Impact of Interest Rate Cuts on Australia

This assignment examines the effects of a decision by the Reserve Bank of Australia to lower interest rates. It explores how this policy change influences business investment, consumer spending, aggregate demand, price levels, and real GDP. The analysis emphasizes the relationship between interest rates, economic growth, and living standards in Australia.

ECONOMICS FOR MANAGERS 1
Economics for Managers
Student’s Name
Course ID
University
Date

ECONOMICS FOR MANAGERS 2
Introduction
In the current discussion, the interest rate decision of Australian central bank and the
effect of the same on the economy has been elaborated providing evidence. In the existing
scenario, government budget deficit has become one of the most dominating issues for the
Australian government. Influenced by the current pressure scenario, Prime Minister of Australia,
Mr. Malcolm Turnbull has decided to reduce the government spending in many segments to
lower the surging pressure of budget deficit. Due to the event, capital funding has become a
crisis in the economy as investors are not showing any interest to make further market
investments. To handle the economic uncertainties, the Reserve Bank of Australia has decided to
keep the benchmark interest rate at a record low so that investors and leading borrowers can take
loans and invest capital in the economy (Letts, 2017). Fundamentally, the aim of the study is to
analyse how the low rate of interest has influenced the business investment and economic
environment of the nation. Furthermore, the study investigates how an increase in investment has
made a significant impact on the aggregate demand curve, real Gross Domestic Product, and
price level in the economy.
Q. a
The Central Banks of major economies have been flexible in their monetary policy to cut
the benchmark interest rate to support during the period of economic slowdown. Under the strict
monetary policy, the RBA has cut the benchmark rate from 4.25% to 1.5% since 2012 to 2017 as
shown in figure below (Tradingeconomics.com, 2017). Due to such monetary policy, the flow of
capital in the Australian economy can be seen. In the meanwhile, by cutting down the benchmark

ECONOMICS FOR MANAGERS 3
interest rate, the RBA has mostly encouraged the borrowers to borrow more money from the
financial institution to support the economic growth.
Figure: Australia Benchmark Interest Rate
Source: (Tradingeconomics.com, 2017)
According to the concepts of economics, lower benchmark interest rate will make
borrowing cheaper for the biggest market borrowers and companies. Due to increase in capital in
hand, the spending as well as business investment will see a boost. As a result of the scenario,
the economic growth and market stability will be further supported. On the other hand, lower
interest rate will offer very small amount of investment in savings. Hence, common public will
be encouraged to invest the money in diverse segments (Tuan, 2012). Thus, the business
investment and economic environment in Australia will be boosted.
In terms of business proposition, lower interest rate will be an encouraging sign for the
business firms to borrow more money from the financial institutions to expand their businesses.
Due to the opportunity of greater finance, firms will borrow more and spend more. In this way,

ECONOMICS FOR MANAGERS 4
larger borrowing amount will increase the expenditure contributing towards the growth of the
economy (Tuan, 2012). Moreover, lower rate of interest rate will help to increase the prices of a
number of assets. As a result, housing industry and other asset related sectors can observe asset
buying (Heath, 2017). In this way, consumer confidence will be increased. Apparently, in this
manner, the RBA has encouraged business investment by lowering the benchmark interest rate in
Australian economy.
Q. b
As per the above analysis, it can be seen that the fall in the bank interest rate will
influence the common people to re-invest their money in the market in place of keeping them
safe in bank accounts. Additionally, the availability of low interest rate loans will help the small
entrepreneurs to invest money on start-up businesses in the Australian market. Hence, it can be
assumed that the fall in the interest rate will lead to increase in investment promoting business in
the Australian economy (Fender, 2012). On the other hand, it is important to note that the
increase in investment will lead to several impacts on the economic indicators such as aggregate
price level (inflation), real GDP and aggregate demand curve in the market. The influence of
enhancement of business investment on price level, GDP and aggregate demand has been
presented using the figure given below:

ECONOMICS FOR MANAGERS 5
Figure: The impact of increase in business investment due to the fall in the interest rate on the
aggregate demand curve, real GDP, and price level
Source: (Forstater, 2016)
On the basis of the above figure, it can be seen that the aggregate demand in the market
will increase leading to a rise in the price level and GDP of the nation. Firstly, the increase in the
business investment will increase the supply of money in the market (Forstater, 2016). For
example, the increase in investment will increase the earnings of the people in Australia leading
to an increase in the purchasing power of the consumers. Additionally, the increase in investment
will promote business leading to better job opportunities and higher living standard of the people
(Phan, 2014). Hence, the increment in the buying power will increase the level of demand in the
market that will further lead to a rightward shift in the aggregate demand curve from AD to AD1
(Forstater, 2016). On the other hand, the aggregate supply curve will remain constant at AS in
the short run because the producers cannot make use of more resources in shorter time.

ECONOMICS FOR MANAGERS 6
Therefore, a rise in the aggregate demand can be evident due to the fall in the interest rate in the
market.
Secondly, it can be seen that the rise in the aggregate demand leads to a shift in the
market equilibrium from E to E1. As per the above figure, the rise in the market equilibrium will
lead to an increase in the aggregate price level of the services and products in the market.
However, the consumption of commodities also increases from Q1 to Q2 leading to a rise in the
real GDP of the nation (Cobham, 2015). Therefore, it can be clearly seen through the illustration
that the aggregate demand, price level and real GDP increases with the fall in the interest rate.
Conclusion
According to the above discussion, the decision of the Reserve Bank of Australia to
reduce the interest rate will work in the favour of the economy. The reduction in the interest rate
will promote business investment and increase the flow of money. Additionally, the earning of
the people will grow leading to an increase in purchasing power and better living standards.
Hence, the Australian economy will be boosted as the aggregate demand, price level and GDP of
the nation will increase with the fall in the interest rate.

ECONOMICS FOR MANAGERS 7
References
Cobham, D. (2015). Monetary Analysis and Monetary Policy Frameworks: Introduction. The
Manchester School, 83, pp.1-4.
Fender, J. (2012). Monetary policy. 3rd ed. Chichester, West Sussex: Wiley.
Forstater, M. (2016). Economics. 5th ed. London: A. & C. Black.
Heath, M. (2017). Australia's interest rates aren't as stimulatory as RBA thinks. [online] The
Sydney Morning Herald. Available at: http://www.smh.com.au/business/the-economy/australias-
interest-rates-arent-as-stimulatory-as-rba-thinks-20170730-gxlxjo.html [Accessed Oct. 2017].
Letts, S. (2017). RBA holds rates at record low 1.5pc, warns of high dollar risks. [online] ABC
News. Available at: http://www.abc.net.au/news/2017-08-01/rba-holds-rates-at-historic-low/
8763628 [Accessed Oct. 2017].
Phan, T. (2014). Output Composition of the Monetary Policy Transmission Mechanism: Is
Australia Different?. Economic Record, 90(290), pp.382-399.
Tradingeconomics.com. (2017). Australia Interest Rate | 1990-2017 | Data | Chart | Calendar |
Forecast. [online] Available at: https://tradingeconomics.com/australia/interest-rate [Accessed
Oct. 2017].
Tuan, B. (2012). Monetary Policy Surprises and Interest Rates: Evidence from Australia. SSRN
Electronic Journal.