Macroeconomic Environment and Monetary Policy of Australia

This essay sheds light on the macroeconomic environment of Australia and analyses the monetary policy as a stabilizing tool for the central bank of Australia. It covers the main macroeconomic goals, indicators, objectives of monetary policy, functions of the Reserve Bank of Australia, limitations of monetary policies, and the effects of cash rate on the economy.

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ECON 11026
ASSESSMENT ITEM 3- TAKE HOME ESSAY

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Contents
Introduction................................................................................................................................3
Analysis......................................................................................................................................3
Question 1..................................................................................................................................3
Question 2..................................................................................................................................8
Question 3..................................................................................................................................9
Question 4................................................................................................................................11
Question 5................................................................................................................................16
Conclusion................................................................................................................................19
Reference..................................................................................................................................20

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Introduction
Economic performance is a great concern for the government and the central banks all around
the world. The politics, diplomatic relationships and power come from the sound operation of
the macroeconomy. The paper aims to shed light on the macroeconomic environment of
Australia. In addition to that, the paper also analyses the monetary policy as a stabilizing tool
for the central bank of Australia (ABC News, 2019). The analysis can help the central bank to
decide on the policies next time the economy requires an intervention.
Analysis
Question 1
Macroeconomic goals of Australia
There are four main macroeconomic goals set by the government of Australia and the central
bank. These are,
 Achieving full employment
 Stability of the price level
 The high and sustainable rate of economic growth
 And a healthy balance of payment.
Overview of the economy of Australia
The Australian economy is well performing mixed economies with an annual GDP of 1.93
trillion USD as per the data of 2018 (Bajada, 2018). The per capita median wealth of the
economy is very high compared to the similar countries. The economy of Australia is mainly
dependant on the service sector that contributes around 67% to the national GDP. Other than
that the resource availability in Australia also helps the economy as well. Findlay & Garnaut,
(2017) stated that Australia often experiences mining boom that further boosts the economy
for a short period. One of the latest mining booms that were experienced by the Australian
economy was in 2003 which lasted till 2013 (Finance.gov.au, 2019). The boost also helped
the economy to deal with the external changes and problems such as the global financial
crisis of 2007. The economy is a member of different trade associations and blocs that helps
in amplifying the export of mining products in different parts of the world.

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The main macroeconomic indicators of Australia
GDP
2015 2016 2017 2018 2019
0
200000000000
400000000000
600000000000
800000000000
1000000000000
1200000000000
1400000000000
1600000000000
Recent GDP trend of australia
GDP
Figure 1: The recent GDP trend
(Source: Tradingeconomics.com, 2019)
The current GDP trend of Australia is upward sloping as of January 2019. Since the drop in
GDP in the year 2016, it increased over the years (Findlay & Garnaut, 2017). The increase in
the GDP of Australia stems from the growth of the service sector in the last few years.
However, in the last few years, the GDP of the country has been the same.
GDP growth
2015 2016 2017 2018 2019
0
0.5
1
1.5
2
2.5
3 2.3360754810
9675
2.8467549510
8566 2.3425822867
6258
2.8349481329
6823
0.2803546000
00001
Annual GDP growth rate
Annual GDP growth rate

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Figure: Growth rate of GDP, Australia
(Source: Tradingeconomics.com, 2019)
The trend in the GDP growth rate has been exceptional since 2015; however, the growth rate
has fallen significantly in the last year. The economic growth rate of the Australian economy
has been reduced by 93% since the last year. However, as per the trend that is evident from
the figure, the GDP growth rate may increase again in the coming years.
Inflation rate
2015 2016 2017 2018 2019
0
0.5
1
1.5
2
2.5
Inflation rate of australia
Inflation rate of australia
Figure 3: The inflation rate
(Source: Tradingeconomics.com, 2019)
Inflation trend is good news for the lawmakers and authorities of the country. The
government had set a goal to keep the prices stable over the years. In the last two years,
inflation has been the same resulting in a constant price level in the aggregate market.
Unemployment rate

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2015 2016 2017 2018 2019
4.6
4.8
5
5.2
5.4
5.6
5.8
6
6.2 6.0542001724243
3
5.7098999023437
6 5.5911998748779
3 5.5988
5.1254
Unemployment rate
Unemployment rate
Figure 4: the Unemployment rate
(Source: Tradingeconomics.com, 2019)
The economy of Australia has been performing well in terms of the unemployment rate. The
current unemployment rate in Australia is lower than in the last few years. The trend in the
unemployment rate in Australia can be attributed to the increase in capital investment.
Exchange rate
2015 2016 2017 2018 2019 43678
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9 0.8208400000000
01
0.69704
0.7199700000000
01
0.78633
0.70419
0
value of australian dollar (in USD)
value of australian dollar (in USD)
Figure 5: The exchange rate

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(Source: Tradingeconomics.com, 2019)
The trend shows that the exchange rate of the Australian currency is fluctuating. In some year
the exchange rate is high and in some it is low. The fluctuations in the exchange rate of
Australia are not good from the perspective of investment inflow.
Government debt
2015 2016 2017 2018 2019
1400000
1450000
1500000
1550000
1600000
1650000
1700000
1750000
Government debt (US mn dollar)
Government debt (US mn dollar)
Figure 6: The government Debt
(Source: Tradingeconomics.com, 2019)
The government currently has a huge debt and given the reducing value of the currency, it is
a great concern for the government. Like the exchange rate, the government debt of the
country is also fluctuating and depends on the position in the business cycle.
Identification of the business cycle based on the performance
Based on the current values of the macroeconomic indicators, it can be said that the economy
is at the peak or expansion phase of the business cycle. In this position, the inflation rate
becomes high and the unemployment rate increases. In economy of Australia as well, this
phenomena is same (Hellwig & McAllister, 2016). However, the reducing GDP growth rate
of Australia can be attributed to the external changes rather than the internal. The economy of
China is suffering at the moment and downturn in the economy of China can be the reason

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for the sudden drop in the growth rate of the economy. Otherwise, the economy shows signs
to be at an expansionary phase of the business cycle.
Question 2
Main objectives of monetary policy
The objective of the monetary policy differs from country to country, however, there are
some of the basic objectives which are common. These are,
 The neutrality of money, which is required to be maintained to have no impacts on the
economic indicators of the country. Rhoades & Smart (2018) stated that monetary
changes can disrupt the operation of the economy and hence the objective is to
maintain neutrality in the money market.
 The exchange stability is also another objective of the monetary policy. The exchange
rate is crucial for economies such as Australia which has a high amount of
government debt (Oecd.org, 2019).
 The most important objective of the monetary policy is the price stability which is
influenced by the market activities.
 Full employment also requires regulations in terms of monetary policies so that each
of the resources of the country is efficiently allocated for the betterment of the
economy.
 Economic growth is also another objective of the monetary policy. Increase in the
money supply in the market increases the aggregate demand for goods and services
leading to a rise in the output or the growth of the economy (Pc.gov.au, 2019).
 Lastly, the money supply also can manage the balance of payment of the country as
well. If the money supply is reduced in the economy, the demand for imported goods
reduces thereby stabilizing the balance of payment of the economy.
Description of the main functions of the reserve bank of Australia
The main functions of the Reserve bank of Australia are,
 To implement the monetary policy and its tool to achieve the desired goal.
 To manage the foreign exchange reserve of the economy.
 To provide stability in the financial market through monitoring and other monetary
policies (Rhoades & Smart, 2018).

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 To issue bank new notes and distribute among the economic entities.
 To govern the banking services operate throughout the country.
Limitations of the monetary policies to stabilise the economy
One of the biggest limitations of the monetary policies is that it cannot guaranty stabilisation
in the different economic sector if the government does not supplement it with similar
policies. For example, if the government implements an expansionary monetary policy and at
the same time it also increases the interest rates as per the fiscal policies, it will have no
effects on the economy (Wilson et al. 2018). The monetary policies often fail when there is
an existence of a black market in the economy. In the case of Australia, the black market
operations often reduce the efforts undertaken by the government. Lastly, in the case of the
Australian market, unfavourable banking habits also contribute to the limitations of the
monetary policies of the government. For example, if the government uses the instrument of
contraction and the banks starts to create risky loans for the customers of the market, the
policies will contradict each other leading nowhere.
Question 3
The cash rate is the interest rate that the central bank charges to the loans taken by the
commercial banks. The loans taken from the Reserve bank of Australia is the main source of
funds for commercial banks. The cash rates can also be monetary tools for the reserve bank
of Australia as well (Wto.org, 2019). As the cash rate is increased, the commercial banks of
the market will find it costlier to borrow from the central bank and the cost will be partly
transferred to the customers of the market in form of the higher interest rate. The higher
interest rate can again make the customers of the market keep their cash deposited in the
bank. This will result in a reduction in the liquidity in the economic system of Australia.

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Figure 7: the housing price index for Australia
(Source: Tradingeconomics.com, 2019)
Now between August 2016 and May 2019, the price of housing was high and to manage the
price of housing the government had increased and maintained this high cash rate so that
demand for housing reduces (Chubb & Watermeyer, 2017). The revision was done by the
reserve bank of Australia in July 2019 corresponding to a slight decrease in the price of
housing. The price of housing during that time reduced even below than the desired level.
After than further, reduction in the price of housing led to a loss of value for the property
owners and hence the government had to take actions to stabilise the housing market of
Australia. Therefore, it reduced the cash rate to 1% so that money supply increases in the
market and customers demand more of housing (Findlay & Garnaut, 2017). Consequently,
the demand for housing would go up leading to a price increase. Therefore, regulating the
cash rate the reserve bank of Australia tried to stabilize the housing market price.
Figure 7 shows the different housing price index of Australian market since 2014. It shows
that the price of housing was rising initially and that is when the reserve bank of Australia
imposed a higher cash rate of 1.5% to reduce the money supply and control the housing price
(Bajada, 2018). After that, the housing price in Australia started to reduce that compelled the
reserve bank to reduce the cash rate along with the changes in the price level in the housing
market. Therefore, the regulation of the cash rates helped the government stabilise the price
level in the housing market.

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Question 4
There are two basic types of monetary policies that are executed or followed by central banks
around the world; these are expansionary and contractionary monetary policies. Expansionary
monetary policy is when the Reserve Bank of Australia expands the money supply in the
economy (McLean & Holmes, 2019). On the other hand, the contractionary monetary policy
is when the central bank decides to reduce the money supply in the economy to achieve a
specific goal. The expansionary policy expands the operation and activity of the economy
whereas; the contractionary policy reduces the output.
Contractionary policy and inflation
Now, when the cash rate is increased from 1% to 1.5% it increases the interest rate in the
market. Therefore, customers become more likely to keep their money in the bank and enjoy
higher interest rates getting accrued to the principle (Croucher et al. 2019). This reduces
their capability to purchase products from the market. Hence, the aggregate demand for the
goods and services reduces shifting the aggregate demand curve to the left side. The new
aggregate demand curve and aggregate supply curve intersects at a point where price and
output are lower. This reduced price helps the government to keep the inflation within the
target rate.
Figure 8: The money market
(Source: Brell & Dustmann, 2019)

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Now in terms of economics, the rise in the cash rate influences the money market that we can
see from the money market. When the money supply is decreased, the vertical curve shifts to
the left and interest rates increases (Gale, 2019). The increased interest rate and the reduced
output shifts the LM curve to the left side and the new equilibrium shows the point where the
interest rate is high and output is low.
Figure 9: The changes in the IS-LM curve due to money supply
(Source: Russell-Smith et al. 2018)
Further, this increase in the interest rate increases the deposits in the bank account and hence
the demand for the goods and services reduces. This shifts the aggregate demand curve to the
left side leading to a reduction in the price level and the output. Therefore, the increase in the
cash rate from 1% to 1.5% helped the government to keep the price level within the target
range. The figure below shows the meeting point of the new aggregate demand curve and the
old aggregate supply curve that resulted in a reduction in the price level in the Australian
economy.

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Figure 10: The leftward shift in the aggregate demand and reduction in price
(Source: Barth et al. 2015)
Expansionary policy and stimulation of the economy
Now if alternatively, the cash rate is reduced from 1% to 0.75% the commercial banks of the
Australian market will find the funds from the central bank cheaper. Therefore they will pass
it on to the customers of the market in the form of a reduced nominal interest rate. In turn, the
customers of the market will realise that their money is not growing in the bank due to the
reduced interest rate and hence the deposits from the commercial banks will reduce (Jenkins,
Heffron & McCauley, 2016). This will result in a situation where the customers of the market
will have lots of money to spend on goods and services. The aggregate demand for the goods
and the services will go up leading to an increase in price and output level in the economy.
Here, the reduction in the cash rate of the economy will help the government to stimulate the
economy.

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Figure 11: the increase in the money supply
(Source: Foerster et al. 2017)
Now in terms of economics, the decrease in the cash rate increases the supply of money in the
money market of Australia. In this case, the vertical money supply curve shifts to the right
side. Given the unchanged downward sloping money demand curve in the market, the
increases in the supply of money reduce the interest rate and increase the output of the
economy.

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Figure 12: the changes in ISLM
(Source: Altman, 2018)
This reduction in the interest rate and the increase in the output shift the LM curve to the right
side. Therefore the new LM curve and the old IS curve intersects at a point where the interest
rate is low and the output of the economy is higher. Therefore, the reduction in the cash rate
fro, 1% to 0.75% reduced the interest rates of the market and increased the output.

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Figure 13: the shift in the aggregate demand and increase in price
(Source: Altman, 2018)
Furthermore, this reduced interest rate is also reflected in the goods market as well. As the
interest rate is low, the customers will withdraw their money from the banks and increase the
demand for the goods and services of the economy. As a result, the aggregate demand curve
will shift to the right side. The new aggregate demand and aggregate supply curve will
intersect at a point where the price is high and the output is also high (Findlay & Garnaut,
2017). The figure above shows the increase in the price and output symbolising an expansion
in the economy of Australia. Therefore, the reduction in the cash rate stimulates the economy
of Australia in this way.
Question 5
Economic growth

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The economic growth is referred to as the increase in the value of goods and services sold in
an economy compared to the value of goods and services sold in the last year. The economic
growth rate helps the economist to understand the progress of an economy over the years.
Determinants of long term economic growth
There are some of the factors that help the economy to grow for a sustained period. One of
the main determinants of the long term economic growth is the productivity of the resources.
With technological advancement, the productivity of the resources such as the labour
increases and hence they produce more at any given cost leading the economy towards a long
term growth (Russell-Smith et al. 2018). Demographic changes also contribute to long-run
economic growth. As the number of workable people in the economy increases, the economy
gets more labours that can produce more output for the economy. Therefore, with the
population, the workforce expands and hence it makes the growth rate sustainable for a long
time. Lastly, the changes in the society can also ensure sustainable growth of the economy as
well. For example, if the women of the society get educated in higher education and join the
labour force, it increases the productivity of the overall labour force leading to an increase in
the output of the economy. These women also become a customer of the market as well and
hence put the economy at a higher level for sustainable growth.
Low-interest rate and growth
The low historical interest rate of around 1-1.5% is sustainable for the economic growth of
the country. The economy of Australia, in the past, has used a low-interest rate to stimulate
the economy which is still returning the dividend to the economy. The low-interest-rate
increases private consumption as the customer gets a lot of money in hand. This, in turn,
increases the demand for housing and other goods of the market. This leads to a rise in the
price of goods and services which in turn increases the inflation rate of the economy (Chubb
& Watermeyer, 2017). However, it needs to be noted that due to the low-interest rate, the
business investment reduces as the rate of return reduces with the interest rate of the
economy.

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Figure 13: house pricing in Australia
(Source: Tradingeconomics.com, 2019)
2015 2016 2017 2018 2019
-70000000000
-60000000000
-50000000000
-40000000000
-30000000000
-20000000000
-10000000000
0
Fiscal deficit
Figure 14: the fiscal deficit of Australia
(Source: Tradingeconomics.com, 2019)
Consumption is one of the important components of aggregate demand which amplifies the
GDP of the economy as well. This also reflects in the fiscal deficit of the economy as well.
The demand for the domestic product has increased so much that the import has reduced
keeping the export at the same level.

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Conclusion
Therefore the macroeconomic environment of Australia is strong and the economic
performance is great. The central bank of Australia uses different monetary tools such as
expansionary and contractionary depending on the goals of the government. It has been also
shown in the study that, these monetary tools are effective in stabilising the price level in the
market. The economic process of the monetary policy and the implementations has also been
highlighted in paper.

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