Gross Domestic Product (GDP)
The assignment will shed light over the different economic variables of the Australian economy and these variables will be discussed in accordance with the real time data available in the World Bank website. Furthermore it would be investigated whether there is a relationship between these variables or not. Finally the assignment would conclude on the basis of the entire analysis whether the Australian economy would face an inflation or a recession in near future.
The Gross Domestic Product or GDP is the final monetary value of all the finished goods and services produced within the boundaries of a nation within a specific time period. The gross domestic product incorporates the public and private consumptions, private inventories, construction costs which are paid-in as well as the foreign balance of trade. Therefore, on a broader sense it can be stated that GDP is a measure of the overall economic activity of an economy. Most commonly GDP measures the overall economic activity of a nation and at the same time provides a broader idea about the standard of living of the country (Hatfield-Dodds et al., 2015). The GDP can be categorized as nominal GDP and real GDP. The nominal GDP is not adjusted against any value while the real GDP is adjusted for inflation. Inflation is defined as the sustained rise in the general price level of the goods and services. In relation to this the rate of inflation will them be defined as the rate at which the price level of the goods and services increase over time.
Figure 1: Real GDP Growth Rate and Inflation Rate (1990-2016)
(Source: Databank.worldbank.org. 2018)
The graph above depicts the relationship growth rate and rate of inflation in Australia for the time period of 1990 through 2016. It can clearly be observed that Australia has always experienced a subtle and stable inflation rate which is sometimes regarded as good for the health of the economy by the economists. Whereas the GDP growth rate has depicted significant fluctuations in its value for this given time period.
Relationship between Australia’s real GDP Growth Rate and Unemployment Rate
Figure 2: Real GDP Growth Rate and Unemployment (1990-2016)
(Source: Databank.worldbank.org. 2018)
There are different factors which affects the gross domestic product and unemployment rate. The historical data substantiated the fact that a one percent decrease in the level of Gross Domestic Product world lead to an increase in the unemployment rate by less than 2 percent point. This relationship is popularly known as the Okun’s Law. The graph above have observed the movement of these two variables for the time period from 1990 through 2016. It has been observed that during the period of 1990 through 1991, GDP and unemployment rate both have increased simultaneously (Hatfield-Dodds, 2015). However, after 1991 when GDP started to decline the unemployment rate kept on increasing following the Okun’s Law. From 2002 through 2004 the gross domestic product kept on creasing at a steady rate while the unemployment rate was diminishing. Right after the emergence of global financial crisis the gross domestic product started to decline sharply and it has been observed that during that period the rate of unemployment also increased a little. Hence it can be stated that these specific time periods mentioned above have depicted significant deviation from the historical evidences. Economists have argued that there may be a decrease in the unemployment rate right after the recovery period as the increase in the level of GDP has compelled the unemployment rate to diminish at a much rapid pace (Ball, 2014).
Relationship between Australia’s real GDP Growth Rate and Unemployment Rate
Evidence of Business Cycle
The business cycle is simply defined as the natural rise or fall of the economic growth which takes place over the passage of time. This is recognized as a useful tool that can be used extensively for analyzing the economy. There are mainly four distinct stages of a standardized business cycle which are namely, expansion, peak, contraction and trough. In the context of the given scenario it can be stated that there are clear evidence of business cycle (Davis, 2016). For instance during the time period 2001 to 2004 and 2006 to 2008 the Australian economy depicted significant expansion and hence these two period can be regarded as the expansion phases. However due to the emergence of global financial crisis the economy faced a severe recession and from the peak of 2008 the Australian economy started experiencing the contraction phase of the business cycle till 2009. Right afterwards 2009 which can be marked as the trough year and the economy started recovery. In both the diagrams above it can be clearly observed that the unemployment rate and inflation rate also varied in accordance with the movements in the GDP and hence it can easily be stated that the figures substantiates the existence of a clear business cycle in the economy.
Relationship between Net Exports and the Real Exchange Rates between USA and Australia
Net exports of a country is defined as the total exports of the country less than the value of the total imports of the nation. This measure is generally used to gauge the expenditure of the country or to measure the gross domestic product of an open economy. In other words net exports can be defined as the extent to which the foreign expenditures on the home country’s goods and services exceeds the home country’s expenditures on the goods and services of the foreign country (Behlul et al., 2017).
On the other hand, the exchange rate is defined as the price of the currency of a nation in terms of the other currency. Hence it is quite evident that exchange rate possesses two distinct components which are domestic currency and foreign currency and can either be quoted directly or indirectly. In the context of direct quotation the price of a unit foreign currency is expressed in terms of the domestic currency. However, in case of the indirect quotation the price of a unit of domestic currency is expressed in terms of foreign currency (Chen et al., 2018).
The figure below represents the exchange rate of Australian Dollar against US Dollar and the Net Exports for the time period 1990 through 2016. The figure would help to trace out the relationship between these two variables.
Figure 3: Net Exports and Real Exchange Rate
(Source: Databank.worldbank.org. 2018)
The figure above reveals the fact that the Australian exchange rate has remained almost constant throughout the year it has not depicted any wider fluctuation. However, in the context of the net exports it can be stated that the net export of the Australian economy always remained on the negative side. This signifies the fact that Australia is a major importer of the foreign goods and services. The net exports was positive only during the year 2011 however, it again came back to the negative side in the very next year. Australia has ranked 23 among the largest exporting economies throughout the world in 2016 (Nasser et al., 2018). During that year Australia exported %159 billion while imported $181 billion and as a result there were a negative trade balance of $22.1 billion. However, the top exporting materials of Australia were Gold, Petroleum Gas, Iron Ore and Coal Briquettes. On the other hand, the top most imports are mainly cars, computers, refined petroleum and crude petroleum.
Evidence of Business Cycle
Now in the context of relationship between real exchange rate and net exports it is essential to understand that there is a significant difference between real exchange rate and nominal exchange rate. The nominal exchange rate signifies the amount of domestic currency that could be exchanged against a unit of the foreign currency. On the other hand, real exchange rate signifies the amount of domestic goods and services that can be exchanged against the goods and services of the foreign country. There exists a significant relationship between real exchange rate and net exports. For instance when the real exchange rate is high it will signify that the relative prices of the goods and services in the domestic country is higher than that of the relative prices of goods and services in the foreign country (Rees et al., 2016). In such a scenario import is favored as in real terms the foreign goods and services become cheaper. However, in the context of Australia it can be stated that the exchange rate of the country remained more or less same during the selected time period and there were significant fluctuations in the net exports, hence no clear relation can be traced out from the graph.
Relation between Australia’s Cash Rate and Federal
Cash rate is defined as the interest rate which the central bank charges to the commercial banks for overnight borrowings. Indirectly this system influences the entire term structure of the overall interest rate in the economy as a whole. The target for the cash rate in other ways expresses the monetary policy decisions.
While Reserve Bank of Australia follows an approach to implement monetary policies is known as the inflation targeting. It signifies that the country sets up a numerical target for achieving inflation and sets up a framework for achieving the desired target. The cash rate of Australia noted a historically low cash rate at 1.5 per cent. Hence if there is a shock which can adversely affect the economy the government would merely get a room to reduce the cash rate furthermore (Pagan and Wilcox, 2015). It is assumed that when the inflation rate is below the target level a reduction the cash rate also reduces the long term interest rates which in turn encourages the people to purchase more goods and services and invest significantly. Increasing the demand raises the price level which as a result brings the level of inflation back to its target level.
The federal government makes use of the forward guidance in order to control the cash arte. During the year 2008 the federal funds rate achieved the lower bound zero and in response to that the Federal Reserve announced that the committee s anticipating the weaker economic conditions would lower the level of federal funds rate for certain times (Hudson and Vespignani, 2018). The federal funds considered the zero cash rate for certain times and the aforementioned communication in turn influenced the publics to believe that in future the US will implement an expansionary monetary policy which will aid the current situation.
Relationship between Net Exports and the Real Exchange Rates between USA and Australia
Figure 4: Federal and Australian Cash Rate (1990-2016)
(Source: Databank.worldbank.org. 2018)
It can be stated from the figure above that the Australian Cash rate have declined significantly during the time period 1990 to 1996. However, it projected a rise during the time period of 1993 to 1994 and soon after that it again fell down as per the monetary policy of the Reserve Bank of Australia. Later on it maintained a steady pace and year on year basis remained almost the same and again declined in the year 2004. Now in the context of the federal cash rate it has been observed that it has not fluctuated rigorously during the selected time period however it can be stated that soon after the great recession the federal cash rate maintained a substantially but continuous low rate and is still maintaining that rate as well. In the context of relationship between these two components it can be stated that the federal cash rate is less likely to influence the Australian cash rate as these are two different components of the monetary policies of these two countries. However, if there exists any link between these two countries in terms of monetary variables the federal cash rate may influence the cash rate in Australia.
Based on the statistics and empirical evidences prevalent and analyzed in the study it can be stated that the Australian economy will continue to grow furthermore at a steady pace. The investments in the business sectors apart from housing and mining sectors will increase as the GDP growth of the economy has been depicting a significantly increasing trend. The exports will also increase due to the enhancements in the resource sector capacities. On the other hand, further strengthening of the labor market as well as the household incomes in turn sustains the private consumptions, inflation and the wages would rise significantly (Garnaut et al., 2017).
The central bank of Australia has also projected that the policy rate would increase in the second half of the year 2018, coupled with the expectations of this move coupled with the macro-prudential measures the housing market would be cooled down. The fiscal condition of the economy is in a robust shape as it has been depicted by the movements of the net exports curve and it is expected that the government of Australia would certainly mitigate the budget deficits. The emergence of an unexpected economic downturn it can be expected that the government of Australia would implement fiscal policy in order to support the activities and protect the income of the most vulnerable portion of the population.
Furthermore the GDP growth rate, inflation and the rate of unemployment signifies the fact that the Australia is facing a potentially good economic environment. It has sustained a substantial GDP growth rate and even after the emergence of the global financial crisis the economy recovered quite quickly. Furthermore, the unemployment rate in the economy is low which means that the major portion of the population is able to obtain a job at the prevailing wage rate in the market. Furthermore, in the context of inflation it has also been observed that the economy has been able to maintain a substantial level of inflation which in turn is beneficial for the economy (Pagan and Wilcox, 2015). Therefore it can be stated that in near future the economy may expect an inflation as the gross domestic product of the country has been declining and is expected to have achieved the trough position of the business cycle and the recovery stage has also been emerged. Since coupled with the extensive increase in the level of GDP it can be expected that the level of inflation would rise as the Reserve Bank of Australia has also decided to increase the cash rate in near future.
Conclusion
On a concluding note, it can be stated that the assignment has successfully evaluated the Australian economy in the light of the data obtained from the World Bank. Throughout the assignment it has been observed that the gross domestic product, rate of inflation and the unemployment are the three main components of determining economic performance of a nation and these three components in the context of the Australian economy has depicted a significantly better position which substantiates that the economy is in a very good shape and health. Furthermore, in the context of net exports and exchange rate no relationships could be established as Australia is a developed country in exports significantly and imports large amount of goods and service as well. The country experiences a trade deficit for almost all the time of the year. However, on the basis of the overall analysis it can be stated that the country would soon face an inflation.
Reference List
Ball, L.M., 2014. Long-term damage from the Great Recession in OECD countries (No. w20185). National Bureau of Economic Research.
Behlul, T., Panagiotelis, A., Athanasopoulos, G., Hyndman, R.J. and Vahid, F., 2017. The Australian Macro Database: An online resource for macroeconomic research in Australia.
Chen, Y., Zhang, H., Tam, K.L. and Wu, M., 2018. The Making of Contemporary Australian Monetary Policy-Backward-or Forward-Looking?. International Journal of Economics and Finance, 10(6), p.127.
Databank.worldbank.org. 2018. World Development Indicators | DataBank. [online] Available at: https://databank.worldbank.org/data/reports.aspx?source=World-Development-Indicators# [Accessed 17 May 2018].
Davis, S.J., 2016. An index of global economic policy uncertainty (No. w22740). National Bureau of Economic Research.
Garnaut, R., Baxter, P. and Frueger, A.O., 2017. Exchange rate and macro-economic policy in independent Papua New Guinea. Canberra, ACT: Development Studies Centre, Research School of Pacfic Studies, The Australian National University..
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Hatfield-Dodds, S., Adams, P.D., Brinsmead, T.S., Bryan, B.A., Chiew, F.H.S., Finnigan, J.J., Graham, P., Grundy, M., Harwood, T., McCallum, R. and McKellar, L., 2015. Australian National Outlook 2015: Economic activity, resource use, environmental performance and living standards, 1970-2050. Canberra, Australia: CSIRO.
Hudson, K.B. and Vespignani, J., 2018. Understanding the deviation of Australian policy rate from the Taylor rule. Applied Economics, 50(9), pp.973-989.
Nasser, F.A.M., Rosid, C.M.A.C. and Baharuddin, N.S., 2018. Relation between Macroeconomic Variables and ASEAN Stock Index. Terengganu International Finance and Economics Journal (TIFEJ), 5(1).
Pagan, A. and Wilcox, D., 2015. External Review–Reserve Bank of Australia Economic Group Forecasts and Analysis. report to the Reserve Bank of Australia.
Rees, D.M., Smith, P. and Hall, J., 2016. A Multi?sector Model of the Australian Economy. Economic Record, 92(298), pp.374-408.
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