Australian economy and its relation with USA

The paper scrutinizes the macroeconomic performance of Australia and its relation with USA in terms of GDP growth, inflation, unemployment, net export, and exchange rate. The trend analysis of GDP growth and unemployment shows a positive influence of economic growth on labor market performance. A weak Australian dollar helps to maintain a trade surplus while a strong Australian dollar does the reverse. The interest rate charged by Reserve Bank of Australia on overnight loans is called cash rate. The same charged by Federal Reserves on overnight loans to financial institution is called fund rate. The central banks of respective nations use these rates to control and money supply in the economy.

Running Head: ECONOMIC ASSIGNMENT
Economic Assignment
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Executive Summary
USA and Australia are two of the most powerful developed nations in the world. The paper has
scrutinized the Australia’s economic performance. In this context, the relation between USA and Australia
has been explored in light of relation between exchange rate and net export and movement and bank rate
in the two nation. The trend analysis of GDP growth and unemployment shows unemployment moves in
opposite direction of growth. GDP growth though initially influences price level the relation however
weakens following inflation targeting policy of unemployment. A weak Australian dollar helps to maintain a
trade surplus while a strong Australian dollar does the reverse. Bank rate in both the nation has declined
overtime following a monetary easing. The quick recovery of Australian economy indicates that the
economy will soon enter in a new era of economic growth.

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Table of Contents
Introduction.................................................................................................................................................. 3
Relationship between real GDP and inflation and unemployment...............................................................3
Growth in real GDP and trend in unemployment......................................................................................3
Growth in real GDP and trend in inflation................................................................................................. 4
Business cycle and economic growth...................................................................................................... 4
Net export and exchange rate.................................................................................................................. 5
Cash rate and fund rate............................................................................................................................... 6
Outlook of Australian economy.................................................................................................................... 7
Conclusion................................................................................................................................................... 7
List of References........................................................................................................................................ 9

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Introduction
Different indicative measures of economic performance of a nation are GDP growth, inflation,
unemployment, interest rate, export and import. Evaluation of economic performance thus requires
analysis of economic performance in each of this indicator (Fontana and Setterfield, 2016). Australia is a
small-developed nation with high dependency on service sector especially financial services. Like several
other developed nation Australia also has experienced dynamic fluctuation in the economy. The interest
factor about austral is that, it has quickly absorbed the economic shocks and successfully balanced the
stable growth path. The paper tries to find insights about macroeconomic performance of Australia for the
last few years specifically from 1990 to 2016. The analysis also includes the economic relation between
Australia and USA.
Relationship between real GDP and inflation and unemployment
Among different interconnected macro variables, relation between GDP growth, inflation and
unemployment is widely discussed. Unemployment and price level in a nation move along with the growth
in real GDP. A rising GDP growth implies a favorable condition for employment growth pushing
unemployment to a low level (Terra, 2015). Growth in real GDP by boosting economic activity pushes up
the price level. Very high price level however has an adverse effect on growth by a lower output resulted
from increasing cost of production.
Growth in real GDP and trend in unemployment
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Real GDP growth and unemployment
Real GDP growth rate Unemployment
Year
Unemployment and GDP growth rate
Figure 1: Unemployment and GDP growth
Figure 1 represents the unemployment trend in Australia along with trend in GDP growth rate. The
unemployment rate except in the last few years has a more or less declining trend. GDP growth on the
other hand has only a moderate growth rate with a sudden fall in growth during years of recession. The
decline in unemployment along with a growth in GDP reduces the gap between rate of growth and that of
unemployment. This shows a positive influence of economic growth on labor market performance. The
economic growth in Australia thus expands opportunities for laborers (Hartwell, 2017). One major driver of
Australian economic growth for several years is the mining sector. The sector being highly labor intensive,
during mining boom of Australian many people get opportunities to get employed. With a decline in
growth rate unemployment increases as reflected from widening gap between unemployment and growth
rate since 2013.

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Growth in real GDP and trend in inflation
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
-1.00
0.00
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Real GDP growth and inflation
Real GDP growth rate Inflation
Year
GDP growth and inflation
Figure 2: GDP growth and trend in inflation
Unlike unemployment, no steady relation is observed between economic growth and that of inflation. The
price level fluctuates more than GDP growth indicating there are factors other than GDP growth having
significant influence on price level (Thorpe and Leitão, 2014). The price level in recent years is much
stable as compared to that in early 1990s. For some years, both growth rate and inflation increases
simultaneously showing signs of economic expansion. While in others the growth rates are associated
with a low level price indicating an inverse relation. One factor explaining existence of economic growth
along with a slow or stable movement of price level is inflation targeting policy of Reserve Bank of
Australia, targets to maintain a price level of 2 percent (Svensson, 2015).
Business cycle and economic growth
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Real GDP growth rate
Year
Growth rate
Figure 3: Fluctuation in economic growth and business cycle

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The economic growth of a nation is subject to fluctuation resulted from shock in domestic and
external economy. The business cycle theory captures the fluctuation in economy growth rate. an
economy generally undergoes through four phases of business cycle – expansion, economic boom,
recession and finally trough. Among these economic boom and trough are the two extreme phase when
the economy records highest and lowest growth point respectively. Expansion implies expansion of
output, employment and other economic activity (Belongia and Ireland, 2016.). During recession there is a
general downward trend in economic activity. Every economy passes through these four phases of
business cycle. No exception is observed for Australia. The time length of business cycle phases however
varies across different economies depending on the internal structure of the economy.
The period of early 1990s showed a clear evidence of economic recession. Growth rate in the
early 1991 was negative. Economic expansion began since 1992 with growth rate gradually started
increasing. Growth rate peaked to 5.01 percent in 1999 (Kent, 2014). Growth gradually, In between these
years, there was a moderate recession in 1995 with growth rate fell to 3.89. Growth rate expanded from
1196 onwards and finally reached to the peak level in 1999. In the beginning if twenty first century growth
rate began to decline with a sign of recovery in 2004, the economy grew at a rate of 4.15 percent. Growth
slightly slowed down in the three years and backed to a rate of 3.75 in 2007. Economic trough gain
evidenced in 2009 with a growth rate of only 1.81 percent (Word Bank, 2018). Expansion began in 2010
and in 2012 growth recovered to 3.63 percent. From 2013 onwards, economy began to grew at a
relatively slow rate with an average growth rate of 2.5%.
Net export and exchange rate
Among four primary components of GDP, net export is one major component. It is an estimate of
net gain from trade and obtained as total export less total import. In context of Australian economy, the
external sector plays an important role in determining GDP (DFAT, 2018). Until the decade of 1960s,
trade relation of Australia was mostly limited to United State and Britain. With passes of time and
development of different industries and service sectors Australia has gained a competitive edge in the
global market leading to expansion of trade relation with several nations across the world. Australia
enjoys a comparative advantage over wide variety of goods and services (Argy and Nevile, 2016). The
competitive advantage of Australia varied from high quality technology intensive product to high quality
wine and in food processing. Service trade of Australia include services like education and tourism,
financial and professional services.
Iron ores and concentrates, coal, natural gas, education related travel service and personal travel
service excluding education are the top five exports of Australia. The goods and services are exported to
different markets of China, Japan, United State, Republic of Korea and India. Australia’s importable
include personal travel service, which excludes education, passengers’ vehicles; refine petroleum, freight
service and telecom equipment and part (Gilpin, 2016). The importable are obtained from China, United
State, Japan, Republic of Korea and Thailand.
The demand for export, import, and hence, balance in trade depends on the relative value of
currency termed as the exchange rate. It measures how much home currency needs to be exchanged for
one unit of foreign currency. High value of home currency is though favorable for import but hurts trade
balance by lowering is export demand. In contrast, low value of currency indicates a weak position of the
nation but is favorable for export and trade balance (Pagan and Wilcox, 2015). The value of Australian
dollar especially against US dollar has a considerable impact on Australia’s balance of trade. Devaluation
of Australian dollar implies a relatively a lower price for exported goods from Australia. This increases
export demand of Australian export. The cheaper export and relatively expensive import improves trade
balance. Currency appreciation has an opposite effect on net export.
The figure below shows pairwise movement of real exchange rate between United State and
Australia and that of the net export of Australia.

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1990
1992
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0
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80000000000
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Net export and Real exchange rate
Net Export Exchange rate
Year
Net Export
AUD/US
Figure 4: Exchange rate and net export
The graph above shows that exchange rate and net export moved in the same direction. That mean a rise
in exchange rate is associated with a rise in net export and vice versa. This is because an increase in
exchange rate implies devaluation of Australian dollar. This increases export competitiveness of Australia
over United States, Canada and other countries. After enjoying a trade surplus from 1990 to 2007, the
country had experienced a trade deficit (Halligan, 2017). The exchange rate in 2008, declined from 1.20
to1.19. In the next year exchange rate though increased slightly to but trade, balance remained negative
mainly due to a decline in global demand following hit of global financial crisis in 2008. AUD appreciated
in 2011 and 2012 aggravating trade balance further. As US dollar gained value in the last two-three years
net export increases.
Cash rate and fund rate
The interest rate that Reserve Bank of Australia charges on the overnight loans given to the
commercial banks is called cash rate. The same charged by Federal Reserves on overnight loans to
financial institution is called fund rate. The central banks of respective nations use these rates to control
and money supply in the economy. When there is a need to provide growth stimulus to the economy,
expansionary monetary policy is undertaken through lowering the bank rate. A lower bank rate induces
investment. The money market is tightened in order to stabilize price level. In view of, international
relationship between USA and Australia, monetary policy in one nation affects that of other nation. For
example, if Fed reduces fund rate then this lowers value of Australian dollar (Blanchard, Cerutti and
Summers, 2015). The string currency though indicates a relatively strong international position of
Australia but hurts the export through appreciation of currency. In order to restore trade balance Australia
then might choose to devaluate currency by reducing the cash rate. An increase in fund rate on the other
hand is favorable for Australia.

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1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
0.00
2.00
4.00
6.00
8.00
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16.00
Cash rate and Fed fund rate
cash rate Fund rate
Year
Cash rate and fund rate
Figure 5: Trend in fund rate and cash rate
Figure 5 presents historical movement of cash rate and fund rate from 1990 to 2016. Overall there is a
declining trend for both fund rate and cash rate indicating an expansionary monetary policy on part of
both the government. In 1990, cash rate set the cash rate at 14.83 (Fischer, 2016). The effective fund rate
was 8.10. Followed by the recessionary hit, RBA in 1991 reduced the fund rate to 10.00. In this year the
fund rate was 5.69. Fed made downward revision in fund rate for the next two consecutive years. The rate
had lowered to 3.52 and 3.02 (FRED, 2018). Cash rate also followed the same trend, which lowered to
6.58 and 5.00. The same trend has followed throughout the entire period reflecting close association of
the two rates. However, in order to recover the effect of global financial crisis Fed made a drastic
downward revision of the fund rate. Fund rate reduced sharply from 5.02 in 2007 to 1.93 in 2008 and to
0.16 in 2009. Cash rate though reduced during this time not as intensively as fund rate did. The cash rate
in 2014 was 2.63 as against a fund rate of 0.09 (Guttmann, 2016). The fund rate increased slightly in
2015 and 2016 while RBA continued to decline cash rate to 2.13 in 2015 and 1.50 in 2016. The average
fund rate for the chosen time period is 3,04 while cash rate averaged nearly around 5.38.
Outlook of Australian economy
In the next couple of years, the economy might experience an expansion. The relatively slow
growth from 2013 is likely to be ended with given economic resilient of the nation (OECD, 2018). The
diversified nature of Australian economy will help it overcome recessionary pressure arising from China’s
slow down and worsening terms of trade. The weak growth in private consumption will be offset by
growing business investment and boost in public demand. This will help to grow domestic demand which
will contribute expansion of economic output. The GDP growth rate is forecasted to be strengthened in
the upcoming years. The depressed demand of mining and construction dragged the economic growth of
Australia. The mining recession has come to an end. Along with this, the policy of monetary easing will
help the economy to get over the phase of business cycle slowdown in terms of income and consumption
growth and increases in investment in non-resource sector (RBA, 2018). Export might face a decline due
to disruption at some major key ports and adverse effect of unfavorable weather condition on rural export.
The positive outlook for export derived from steady growth in the production and export of liquefied
natural gas. The economy thus is forecasted to maintain history of its stable growth pace.
Conclusion
The analysis so far has been made indicates that for Australian economy, GDP growth and
unemployment has a fairly opposite relation. For price level, though GDP growth initially surges price
level, but gradually the effect has reduced because of anti-inflationary policy undertaken by RBA. In the
economy, presence of business cycle has evidenced with phases of recession and expansion. Trade

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balance of Australia is subject to variation in the exchange rate between Australia and USA. So far as
monetary policy is concerned, USA and Australia both has provided monetary policy stimulus as a
strategy of economy growth. Economic slowdown of Australia is likely to be recovered within a next few
years moving it again to the path of economic expansion.

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List of References
Data.worldbank.org. (2018). Official exchange rate (LCU per US$, period average) | Data. [online]
Available at: <https://data.worldbank.org/indicator/PA.NUS.FCRF?locations=AU> [Accessed 19 May
2018].
Reserve Bank of Australia. (2018). Cash Rate | RBA. [online] Available at:
<https://www.rba.gov.au/statistics/cash-rate/ > [Accessed 19 May 2018].
Fred.stlouisfed.org. 2018. Effective Federal Funds Rate. [online] Available at:
<https://fred.stlouisfed.org/series/FEDFUNDS> [Accessed 21 May 2018].
Department of Foreign Affairs and Trade. 2018. Trade. [online] Available at: <http://dfat.gov.au/about-
australia/australia-world/Pages/trade.aspx> [Accessed 23 May 2018].
Oecd.org. 2018. Australia - Economic Forecast Summary (November 2017) - OECD. [online] Available at:
<http://www.oecd.org/eco/outlook/australia-economic-forecast-summary.htm> [Accessed 23 May 2018].
Reserve Bank of Australia. 2018. Economic Outlook | Statement On Monetary Policy – February 2018 |
RBA. [online] Available at: <https://www.rba.gov.au/publications/smp/2018/feb/economic-outlook.html>
[Accessed 23 May 2018].
Fontana, G. and Setterfield, M. eds., 2016. Macroeconomic Theory and Macroeconomic Pedagogy.
Springer.
Terra, C., 2015. Principles of International Finance and Open Economy Macroeconomics: Theories,
Applications, and Policies. Academic Press.
Belongia, M.T. and Ireland, P.N., 2016. A Classical View of the Business Cycle (No. 921). Boston College
Department of Economics.
Kent, C., 2014. The Business Cycle in Australia. Address to the Australian Business Economists,
Sydney, 13.
Pagan, A. and Wilcox, D., 2015. External Review–Reserve Bank of Australia Economic Group Forecasts
and Analysis. report to the Reserve Bank of Australia.
Halligan, J., 2017. Reform design and performance in Australia and New Zealand. In Transcending New
Public Management (pp. 55-76). Routledge.
Hartwell, R.M., 2017. The industrial revolution and economic growth (Vol. 4). Taylor & Francis.
Thorpe, M. and Leitão, N.C., 2014. Economic growth in Australia: Globalisation, trade and foreign direct
investment. Global Business and Economics Review, 16(1), pp.75-86.
Argy, V.E. and Nevile, J. eds., 2016. Inflation and Unemployment: Theory, Experience and Policy Making.
Routledge.
Blanchard, O., Cerutti, E. and Summers, L., 2015. Inflation and activity–Two explorations and their
monetary policy implications (No. w21726). National Bureau of Economic Research.
Svensson, L.E., 2015. The possible unemployment cost of average inflation below a credible
target. American Economic Journal: Macroeconomics, 7(1), pp.258-96.
Gilpin, R., 2016. The political economy of international relations. Princeton University Press.
Fischer, S., 2016. Monetary policy, financial stability, and the zero lower bound. American Economic
Review, 106(5), pp.39-42.
Guttmann, R., 2016. How Credit-money Shapes the Economy: The United States in a Global System:
The United States in a Global System. Routledge.

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