisis that can only be avoided by strong intervention of monetary authority (Armstrong, 2015).

Business Cycle Theory and Its Implications for the Australian Economy

Conclusion: 

In reference to Australia economy, growth in real GDP has found to be inversely related with unemployment.  With a low growth rate of 2.77 percent unemployment remained significantly high at the level of 5.70 percent. Inflation has a negative influence on real GDP and hence on the real GDP growth. In reality however, inflation is likely to influence economic growth positively. In case of real exchange rate and net export, there exists an inverse relation between the two. A higher net exchange rate by lowering export reduces net export. Cash rate and fund rate though move in the same direction but fund rate is lower than cash rate. Despite some recent interruption, policy makers still have a positive outlook for the economy.

Australia is the 14^th largest economy in the world. The nation in the past few decades have accounted an outstanding growth and development. Service sector is the most dominating sector of the economy making the highest contribution in GDP. Australia also has a strong industrial and agricultural sector. The nation shares international relation with a number of developed and developing nations. Trade account a significant portion of Australia’s GDP. In the last few years however Australia has accounted a decline in is economic growth rate (RBA, 2018). The steady performance of Australian economy makes it an interesting area of research.

Reference:  

Abs.gov.au. (2018). 6401.0 – Consumer Price Index, Australia, Mar 2018. [online] Available at: https://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/6401.0Mar%202018?OpenDocument [Accessed 19 May 2018].

Andersen, T.B., Malchow-Møller, N. and Nordvig, J., 2015. Inflation targeting and macroeconomic performance since the Great Recession. Oxford Economic Papers, 67(3), pp.598-613.

Aph.gov.au. (2018). Australia’s trade in figures – Parliament of Australia. [online] Available at: https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/BriefingBook45p/AustraliaTrade [Accessed 19 May 2018].

Armstrong, S., 2015. The economic impact of the Australia–US free trade agreement. Australian Journal of International Affairs, 69(5), pp.513-537.

Data.worldbank.org. (2018). Official exchange rate (LCU per US$, period average) | Data. [online] Available at: https://data.worldbank.org/indicator/PA.NUS.FCRF?locations=AU [Accessed 19 May 2018].

Dauvin, M., 2014. Energy prices and the real exchange rate of commodity-exporting countries. International Economics, 137, pp.52-72.

Goodfriend, M., 2016, August. The case for unencumbering interest rate policy at the zero bound. In Federal Reserve Bank of Kansas City’s 40th Economic Policy Symposium. Jackson Hole, WY. August (Vol. 26).

Halling, M., Yu, J. and Zechner, J., 2016. Leverage dynamics over the business cycle. Journal of Financial Economics, 122(1), pp.21-41.

Ihrig, J.E., Meade, E.E. and Weinbach, G.C., 2015. Rewriting Monetary Policy 101: What’s the Fed’s Preferred Post-Crisis Approach to Raising Interest Rates?. Journal of Economic Perspectives, 29(4), pp.177-98.

Jiang, B., Athanasopoulos, G., Hyndman, R.J., Panagiotelis, A. and Vahid, F., 2017. Macroeconomic forecasting for Australia using a large number of predictors. Monash Econometrics and Business Statistics Working Papers, 2, p.17.

Kent, C. (2018). The Business Cycle in Australia | Speeches | RBA. [online] Reserve Bank of Australia. Available at: https://www.rba.gov.au/speeches/2014/sp-ag-131114.html [Accessed 19 May 2018].

Kent, C., 2014. The Business Cycle in Australia. Address to the Australian Business Economists, Sydney, 13.

Keynes, J.M., 2016. General theory of employment, interest and money. Atlantic Publishers & Dist.

Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning.

Mercer, A., de Rijke, K. and Dressler, W., 2014. Silences in the midst of the boom: coal seam gas, neoliberalizing discourse, and the future of regional Australia. Journal of Political Ecology, 21(1), pp.279-302.

Reserve Bank of Australia. (2018). Cash Rate | RBA. [online] Available at: https://www.rba.gov.au/statistics/cash-rate/ [Accessed 19 May 2018].

Svensson, L.E., 2015. The possible unemployment cost of average inflation below a credible target. American Economic Journal: Macroeconomics, 7(1), pp.258-96.

Zhang, H.J., Dufour, J.M. and Galbraith, J.W., 2016. Exchange rates and commodity prices: Measuring causality at multiple horizons. Journal of Empirical Finance, 36, pp.100-120.

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