Impact of Drought on Macroeconomic Environment of Australia

This essay traces the effect of drought on macroeconomic environment of Australia. It discusses nature of policy intervention and its likely consequence to alter drought outcome. The impact of drought on macroeconomic equilibrium of Australia depends on likely influence of drought on aggregate demand or aggregate supply of the economy.

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Introduction
It is difficult to properly define drought as no universal definition is available for the
particular natural calamity. Definition of drought depends on climatic condition of specific
region. In general, drought occurs when a country experiences prolonged period of extremely dry
condition. The severity and extent of drought is examined in terms of deficiency in rainfall and
associated impact on water level, agricultural sector and natural environment. The essay traces
effect of drought on macroeconomic environment of Australia. Drought is seen as an integral
part of Australian economy and attacks the economy more than that flood or fire does (Banerjee
et al., 2013). Some droughts are short lived having a relatively small impact. The intense drought
extended for a loner period has a prolonged consequence on the economy and environment.
Government policy intervention occurs to safeguard the economy from damage caused by
drought. The essay also discusses nature of policy intervention and its likely consequence to alter
drought outcome.
Analysis
Impact of drought
The impact of drought on macroeconomic equilibrium of Australia depends on likely
influence of drought on aggregate demand or aggregate supply of the economy. Macroeconomic
equilibrium of an economy is explained with the help of aggregate demand and aggregate
supply. Aggregate demand shows the sum of demand of all household, business, the government
and net export. The aggregate demand curve explains the relationship between real GDP
demanded and price level. Aggregate supply of an economy is defined as sum of quantity that
different firms in the economy are willing to supply at different prices (Heijdra, 2017) Aggregate

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supply curve captures the relationship between total quantity supplied and price. The aggregate
demand curve slopes downward both in the short run and in the long run. Shape of aggregate
supply curve in the long run however is different from that in the short run. Aggregate supply
curve slopes upward in the short run. The long run aggregate supply is fixed at the potential real
GDP and is shown by a vertical line.
Figure 1: Macroeconomic equilibrium of Australia
(as created by Author)
The long run macroeconomic equilibrium cooresponds to the point E. The stable long run
equilibrium is achived where short run and long run aggregate supply match with the aggregate
demand in the economy (Mankiw, 2014). Change in condition of aggregate demand or aggregate
supply results from external shocks changes the position of macroeconomic equilibrium and
changes real GDP and price level from the stable position.

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Droughts have become one feature of environment of Australia occurring at a regular
interval due to a change in climatic condition. The agriculture sector of Australia suffers largely
due to drought. As agricultural sector is largely dependent on climatic condition especially on
rainfall, there is a huge loss of agricultural production. Many livestock destroyed as a
consequence of drought. Decline in productivity of agricultural sector not only affects rural
Australia but also the national economy (Wilhite, Sivakumar & Pulwarty, 2014). There might be
a significant long term effect of drought in terms of degrading quality of land and water. Impact
of drought is not restricted to impact of destroying crops and livestock. Sector like energy
production and other associated sector are adversely affected due to attack of drought.
Production of thermal and hydropower depends on adequate supply of water (Cbsnews.com.,
2018). The dry condition as a result of drought hampers water supply and reduces energy
production. Shortage of energy result in a higher cost of energy for businesses and household.
Drought also affects tourism and recreation industry of Australia. There is a financial impact on
business like rental shops for water sports.
In the beginning of 2000s, the Australian economy experienced a severe drought
affecting rural and national economy. The drought occurred during this time drove agricultural
production and employment to a recorded low level. The official drought declared areas were
New South Wales, Queensland, South Australia, Northern Territory, Tasmania Western
Australia and Victoria. After drought, the economy contracted by a large extent. The gross
output of farm sector contracted by almost 25 percent (Aghakouchak et al., 2014). Agricultural
export constitutes a large portion of total export, decline in agricultural production means a
decline in net export. Rural export dropped by 27 percent. Farmers suffered a net loss in income
as income declined by 46 percent. The contraction of agricultural sector caused almost 100,000

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people to lose their jobs directly or indirectly related to farm sector
(australiaanddroughts.weebly.com., 2018). Contraction in agricultural output has an immediate
effect on food prices. Shortage of necessary food crops raise food prices
(aicd.companydirectors.com.au., 2018). As food price is an important part of overall consumer
price index, there is an increase in general price level or inflation. Agriculture though constitutes
only 3 percent of aggregate output and 4 percent of total employment, the overall economic
growth contracted by 1 percent during 2002-03. The overall impact of drought thus extends
beyond the farm sector.
Drought thus can be think of a negative supply shock causing the economy to contract
largely. This can be understood using the model of long run macroeconomic equilibrium. The
effect on macroeconomic equilibrium arising from drought is explained in figure 2.
Figure 2: Effect of drought on macroeconomic equilibrium
(as created by Author)

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Point A denotes the stable economic equilibrium obtained from combined forces of short
run and long run aggregate supply and aggregate demand. The long run potential GDP is at Y*
while price level is at P*. A negative supply shock shifts the short run aggregate supply curve
inward (Gottheil, 2013). Negative supply shock of drought shifts the short run aggregate supply
curve from SRAS to SRAS1. The economic equilibrium shifts from A to B. At B, real GDP
slides down to Y1. As against contraction in real GDP price level rises from P* to P1. As output
contracts, there is a contraction of employment as well. The recent drought in Australia is likely
to impose an additional cost burden of $12 billion to the economy. Outbreak of drought thus sets
macroeconomic equilibrium corresponding to a lower real GDP and higher price.
Government Intervention
In a situation of economic contraction government comes with various policy instrument
to protect the economy from a long term negative consequence. Drought being a part of natural
environmental feature of Australia, government aims to design a well suited policy for providing
necessary drought assistance to farmers. Despite facing persistent problem in designing proper
policy, government attempts to mitigate contractionary effect of drought through time to time
development of the policy. The initiatives started from the middle of 20th century with an
irrigation expansion strategy along with designing drought proof interior (Botterill, 2013). Since
1970s, drought was started to be treated like a natural disaster and financial assistances are
designed to offer financial assistance to farmers under surveillance of State and Commonwealth
government. This policy was known as National Disaster Relief and Recovery Agreements
(NDRRA). Finding flaws of ongoing policy, government introduced a new policy named
National Drought Policy in 1992 (abc.net.au., 2018). This policy offers payment for supporting

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farmers’ family along with an interest rate subsidy to overcome financial difficulty. The policy in
1997 was renamed as EC Interest Rate Subsidy.
There are thus several government program in Australia to assist the farmers to recover
economic shocks suffered due to drought. Government initiatives to design support program
results in a significant increase in government spending. This is fiscal policy that manages that
directs government expenditure during recession or expansion. Policies of raising government
funding to support the economy in times of drought is a part of expansionary fiscal policy. It is a
demand sided policy that helps in economic expansion by stimulating aggregate spending.
Increasing government spending during recession helps to expand aggregate demand and moves
economic output towards long term potential GDP (Galbacs, 2015). The impact of government
expansionary policy on macroeconomic equilibrium is described in figure 3
Figure 3: Effect of government policy intervention
(as created by Author)

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The supply shock resulted from drought shifts economic equilibrium from A to B. The
real GDP is lower than the potential GDP of Y* while price level is above the equilibrium price
level of P*. An expansionary government policy has the effect of shifting aggregate demand
curve to the right to AD2. This helps the economy to reach to a new stable macroeconomic
equilibrium at C. Output matches with the potential output of Y* and price level increases to P2.
Conclusion
Drought might have a severe negative supply side impact on Australian economy. As an
immediate impact of drought, real GDP contracted along with an increase in price level. GDP
contracts due to a sharp decline in rural output and export. Apart from agriculture, other sectors
of the economy vulnerable to drought include energy production, tourism and recreation.
Contraction in output leads to a contraction in employment. Occurrence of drought in Australia
is quite frequent and hence, the economy is likely to suffer its contractionary consequences.
Government takes different policy measures to recover the economy from drought. Government
in Australia already has several policies for drought. Government intervention in the form of
expansionary policies help the economy to move back to the potential GDP and expand price
level.

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List of References
abc.net.au. (2018). Dry argument: Australia's drought policy dilemma. Retrieved from
https://www.abc.net.au/news/rural/2014-02-21/drought-assistance-in-australia/5269062
Aghakouchak, A., Feldman, D., Stewardson, M. J., Saphores, J. D., Grant, S., & Sanders, B.
(2014). Australia's drought: lessons for California. Science, 343(6178), 1430-1431.
aicd.companydirectors.com.au. (2018). The economic impact of farm drought in rural Australia.
Retrieved from http://aicd.companydirectors.com.au/membership/company-director-
magazine/2018-back-editions/october/economist-the-big-dry
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https://australiaanddroughts.weebly.com/economic-impacts.html
Banerjee, O., Bark, R., Connor, J., & Crossman, N. D. (2013). An ecosystem services approach
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Botterill, L. C. (2013). Are policy entrepreneurs really decisive in achieving policy change?
Drought policy in the USA and Australia. Australian Journal of Politics &
History, 59(1), 97-112.
Cbsnews.com. (2018). Australians suffer as heatwave knocks out power, fuels fires. Retrieved
from https://www.cbsnews.com/news/australia-heatwave-knocks-out-power-fuels-
wildfires-amid-drought/
Galbacs, P. (2015). The Theory of New Classical Macroeconomics. New York: Springer.
Gottheil, F. (2013). Principles of macroeconomics. Nelson Education.
Heijdra, B. J. (2017). Foundations of modern macroeconomics. Oxford university press.

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Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.
Wilhite, D. A., Sivakumar, M. V., & Pulwarty, R. (2014). Managing drought risk in a changing
climate: The role of national drought policy. Weather and Climate Extremes, 3, 4-13.