Macroeconomic Assessment of Australia
Discuss about The Exchange rate pass-through in the global economy.
In the contemporary global framework, one of the leading economies, with impressive growth and economic development over the last few years, is the economy of Australia. Being fourteenth largest in terms of Nominal GDP, the economy holds the record of longest uninterrupted growth of GDP for twenty-six years (Pieterse, 2015). Much of this highly impressive growth of the country can be linked to the development of the industrial and service sector of the country, with more than seventy percent of the total workforce being employed in the latter only. The mining, gas and real estate industry are among the most notable industries in the country, which clubbed with the highly developed and efficient external sector of the country and its robust policy framework, contributed to the economic welfare of the country (Dyster and Meredith, 2012).
Apart from GDP, there are other vital economic indicators, like inflation, unemployment, exchange rate, cash rate and net exports, which have considerable implications on the economic wellbeing of Australia. The report, keeping this into consideration, tries to interpret the relation and dynamics among these economic variables in the country, within the chosen time frame (1990-2015). It also tries to analyze the reasons behind such dynamics and the implications of the policy framework of the country on the same, thereby forecasting the possible economic situations in the country in near future (Ravenhill, 2017).
The primary indicator of economic growth, which is most widely used across the globe, is the Gross Domestic Product of the country, which shows the value of all the final goods and services that are in a year, produced within a country. The Real GDP, is the inflation adjusted measurement of GDP, which the values of goods and services taking a stable economic year the base. In case of the economy of Australia, a moderately stable growth trend of Real GDP is observed within the concerned period (3.1%), with occasional troughs (-0.38% being lowest in 1991) and peaks (highest being 5.01% in 1999). The dynamics in the Real GDP, however, is dependent on the changes in the other economic indicators, as discussed above. This is discussed in the following section (Arkolakis, et al., 2013).
The economic welfare of a country and its residents in particular depends considerably on the employment scenario of the country in the concerned period. High employment generation implies high income in the hands of the people of the country, which in turn increases their aggregate demand, thereby contributing positively in the productivity of the country. Therefore, the relationship between GDP and unemployment is bilaterally negative, theoretically.
Unemployment Rate and Rate of Growth of Real GDP
The unemployment in Australia has been maintained at a moderate average level of nearly 6.8% between 1990-2015. However, the rate was exceptionally high in 1993-1994 (11%) and considerably low in 2007-2008 (4.4%). The relationship between unemployment rate and the growth rate of the Real GDP of the country, within the period under consideration, is found to be negative, with the correlation being -0.13 (Kubiszewski, et al., 2013). The trends from the empirical evidences also assert the same as can be seen below:
Figure 1: Relationship between unemployment rate and Real GDP growth rate
(Source: Data.worldbank.org, 2018)
The above figure clearly shows the presence of a negative relationship between the unemployment rate and the rate of growth of Real GDP in Australia in 1990-2015. Within the period in concern, unemployment has decreased considerably, while the Real GDP has maintained a steady growth rate, in spite of occasional fluctuations. Much of this decrease in unemployment can be attributed to the considerably huge industrial growth in the country over the years, which has created large job scopes, thereby increasing the financial welfare of the residents. This in turn, by increasing the aggregate demand and supply, has increased the GDP of the country considerably (Stewart, 2013).
The economic stability and welfare of a country also depends on the overall price levels prevailing in the country at a point of time and the dynamics in the same. The presence of a very high price level, indicating higher inflationary pressure on the economy, has highly negative implications on the welfare of the residents. On the other hand, very low price levels can be detrimental to the producers as their revenue decreases significantly. On the other hand, while a demand-pull inflation increases the productive activities in a country, a cost-push type of inflation hampers the production (Green, 2016). Generally, with the economic growth and increase in the productivity of country, the level of disposable income and the aggregate demand both increases, thereby raising the average level of price. This indicates towards a positive relationship between the inflation and the GDP of a country.
Australia, in general, has maintained a low rate of inflation (average rate being 2.7%). The rate however, increased massively in 1990 (7.27%) in 1990s, due to the period of excessive aggregate demand preceding that. RBA responding to the same, implemented contractionary monetary policies, which brought the inflation rate down to 0.25% by 1997. The relationship between the two-concerned variable, in case of Australia, however, seems a bit confusing as it is not seen to be following the theoretical pattern. The correlation between the same is found to be -0.03 (Kumar, Webber and Perry, 2012).
Inflation Rate and Growth Rate of Real GDP
Figure 2: Relationship between the Growth Rate of Real GDP and Inflation Rate
(Source: Data.worldbank.org, 2018)
There remains a negative relationship between the inflation rate and the Real GDP growth rate in Australia, which can be partially explained with the presence of a huge debt burden in the country in the concerned period. This high debt in the country, existing in the contemporary period, has contributed negatively in the growth rate of the Real GDP of the country, even in the presence of high inflation, which justifies the presence of the negative relationship between the rate of inflation and the Real GDP growth rate (Hossain, 2014).
The external sector and the exports imports of country as well as the balance of payment of a country depends substantially on the exchange rate prevailing in the country, which is the value of the currency of the country in terms of the same of other country (Conventionally US $). An increase in the exchange rate lowers the value of the domestic currency, which in turn makes exports easier, which raises the GDP of the country. Thus, theoretically there exists a positive relation between these two variables (Bussière, Delle Chiaie and Peltonen, 2014).
Figure 3: Relationship between the exchange rate and the growth rate of Real GDP
(Source: Rba.gov.au, 2018)
In case of Australia, this seems to hold as the correlation is seen to be 0.2. The above figure also shows the presence of a roughly positive relationship between the two variables. The exchange rate being kept between $1 and $2 (USD) has facilitated the exports of the country over the years considerably, which can be seen from the more or less growth rate of the Real GDP of the country, despite of several noticeable fluctuations.
As discussed above, the exchange rate of a country determines the import and export dynamics of a country substantially, which in turn has its implications on the overall economic growth of the country. When the exports of a country is greater than the amount imported, then the net export of the country is seen to be positive, which contributes positively to the balance of payment of the country. This in turn increases the GDP of the country. This thereby indicates towards the presence of a positive relationship between the growth of the GDP of a country and the amount of the net exports in the concerned country (Kelly, 2014).
Exchange Rate and Growth Rate of Real GDP
The same trend can be seen in the economic growth pattern of Australia, with the correlation among the same being 0.23.
Figure 4: Relationship between the Net Exports and Growth Rate of the Real GDP
(Source: Data.worldbank.org, 2018)
The above figure shows that Australia has over the years maintained a more or less positive trade balance, except in between 2010 and 2012, when there occurred in trade deficit in the country. This may be due to the increase in the import of intermediate goods and services as well as the increase in the aggregate-demand of foreign consumption goods (Atkin and Connolly, 2013).
In general, the cash rate in a country is defined to be the rate of interest, which the monetary authorities of the country charge from the private banks if the latter take loans from the former. In presence of a low cash rate, borrowing is stimulated which in turn helps in stimulating the investment and contributing positively in the economic growth of the country. Thus, there exists a negative relationship between the two concerned variables in terms of the exiting theories.
As is evident from the above figure, the concerned variables show a clearly negative trend over the concerned period, with the correlation among the two variables being -0.08. This can be linked to the monetary policies taken by the Reserve Bank of Australia, in which the cash rate has been deliberately kept low, in order to increase the investments in the country. The cash rate, being at 2.13% has facilitated the investments and economic growth in the country, which can be seen from a stable economic growth in the country in the contemporary period.
The two indicators, inflation rate and the rate of unemployment, are in general inversely related. This can be explained with the help of the theory of Phillips Curve, which was first proposed by A. W. Phillips. According to the theory, when there is economic growth in a country, this leads to an increased in the employment scopes in the country as a whole. This in turn increases the economic welfare of the residents of the concerned country by increasing their disposable income, which in turn increases their aggregate demand for the goods and services. The excess demand in the economy pushes up the average price level, thereby creating an upward pressure on the average price level in the country, which leads to an increase in the inflation in the same, which can be seen from the following figure:
Net Exports and Growth Rate of Real GDP
From the above figure, it can be seen that with the increase in the level of employment, that is with the decrease in the rate of unemployment in the country, the excess demand for goods and services pushes up the price levels in the economy, thereby creating an upwards trend of the rate of inflation in the country. This justifies the negative trend between the rate of inflation and the rate of unemployment in the country.
In case of Australia, there exists a visibly negative relationship between the rate of inflation and the unemployment rate in the period of consideration, which can be seen from the following figure:
The above figure clearly shows inverse relationship between unemployment and the inflation rate of the country. Over the concerned period, the unemployment rate has been seen to be consistently falling with several exceptions, like that in 2012-2014, when the same is seen to be increasing considerably. However, the rate of inflation has seen to undergo considerable fluctuations, with positive trends in many instances (Ormerod, Rosewell and Phelps, 2013). The relationship between the two concerned indicators has however been positive in 1994 and 1995, where the fall in the price level is accompanied by a fall in the rate of unemployment. This has again been observed in 2004, which can be attributed to the policies, which have been taken by the RBA. The policy framework is targeted to reduce both the inflation and the unemployment to a moderate level.
In general, the Central Banks or the monetary authorities of a country take contractionary or tight monetary policies, when there is excessive liquidity in the economy, contributing to an upward trend in the overall price levels in the country, thereby affecting the residents adversely. In case of Australia, this type of policy framework was adopted in 1980s following a period of excessive inflationary burden, which however landed the country in a phase of acute recession (Rey, 2015). In the recent periods (post 2004), this has again been done by the RBA, in order to respond to the excessive demand in the economy and the presence of high household debt burden in the economy.
The Australian economy is expected to keep on going at a moderately impressive rate of 2.5% to 4% in the coming years, much of which can be attributed to the policies, which are expected to be taken by the government and the monetary authority of the country. The wage level, however, is not expected to increase, which can be beneficial in keeping the inflationary pressures in check. However, low wage can lead to low rates of savings, which again however, is not expected to affect the investment in the country, which is hoped to increase in the coming years, thereby reducing the risk of recession in the economy (McLean, 2012).
Conclusion
As can be seen from the above empirical evidences and the relevant economic interpretation of the same, in spite of the presence of considerable fluctuations and dynamics in the overall economic activities of the country, Australia, has been and is still one of the most stably growing economies in the world. Much of which can be attributed to the stable economic policy framework of the country, which in the cases of occurrences of any discrepancy or diversion from the equilibrium state, operate efficiently in bringing back the economy on the path of sustainable economic growth and contributes in increasing the overall welfare of the residents of the country.
References
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Atkin, T. and Connolly, E., 2013. Australian exports: global demand and the high exchange rate. RBA Bulletin, pp.1-10.
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