Macroeconomic Environment of Australia
Discuss about the Industrial Revolution and Economic Growth.
Several advanced and emerging economies are experiencing some major changes in response of changes occur in domestic and international economy. Australia is no exception and is undergone such structural changes. In an interconnected world, changes occur in economic scenario in one nation, affects other nations as well. Recent slow growth in China dampens minerals demand of Australia. As mining boom in Australia ends, the economic growth of Australia slows down. Government of a nation intervene using fiscal and monetary policy. Central bank designs monetary policy by adjusting interest rate (Pieterse, 2015). Different objectives of monetary policy include stabilize price level, achieving stable economic growth, full employment and external stability. There remains a debt over rule and discretion based monetary policy.
The essay aims to portrait present macroeconomic environment of Australia. The economic environment has been evaluated using different indicators like GDP, unemployment and inflation. Focus has also been given on current framework of monetary policy and its effectiveness as a stabilization tool.
Macroeconomic environment of nation depends on a number of different indicators. Gross Domestic Product indicates aggregate output of a nation. GDP is a symbolic measure for monetary value of goods and services produced by a nation. Goods and services assessed with market price of current year is called nominal GDP while goods and services assed using market price of a fixed base year is called real GDP. Rate of change in GDP is a measure of economic growth indicating economic progress of a nation. Performance of labor market is an important indicator of productivity growth (Hartwell, 2017). Labor market performance is measured from rate of unemployment. Rate of unemployment is expressed as a percentage of number of people who are looking for jobs but are unable to find one in the total labor force. Movement of price level or inflation is another important indicator of macroeconomics performance of a nation.
The figure above shows nominal and real GDP growth rate of Australia since 2000. Following a relatively stable inflation rate, real GDP growth rate constitutes stable trend remaining around the stable price level. Nominal GDP measuring volume and price of goods and services shows a rising trend (businessinsider.com.au, 2018). The nominal GDP reached to its highest value since the mining boom earlier to the previous decade.
Increasing trend in nominal GDP indicates economic progress of Australia shows a nominal reflation. Real economy though kept growing but it remained around its trend rate. After last few years of economic weakness nominal economy has picked up. The main driver of economic growth was growing commodity prices. Profitability of mining sector has recovered this year. This along with increased investment in infrastructure raised profitability of other sectors and boosted tax revenue. Improvement in the nominal economy enhances business confidence and profitability.
Business Cycle in Australia
Rate of inflation has been recovered from 1.25% in 2016 to 1.97% in 2017. In 2018, inflation rate is expected to be averaged at 2.24%. Unemployment rate in Australia is stood at 5.6% showing an increase of 0.1 percentage point as compared to the previous quarter (tradingeconomics.com, 2018). Government however has attempted to reduce the unemployment rate by boosting rate of job growth. The modest growth in wages is expected to raise income of household accelerating spending of consumers.
Business cycle corresponds to ups and down in economic growth. The stages of business cycle are associated with alternative expansion and contraction of economic activity (Sloman, Norris & Garrett, 2013). At present, Australian economy is passing through phase of slow recession with a slightly declining trend in GDP growth and a high rate of unemployment. The main forces behind economic slowdown is the decline in mining investment, contraction of construction sector, slow growth of wages and decline in consumer confidence (Halling, Yu & Zechner, 2016). RBA adapts monetary policy tool to overcome the recessionary phase and secure a stable growth rate.
Government of a nation designs policy framework of a nation to achieve certain macroeconomic goals. The main objectives of Australian government are the following.
A strong and sustainable economic growth implies an overtime increase in real GDP of Australia, which does not create any inflationary or external pressure. Sustainability in economic growth refers to the maintenance of steady growth rate in the long run by ensuring that present growth rate does not completely absorb non-renewable resource stock, damage the environment or reduce ability of next generation to meet necessary wants. At present the government targets to attain an approximate growth rate of 3 to 4 percent (Chattopadhyay & Bose, 2015).
The main objective of RBA’s monetary policy is to attain a low and stable price level for Australia (Robinson et al., 2017). RBA currently targets to keep inflation rate in a range between 2-3%.
The other macroeconomic goals include attainment of full employment, achieve external stability and achieve equality in distribution of personal income
Monetary policy a macroeconomic policy designed by central bank of a nation. The monetary policy of central bank aims to manage money supply of the nations and adjusts interest rate depending on state of the economy (Gali, 2015). This is a demand side policy used to achieve macroeconomic goals like inflation, economic growth, consumption and liquidity.
Government Policy Framework and Objectives
The objective of monetary policy is to attain both internal and external price level stability. Steady rise in price level has a destabilizing impact on the economy. Persistent decline in price level has an even more deteriorating effect on the economy (rba.gov.au, 2018). As both increase and decrease in price level is a threat to steady economic growth, price level needs to be stabilized to support economic development.
Government using the monetary policy tool aims to ensure full employment in the economy. A country should aim to achieve a near full employment. Waste of labor can be prevented by pushing up aggregate demand (Kiley & Roberts, 2017). Successful implementation of monetary policy stimulates aggregate demand.
Attaining a steady growth rate is the predominant goal of monetary policy. A suitable monetary policy adjusts money supply in favor of economic growth. Monetary policy by directing credit to specific economic areas creates a favorable environment of economic growth.
Objective of monetary policy is to facilitate borrowing of government and manage pubic debt. Monetary policy is used to attain sound debt management policy and establish an orderly condition in security and bond market.
The first and direct effect of a change in money supply as a part of monetary policy is on the equilibrium interest rate in the money market. The effect in money market transmitted to goods market and affects economic growth and inflation through different transmission channel (Agénor & da Silva, 2014). Consider the effect of an expansionary monetary policy
Supply of money in an economy is fixed and s controlled by the central bank of a nation. The straight line, Ms represents the money supply curve. The money demand curve MD is a downward sloping function of interest rate. During expansionary monetary policy, central bank raises money supply indicated by a right ward shift in money supply curve to Ms1. The equilibrium rate of interest, obtained where money supply and money demand curve intersects lowers from r* to r1.
The impact of low interest rate now transmits to goods market through different channels. The direct channel of transmission mechanism is the cost of credit. An expansionary monetary policy raises credit demand by lowering interest rate. Borrowing now becomes cheaper to investors because of lower cost of repayment (Bell, 2017). Lower interest rate implies a lower return to saving. As saving becomes less attractive, spending on consumption increases which further raises aggregate demand.
Monetary Policy and its Objectives
Reserve Bank of Australia releases monetary policy statement four times in a year. The policy statements are based upon current state of economy and future prospects of growth and inflation. The latest monetary policy statement of RBA has given stress on following policy objectives.
In this year, RBA has decided to keep cash rate at 1.50 percent. Global economy in the last few years has strengthened. Most of the advanced nations are experiencing a growth rate, which is above the trend growth rate. Along with high growth rate, these nations have also achieved the target of a low unemployment rate (rba.gov.au, 2018). Globally, the rate of inflation remains at a low level. In some countries, however inflation has increased showing possibility of further increase following a tight condition in the labor market. The global economic condition influences domestic economic environment and framework of monetary policy.
The central bank forecasts that economic growth in Australia is exacted to pick up. The economy is expected to grow at a rate above 3 percent in 2018 and 2019. Recovery in economic growth rate should reduce spare capacity of the economy. Business condition remains favorable with a growth in non-mining investment (rba.gov.au, 2018). High public expenditure on infrastructure provides a great support to the economy. The economy expects a strong growth in export. Uncertainty remains regarding growth of household consumption. Growth in household income is slow along with a high debt level.
The monetary policy statement regarding employment states that though employment has grown steadily in the last few years but has slowed down in recent months. Steady growth in employment has been accompanied by a considerable increase in labor force participation. Participation increases particularly among with females and older Australians. Unemployment though increases but remain stable around 5.5 percent (rba.gov.au, 2018). Despite employment growth, wage growth remains low. Inflation in the economy remains low. Recent data on inflation shows that both consumer price index and underlying inflation rate match expectation of the central bank. The central bank forecasts inflation to remain low for some time.
Depending on global and domestic economic condition, RBA designs the latest monetary policy. RBA in its latest monetary policy statement states that it will keep the cash rate as low as at 1.50%. With this cash rate remains at the level consistent with the rate since 2016. RBA has taken thus decision following a mild inflationary pressure. By keeping the interest rate at a low level, RBA aims to bring inflation back to the targeted level and support domestic economy.
Transmission Mechanism of Monetary Policy
Since the last few years, RBA has maintained a historically low cash rate. The low interest rate affects various major areas of the economy. The interest rate set by RBA has major impact on housing market, GDP, unemployment, business investment, retail performance, consumer confidence and on the global economy. Interest rate has a direct relationship with housing construction and property prices. Low interest rate allows people to borrow more money to build and buy new properties. This in the long-run though is a good news for construction sector but in the long run it comes with several side effects. Growing property demand creates an upward pressure on housing price. Housing price has increased significantly in Sydney, Melbourne and other capital cities (Ellis & Littrell, 2017).
Low interest rate in Australia has designed to support business investment. Lower interest rate means a lower cost of borrowing and repayment. The low interest rate is Australia led to a strong growth to business lending. Credit has recorded a moderate overall growth. Investment in both mining and non-mining sectors has increased. Business environment in Australia had improved. With rise in business investment, more businesses are now prepared to take risk and willing to invest in new assets. The improved business condition in turn contribute to a growth of consumer spending. Despite low interest rate, businesses are still trying to cut business cost. As a result, despite growth of business investment wage growth remained slow.
Low interest rate increases households’ debt in Australia. In the financial year of 2015-16, more than 29 percent or 1.9 million households are found to indebted. They had a debt which is three or more times of their disposable income (theguardian.com, 2018). Household having a mortgage are more likely to be over-indebted. Younger household falling in the age bracket of 25 to 34 has a higher indebtedness. Melbourne has the largest number of indebted household with number of over-indebted household being 419,600. In terms of indebted household, Sydney follows Melbourne with number of indebted household being 407,000. The over-indebtedness is however greater in Sydney.
Interest rate is one primary monetary policy tool of RBA. However, in the past few years, interest rate is found to have a limited impact on Australian economy. Several economies including Australia has taken policy of quantitative easing and cut in interest rate. In Australia, the economy however does not respond to low interest rate in the same way as expected. The major reason behind this is the pre-existing debt in Australia. Households’ borrowing in Australia has increased significantly over the decade because of their response to nominal interest rate. Saving rate fell significantly contributing to an increase in indebtedness (Caceres, Carriere-Swallow & Gruss, 2016).
Monetary policy of most of the advanced economies is now based on discretion. The monetary policy regime is designed to achieve a targeted level of inflation. With a flexible exchange rate system, a group of monetary authority sets interest rate to attain the targeted inflation level through controlling aggregate demand. The discretionary monetary policy often caused more harm to the economy beyond achieving targeted inflation. There are various problems with discretionary monetary policy. One common associated with rules as opposed to rules is indeterminacy regarding effect of set interest rate (Gust, Johannsen & López-Salido, 2017). Economic agents like firms, households have to worry about unexpected change in market and macroeconomics condition. Because of this uncertainty and other side-effects policy makers often believes monetary policy rule is better than discretionary inflation targeting.
Conclusion
The paper critically evaluates the current macroeconomic condition of Australia in reference to design of monetary policy framework. The economy currently experiencing a decline in the growth rate. Mining being one of the biggest contributor of economic growth of Australia, a slowdown in mining investment has significant impact on overall economic growth. The economy mostly suffers from structural and cyclical unemployment. Reserve Bank of Australia designs monetary policy. Main target of monetary policy is to attain a low inflation rate along with a sustainable economic growth. RBA sets the cash rate depending on global and domestic economic condition. Under the current monetary policy framework, cash rate has been set to a historically low level. Since August 2016, RBA kept the interest rate to a low level of 1.50 percent. The low interest rate results in an increase in property price along with an increase in household indebtedness. This raises question on efficiency of discretionary inflation targeting policy over rule-based policy. This is high time for RBA to shift the focus of monetary policy in order to counter associated problem of historically low cash rates.
Reference list
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