The State of Australian Economy: Challenges and Opportunities

This article discusses the current state of the Australian economy, both domestically and internationally, and the challenges and opportunities it faces. It covers topics such as GDP growth, inflation, household debt, monetary policy, protectionist tendencies, global financial market uncertainty, and uncertainty in the US economy.

Contents
1Global Tariff Uncertainty ..................................................................................................................4
Global Financial Market Uncertainty ..................................................................................................4
2Uncertainty in the US Economy.........................................................................................................5
3Conclusion..........................................................................................................................................6
Introduction 2
The Current State of Australian Domestic Econoomy 2
Australian Economy and the Global Markets3
Australia and the rise of Protectionist Tendencies 3
Global Financial Markets 3
Conclusion 4
Bibliography 5

The State of Australian Economy
1 Introduction
The Governor of Australia recently expressed satisfaction at Australia growth rate in the first two
quaters of 2018, while expressing concerns over the unstable global economy which could hampler
this growth, precisely the impending trade war between China and the US, the threat of
protectionism (Shane, 2018) and the increase in tariff barriers , in world trade in general, and
growing volatility in the financial markets. This paper is a glance the current economic situation of
Australia , domestic and internationally as well as the possible impact.
State of the Economy
Australia has had the strongest growth in GDP in the last two quarters and compared to the last few
years and is project to grow by 3% in the year 2018 (OECD Data, 2018) . A rise in the GDP would
imply a rise in infllation as well as arise in wages. Wages in Australia have remained stagnant in the
last few years and were beginning to become a cause of concern. (OECD, 2017)
The declining growth in unemployment should, hopefully raise the Aggregate Demand within the
country further (Illustration 1). An increase in the wages shall help induce greater consumption
demand within the economy. However, at the current rate, the consumption demand in Australia is
not a cause of concern as the Australian household debt in already among the highest in the world at
211% of the world. (OECD Data, 2018) Unless some measure to introduce savings are induced, this
household debt may rise further. Hence, a monetary policy of cheap money should be abandoned by
Reserve Bank of Australia to give way for higher interest rates. Since the inflation has been rising
and is within the inflation target of Australia, there are no expected harmful effects to be experience
to inflation targeting.
Illustration 1: Unemployment Rate in Australia since 2016 (Source: OECD Data, 2018)

In the past few years, Australia has been following an expansionary monetary policy in order to
maintain inflation levels and GDP growth rates. Hence, interest rates in Australia have remained
consistently low in the last few years. The impact of low interest rates should have led to a high
demand for investment. (Illustration 1). This demand has been channeled into the housing sector. A
consumer led spending growth in the housing sector has led to a boom in the housing sector. On the
other hand, the mortgages on houses, along with cheap credit for consumption purposes have led to
a high spending among consumers and greater household debt. Lower interest rates do not spur the
consumer to save more. Hence, it is time that monetary policy for Australia must take a somewhat
reverse path and should be aiming at raising interest rates.
Illustration 2: The Dangers of Aggregate Demand (AD) moving beyond Sustainable supply (Full
employment)
Source: Adapted from (Samuelson & Nordhaus, 2004)
If wages, consumption demand and aggregate demand rise further, it will push the economic growth
beyond the sustainable supply level of full employment. Full Employment is usually considered to
be at 5%. In the current scenario, if Australian Economy pushes any lower than 5% employment, it
would be dangerously close to pushing past the Aggregate Supply and experience high inflation,
macro-economic instability and rising asset prices. Hence, there is a case for a tighter monetary
policy. (Mankiw, 2009)
Australia had also accumulated high budget deficits following the Global Financial Crisis of 2008-
2009 as the national policy required to have expansionary policies. However, measures have been

taken to reduce budget deficits and have yielded good results since 2017. Australia may not need
expansionary policy at this stage. Hence, it would be a economically viable to have lower budget
deficits. If the current policy of lower budget deficits is continues, it is expected that Australia may
have a budget surplus in the fiscal year od 2020-21.
2
1 Global Tariff Uncertainty
In the last few years, globalism has seen a decline in popularity. The US voted to elect Donald
Trump, partly based on his promises of laying more tariffs on imports, while Britain voted to exit
the European Union, a move now known as 'Brexit'. This may lead to the rise in protectionism as
Britain would no longer be obliged to follow the policies of European union while the USA is on
the brink of a trade war.
US president Trump has voiced concerns on the trade deficit that USA has been posting
consistently against China in the last few years. As a protective measure, the US has introduced
trade barriers against Chinese imports in the form of tariffs. (Shane, 2018) These tariffs, among
other products, are have been levied in a greater measure on metal ores and meat products from
China. (Federal Reserve Bank of St. Louis, 2017) The levy against metal ores is specifically
expected to affect steel product imports from China. China, in retaliation, has introduced higher
tariffs on US imports leading to what can be characterised as as a “Trade war“. This trade war
cannot exist in a vacuum and shall have far reaching effects, including on countries like Australia,
which as both China and USA as a significant trade partner. On one hand, this rise in protectionist
policies“(Shane, 2018) On one had , the situation present opportunities, in order to allow Australia
develop better trade ties with both nations. On the other hand, the complex global supply chain
would get disturbed. Australia's iron ore exports to China could be negatively affected due to a fall
in demand for Chinese steel goods. (Shane, 2018)
Protectionist tendencies are not just limited to the trade war between USA and China. In 2017, USA
aalso, pulled out of the Trans Pacific Partnership which could have helped open up US markets to
Australia further. (Sherwood & Iturrieta, 2018)
The rise of protectionist tendencies by USA which has been a traditional trade partner to Australia
his concerning. However, as it stands in the current situation, Australia has a Free Trade Agreement
with USA (Department of Foreign Affairs and Trade, 2018) which may allow it to take advantage
of the deteriorating ties between USA and China. Additionally, being a part of the TPP should also
be able to insulate Australia from the rising uncertainty in tariffs. Hence, while the rising
protectionist waves may be a threat, they may also, signal newer opportunities for Australia.
Global Financial Market Uncertainty
Australia is a highly globalised country and hence, incidents in the global financial markets would
tend to threaten the Global Financial uncertainty. The value of Australian bonds and foreign
investment in Australia could have an impact due to uncertainty in both developed and developing
countries. (Reserve Bank of Australia, 2018)
Australia's financial system is particularly closely tied to the financial system in New Zealand
where Australia's big four banks operate. High Household debt (particularly the debt from the
housing mortgages and dairy sector) in the New Zealand could lead to accumulation of Non
Performing Assets within the Big Four Banks, all of which own subsidiary bank in New
Zealand.There is a risk of the contagion spreading to Australia through the Big Four.
APRA must fulil a greater role by adopting stringent measures to ensure that the crisis of New
Zealand in contained in New Zealand. Australian banks have been consistently opening more and
more to global investment since the 1980s and it is time to re-assess the policy of greater
globalisation of Australian banks (Reserve Bank of Australia, 2018)

Other key causes of concern Financial instability in the corporate sector, particularly the large sums
of perceived bad debts accumulated by Chinese firms affect import demand from China in
Australia. Debts by Chinese markets could have an indirect impact too as defaults by Chinese
borrowers may make the world capital markets more volatile(Reserve Bank of Australia, 2018).
Further, currency depreciation or devaluation from China and other emerging Markets could further
impact the export earnings for Australia. Other emerging markets such as Venezuela, Turkey, etc.
Are experiencing significant cises, some of which may lead to depreciation or devaluation of local
currencies. (Miller & Robins, 2018) The uncertainty faced in these markets, may snowball into a
currency crisis, which could further lead to a larger financial crisis. China is the apparent weak link
that could pass the contagion from these markets on to Australia. (Reserve Bank of Australia, 2018)
(Miller & Robins, 2018)
Australia has over 2 trillion Australia Dollars tied up in pension funds that are closely ties to the
global capital markets. Assets tied in pension funds have been experiencing high growth rates. The
investment of these pension funds was largely in domestic housing sector in Australia, in the past.
The investment allocation has been moving towards equities as a recent trend. Australia faces risks
from both ends, in this case. (Willis Towers Watson, 2018)
Factors such as the sovereign debts in countries like Greece, Italy and Turkey too could pose a
threat as there is a risk of a global Financial contagion that could be triggered by events of defaults
by these countries. Sovereign debts in these countries could cause crises within the global capital
markets. Australia has links to these crises due to government borrowings in Australia as well as
pension funds. Similarly, financial institutions in the UK face risks concerning uncertainty
surrounding Brexit and are these financial institutions could then transfer the risks on to the
Australian financial markets. (Reserve Bank of Australia, 2018) (Miller & Robins, 2018)
2 Uncertainty in the US Economy
As seen above, the US economy is operating at nearly full employment level and is growing. If the
Aggregate Demand pushes further than the sustainable supply levels, inflationary pressures and
macro-economic instability will rise in the economy. Furthermore, the fiscal stimulus provided by
the recent tax cut, may increase the money supply into the economy, leading to an expansionary
effect as shown in Illustrations 2 and 3. This may lead to further inflationary pressures. (Bachman
and Majumadar, 2018)

Illustration 3: Inflation in USA between Jan 2011 and May 2018
Source: (OECD, 2018)
As seen in the illustration above, the inflationary pressures are rising. It is possible that the USA,
too, may adapt contractionary measures, which may lead to a reduction in consumption in the US
market and thus, affect the demand for Australian goods. Furthermore, uncertainty in the US
markets may lead to crises in the financial markets, especially the equity markets. (Bachman and
Majumdar, 2018) As explained above, the Australia is closely tied to the global financial markets
and the risks of contagion spreading to Australia looms large.In addition, the state of USA is
precarious. On the other hand, growth forecast has been cut due to fiscal uncertainty. This presents
a very uncertain picture for Australia.
3 Conclusion
The Australian economy, in its current state, can be characterised into a growth phase. Australia is
expected to grow at a higher pace than in the recent past.However, owing to the GDP growth,
Australia faces a set of challenges, both from the domestic economy as well as from world
economic factor. However, each of these challenges presents a unique set of opportunities for the
Australian market to grow.
Australia also, faces risks from global financial markets, impending trade wars and the rising
protectionist sentiment in the world, and uncertainty in the world markets sure to uncertainty is US
economic condition.
The most imminent threat however, currently , seems to be from the New Zealand which is closely
tied to the Australian banking system. More stringent norms under the Australian Prudential

Authority might be necessary to contain an impending crisis that may emerge through the largest
banks of Australia.
4

5 Bibliography
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