Macroeconomic Environment of Australia

Running Head: MACROECONOMIC ENVIRONMENT OF AUSTRALIA
Macroeconomic Environment of Australia
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MACROECONOMIC ENVIRONMENT OF AUSTRALIA
Introduction
Global economy is now undergoing several structural change. In a world of globalization,
changing dynamics on one nation spread over other nation. Measuring economic performance of a
nation involve analysis of economic performance in different dimensions. Some of the key economic
indicators include GDP, unemployment, rate of inflation and others. Every economic aims to achieve a
stable economic growth along with a low level of unemployment and stable price level. In order to
achieve these objectives government supports using policy tools of fiscal and monetary policy. Monetary
policy works through adjustment in the supply of money by use of varying instruments like interest rate,
open market operation and other money market tools. The paper conducts a study on economic
environment of Australia. The robust uninterrupted growth history of Australia has always made the
economy attractive to the researchers (Hellwig & McAllister, 2016). Special focus has been given on
existing structural problems like crisis in housing market, contraction of manufacturing, low wage
growth and rising debt of households. In reference to current state of the economy the framework of
monetary policy has been critically evaluated.
Economic environment of Australia: overview
Economic performance of nation is measured in terms of indicators measuring economic
performance in various dimension. These indicators include Gross domestic product, Unemployment
rate, rate of inflation, trade balance, interest rate and others. The trend analysis of these indicators over
a sufficiently long time period provides a brief overview of macroeconomic scenario in Australia.
Gross Domestic Product (GDP)
GDP is a proxy measure of produced output of the nation. This is the sum of monetary values of
goods and services (Sloman, Norris & Garrett, 2013). An overtime increase in GDP indicates an increase
in productive capacity of the nation. This is a sign of economic expansion.
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Figure 1: GDP of Australia
(Source: tradingeconomics.com, 2018)
Figure 1 shows GDP of Australia in the last ten years. In 2016, GDP worth 1204.62 USD billion, lower
than that of 1345.38 USD billion in 2015. GDP of Australia constitutes 1.94 percent of total GDP of world
economy. From 1960 to 2016, the average GDP in Australia is recorded as 401.44 USD billion
(tradingeconomics.com, 2018). After reaching to the highest level in 2013, GDP in recent year has
started to fall. This marks a deceleration of economic activity especially in mining, housing and
construction sector.
GDP growth
Change in GDP from one year to another measure growth in GDP and is also considered as a
measure of economic growth of a nation. When GDP increases at an increasing rate then the economy is
said to progress rapidly.
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Figure 2: Economic growth in Australia
(Source: tradingeconomics.com, 2018)
As shown from the above graph the dynamic of economic growth in Australia has undergone several
fluctuations. The peak and trough in economic growth indicates phases of recession and expansion.
Growth in the past few years is found to be significantly lower as compared to that in the previous
period. The economy quickly recovered shocks of global financial crisis in 2008 and constituted a sharp
increasing trend reaching close to 5 percent (Nielsen, 2017). However, reaching peak in 2013, economic
growth started to decline and remained around 2 to 3 percent.
Unemployment rate
Rate of unemployment is measure of labor market status. A person in the labor market is
identified as unemployed if the person is incapable of finding a job despite being willing to do so. The
employment level is an indicative measure of nation’s productivity and that of aggregate supply
(Goodwin et al., 2015). The trend in measured unemployment rate of Australia is given below
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Figure 3: Unemployment rate in Australia
(Source: tradingeconomics.com, 2018)
The recent unemployment rate in Australia is above 5.5 percent. The unemployment rate is quite high as
compared to global standard. The economy has accounted a high jobless rate. Despite addition of
22,600 new job unemployment has still raised to 10,600. The average rate of unemployment in Australia
is 6.88 percent. Following a deceleration in economic growth, people engaged in various sectors like
mining, manufacturing and construction have lost their jobs (Gregory & Smith, 2016). High
unemployment rate is not a healthy sigh for economic growth and productivity.
Inflation
Trend in inflation rate indicates movement of average price level. Inflation measures the extent
of increase in average price level. It is computed as a percentage change in consumer price index from
one year to another reflecting change in cost of living in two different periods. Inflation has close
association with both unemployment and economic growth (Sloman, Norris & Garrett, 2013). Lower
unemployment leads to an increase in inflation. A low to moderate inflation support economic growth.
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Figure 4: Rate of inflation
(Source: tradingeconomics.com, 2018)
Rate of inflation in Australia has shown a gradual declining trend. Inflation rate has remained within
RBA’s targeted level of 2%. With a decline in consumption spending and a relatively slow wage growth
inflation even fall below the targeted level since 2015. RBA then takes policy of monetary easing by
keeping the cash rate to a considerable low level. This has contributed to an increases in price level to
the targeted level of 2% (Berument & Froyen, 2015).
Structural problem in Australian economy
With a dynamic change in external and internal economic environment, some significant
structural changes have been observed in the economy. Some problems that needs special attention
include housing affordability crisis, contraction of manufacturing factor, slow growth of wages,
increasing household debt and such others.
Housing affordability crisis
Houses in major capital cities of Australia has become increasingly unaffordable. Growing
demand along with a relatively inelastic supply housing price soared in Sydney, Melbourne, Perth and
other cities. One major factor responsible of growing housing demand in the low cost of borrowing
because of the existing low interest rate. The RBA’s decision to keep the interest rate to a considerably
low level increases investment demand in the property market (McLaren, Yeo & Sweet, 2016). Growing
population and flow of immigrants also contribute to an increase in demand-side pressure.
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Figure 5: Housing price trend in Australia
(Source: thenewdaily.com.au, 2018)
Contraction of manufacturing sector
The manufacturing sector has experienced a contraction as the economy makes a huge leap
towards being a service dominated economy. The falling share of manufacturing causes thousands of
people to loss their current jobs contributing to rising unemployment.
Figure 5: Decline in manufacturing sector of Australia
(Source: aph.gov.au, 2018)
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As indicated from above figure, contribution of manufacturing sector of Australia has been declining
since the early 2000s. The rate of decline increases particularly after 2010. Share of manufacturing in
overall GDP of Australia was 6.5 % in 2013-14 (Bishop & Cassidy, 2017). The contribution reduced by
more than half as compared to that at four decades back.
Low growth of wage
Slow wage growth appears as one severe problem for the economy. The nation has appeared to
be locked under a situation of low wage growth and associated low rate of inflation (theguardian.com,
2018). Because of a low wage growth, the Australian households now have a lower disposable income.
Figure 6: Wage price index in Australia
(Source: reuters.com, 2018)
Wages on average grows at a rate of 3.5% since 2012. Wage growth remained stagnant around
2 percent since 2016 (reuters.com, 2018). The spare capacity of labor market held responsible for
discouraging employer to pay a high wage. The jobless rate in Australia remained around 5.5 percent
leading to a persistent problem of unemployment.
Business cycle experience of Australia
Business cycle reflects the alternative upswing and downswing in economic growth. The
continuous expansion and recession are explained with four consecutive phase of business cycle
expansion, boom, recession and trough. In times of expansion economic activity expands along with an
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expansion in economic growth and employment opportunity. Continuous expansion helps to achieve
the extreme point of economic growth known as peak. After that, economic growth starts to fall
defining period of economic recession (Goodwin et al., 2015). In recession, the economy contracts
indicated by a contraction of GDP and employment opportunity. Persistent recession moves the
economy towards economic trough where lowest growth point is reached.
Figure 7: Stages of Business Cycle
(Source: Sloman, Norris & Garrett, 2013)
Current state of Australian economy can be described as having a high unemployment rate in the last
couple of years. Australia is now recording a below trend growth rate. All these though indicates sign of
business cycle recession but some parts of economy like non-mining sectors are experiencing a gain in
business investment following a low interest rate (rba.gov.au, 2018). The economy thus forecasted to
enter a new phase of recession supported by non-mining investment and service led growth.
Macroeconomic goals and monetary policy
Every economy tries to attain some major macroeconomic goals. The first and foremost
important goal is to achieve a steady and sustainable economic growth. Steady growth indicates long-
term trend growth without side effect of external or inflationary pressure. A sustainable growth implies
attainment of economic growth for present generation without sacrificing growth prospect of future
generation. Achieving stability in price level is another major macroeconomic goals. The targeted
inflation rate varies across countries. For Australia, RBA targets in attaining a stable inflation rate lying
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between 2 to 3 percent. Besides this, operating at the level of full employment, maintaining stability in
external and internal economy are included under macroeconomic goals of a nation.
In order to achieve the set of macroeconomic goals government takes some supportive measure
using fiscal and monetary policy tool. Monetary policy is a demand sided policy that works through
adjustment in supply of money and prevailing interest rate. The main objective of monetary policy is to
attain a stability in price level. Both a persistently rising or declining inflation rate has detrimental effect
on long-term steady growth rate. A stable price level on the other hand supports a stable growth rate in
the economy (Goodwin et al., 2015). Through price level stability monetary policy aims to attain a steady
economic growth. Monetary policy also helps to achieve fiscal objectives through managing public debt
and government borrowing. Debt management policy is used to maintain a stability in government
bond and security market.
Monetary policy and transmission mechanism
The effect of expansionary or contractionary monetary policy is first realized in money market in
form of increasing or decreasing interest rate. The new interest rate then affects the aggregate demand
and influence aggregate output and price level. During low inflationary pressure, the central bank adapts
an expansionary monetary policy (Sloman, Norris & Garrett, 2013). An expansionary monetary policy is
undertaken in form of increasing money supply.
Figure 8: Monetary policy and impact on aggregate demand
(Source: Goodwin et al., 2015)
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In the above figure panel (a) shows the effect of monetary policy on equilibrium interest rate.
The impact on aggregate demand is described in panel (b). As central bank raises supply of money, the
money supply curve shifts rightward (MS1 to MS2). Given the money demand, an increase in money
supply lowers the interest rate from r1 to r2. A lower interest rate by reducing borrowing cost
encourages investment. In addition, lower interest rate reduces saving by lowering opportunity cost of
holding money (Sloman, Norris & Garrett, 2013). Increase in consumption and investment results in an
increase in aggregate demand. This is shown in panel (b) of figure 8. As aggregate demand shifts
rightward from AD1 to AD2, both output and price level increases.
Current Monetary policy framework of Australia
RBA publishes statement of monetary policy on quarterly basis. The statement provides
rationale behind current monetary policy based on domestic and global economic condition. The main
instrument used by RBA for tackling inflation and economic growth is the cash rate. It is the rate at
which commercial banks borrow from central bank. In the global economy, most developed nations are
now experiencing a robust growth with growth rate being above the trend growth (rba.gov.au, 2018). In
order to support economic growth of Australia RBA has decided to maintain a relatively low cash rate.
Over the last few years RBA continuously lowered the cash rate. Cash rate now remained steady at the
level where is was in three years back. RBA has maintained the cash rate at 1.5 percent to expand
output, employment and price level.
Figure 9: Historical cash rate
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(Source: rba.gov.au, 2018)
The figure above shows a steady decline in cash rate. RBA expects the low interest rate would help to
expand economic activity by encouraging business investment. The low interest rate is though
successful in improving business investment but this is not without its side effect. Crisis in housing
affordability and rising household debt are the direct consequence of low cash rate. The lower cash rate
reduces cost of mortgage repayment and hence, encourages in investment in property market. This has
pushed up housing price to a level than it is ever expected (Chen et al., 2018). The lower saving rate and
increasing tendency of household to borrow significantly raises household debt as a percentage of GDP.
Figure 10: Household debt to GDP for Australia
(Source: tradingeconomics.com, 2018)
Monetary policy limitation
The current framework of monetary policy in Australia has put stress on maintain a low and
stable interest rate. The policy of cutting the interest rate however works with a limited extent. In
addition to achieving targeted inflation level, the low interest rate leads to some unwanted structural
problem in the economy. Household debt has risen significantly (Brown & Gray, 2016). In the housing
market, problem of housing affordability has come to the front. Declining saving rate results in rising
household indebtedness. Growing household debt has now become a major concern than inflation
targeting. This is the reason why some economists favor rule based monetary policy over discretionary
inflation targeting. Under a discretionary monetary policy, there always remain an uncertainty regarding
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what interest rate the monetary authority sets in response to economic shocks (Goodwin et al., 2015).
This in turn raises uncertainty in firm and business decision. Targeting only consumer prices instead of
targeting overall price level narrowed the objective of monetary policy as a tool of economic
stabilization.
Conclusion
The essay summarizes state of macroeconomic environment of Australia. Economic
environment has been examined based upon performance of output, employment and price level. GDP
is the indicator of output performance. From the historical trend in GDP it has been observed that the
economy experienced a decline in the Gross Domestic Product since 2013 leading to a decline in
economic growth. Despite job growth, unemployment has remained a major problem in Australia. So far
as price level is concerned, inflationary pressure has remained under control following inflation targeting
policy of RBA. RBA designs monetary policy to stabilize the economy. The effect of changing dynamics of
money supply affects interest rate in the money market and influences output and prices through
affecting aggregate demand. The trend in historical cash rate shows a continuous declining trend
reflecting an ease monetary policy. The low interest rate today has become less affective because of
associated structural problem in form of rising household debt and rising property prices. The situation
further worsens from gradual downturn of manufacturing sector. The interruption in robust growth path
of Australia creates a room for criticizing current monetary policy advocating an alternative monetary
policy.
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