Economic Principles and Decision Making Report: Australia's Economy

This report provides an analysis of the Australian economy, focusing on economic principles and decision-making processes. It examines the influence of the Reserve Bank of Australia (RBA) and the impact of the cash rate on economic growth, inflation, and unemployment. The report further explores the effects of the US-China trade war and the slowdown of the Chinese economy on Australia's trade relations and overall economic performance. It discusses the role of key macroeconomic variables, such as GDP, and analyzes the potential consequences of various economic factors on Australia's growth prospects, including the impact of trade relationships and monetary policy decisions. The report highlights the interconnectedness of global economic events and their implications for the Australian economy.

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Economic Principles and Decision Making
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Introduction
The economy of Australia has made a record for experiencing the longest period of
economic growth that occurred in the past two decades, since July 1991. The rate of economic
growth has fluctuated over the years but the country has been successful in maintaining the
positive growth even during the global financial crisis. Despite experiencing a decline in the
largest sector, mining, Australia was able to mitigate the negative impact on the economy. It has
been stated by Bell (2017) that the monetary policies taken by the Reserve Bank of Australia
(RBA) played a significant role in helping the country to overcome the challenges generated
from the global financial crisis. In 2017, the GDP of Australia was AUD 1.69 trillion, and its
total wealth as of 2016 was AUD 8.9 trillion (Greasley et al. 2017). The inflation rate has been
more or less stable over the years and in the first quarter of 2019, the inflation rate was 1.9%
indicating a moderate economic growth. Regarding another significant macroeconomic variable,
that is, unemployment rate, it is around 5% in 2018-19 despite creation of jobs (Pandey, 2019).
Cash rate is a very significant factor that influences the money market. It is an important
component of monetary policies designed by the RBA. Cash rate represents the overnight money
market rate of interest. The changes in the cash rate have knock-on effects on various moving
parts of the economy, such as, investment, spending, inflation and unemployment (Alim &
Connolly, 2018). It is assumed that the cash rate might decline further from 1.5% and the GDP
might also fall from 3% in 2019. These would imply a slower growth of the Australian economy.
Along with that, the largest trading partner of Australia is China which is also experiencing an
economic slowdown, which would also affect the growth rate of the economy of Australia. This
report aims to discuss the above mentioned factors of the domestic economy as well as the

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external factors, such as, the economic condition of China and its impact on the Australian
economy in an attempt to explore and evaluate the growth possibility of Australia.
Discussion
Economic growth and impact of cash rate
Economic growth is defined as the increase or expansion in the size of a nation’s
economy over a period of time. The size of the economy is usually measured by the gross
domestic product (GDP) which represents total output level in a given financial year that
occurred within the geographic boundaries. The total production level in a nation depends on
various factors of production along with various intangible aspects in the economy, such as,
money supply, level of demand and expenditure, interest rates, unemployment, inflation, tax
rates, level of import, exports and tariffs and many more (Johnson, 2017). Hence, the RBA has a
significant role to play in influencing the total level of production in Australia. Among the
measures taken by the RBA, cash rate is an important element that is controlled by the RBA to
control the money supply in the economy, which in turn affects the demand and supply of goods
and services in the economy as well as other factors of economic growth.
As highlighted by RBA (2019), cash rate is the metric that is used to represent the rate of
interest on the overnight funds. These funds are those which are used by the commercial banks
for lending one another for meeting their daily cash needs on an overnight basis. However, cash
rate also serves as the benchmark rate for all types of lending, such as, mortgages, interest rates
on the savings accounts, exchange rate and many more aspects of the monetary policy designed
by the central bank, that is, Reserve Bank of Australia (RBA). Hence, cash rate affects the
channels of money supply in the economy. For example, when an economy is strong and demand

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is pushing up the prices of goods and services, that is, inflation is going up, then the cash rate is
raised to slow down the economy and keep the inflation under a healthy range (rba.gov.au,
2019). Similarly, when the RBA decreases the cash rate, it aims to encourage investment and
spending and push the prices in the market up to accelerate the growth through the increase in
the flow of money in the economy. Thus, it can be said that rise (fall) in cash rates indicates a
rise (fall) in the interest rate in the economy.
RBA maintained the cash rate at one of the highest points of 4.75 during 2011 and since
2012, the cash rate has been cut by RBA. According to RBA (2019), since mid 2016, the cash
rate was kept fixed at 1.50%, however, it has been observed that there was a further fall in the
cash rate. This implies that the Australian economy has been experiencing a slower economic
growth than the expected and to boost the economy, RBA decreased the cash rate further.
The decision on the cash rate depends on various factors, such as, inflation, employment,
economic growth and international economy (Brown & Karpavičius, 2017). Australia has an
inflation rate of 1.9% which is less than the target range of 2% to 3%. Hence, this implies that
the economy needs a boost up and decrease in the cash rate is beneficial for that. It is found from
the last recorded information, RBA decreased the cash rate by 25 basis points in June 2019 and
further by 25 basis points in July which has pushed the cash rate down to 1% from 1.5%
maintained since August 2016 (RBA, 2019). The condition in the international economy is a
major factor that affects the decision on cash rates by the RBA. Thus, any turbulence in the
international economy, such as, the global financial crisis, has prominent impact on the cash rate.
A strong overseas economic growth especially in the trade partners implies higher demand for
the Australian products, while in the weak financial condition or issues with the trade partners
the economy of Australia gets affected. Similarly, the employment or unemployment level in

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Australia indicates the level of performance of the economy (Talukder, Vickers & Khan, 2018).
RBA might decrease the cash rate if the level of unemployment is high in the economy as
lowering the interest rates would stimulate the investment, spending and creation of employment
opportunities. Thus, it can be said that when the RBA plans to decrease the cash rate, the aim is
to stimulate the domestic economy by pushing down the interest rate, and encouraging the
expenditure and investment, that is, encouraging more flow of money into the economy.
It has been observed that the economic growth in Australia has been very slow in the
recent few years. According to a report by Scutt (2019), the economy of Australia grew by only
1.8% in the last financial year of 2018-19, which is the weakest record since the global financial
crisis. The household consumption, which is the largest part of the economy, has been very
weak, which was underpinned by the demand created by the government and GDP per person
has declined marginally, which extended the per capita recession in Australia into third
consecutive quarter, however, the nominal GDP remained strong which boosted the income
revenues for the government, although the growth was exceptionally slow.
US – China Trade War and its impact on Australia
Another aspect of the slow growth of the economy of Australia was the impact of U.S. –
China trade war and slow growth of the Chinese economy. China is the biggest trade partner of
Australia, with major demand for coal, iron ore and liquefied natural gas. In 2017-18, China
contributed around $194.6 billion worth of exports and imports in the Australian economy
(Chau, 2019). The large mining companies of Australia are heavily dependent on China for
exports (Ellem & Tonts, 2018). Australia is also a trade partner of the U.S., and if China’s

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economy was affected by any situation in the international trade, then it also affects the trade
relation with Australia. The U.S. – China trade war was started in 2018 regarding the increase in
tariffs and other measures. The U.S. Government in assistance with the United States Trade
Representative (USTR) decided to apply tariff on USD 50-60 billion worth of Chinese imports in
order to curtail the unfair trade practices of China happening over the years, which includes theft
of US intellectual property (Wang, Pang & Li, 2019). More than 1300 categories of Chinese
goods were listed for tariffs, such as, batteries, aircraft parts, medical devices, flat-panel
television, various weapons and satellites (Guttmann et al., 2019). In response to the decision by
the US, the Chinese government imposed tariffs on 128 product categories imported from the
US, which includes cars, airplanes, pork, soybeans, aluminium, steep piping, fruits and nuts (Liu
& Woo, 2018). Within the next course of time both the countries continued to impose as well as
increase tariffs on goods worth of billions. Due to these economic decisions, China’s economy
experienced a slowdown as its exports have been affected. Along with these, China is also
experiencing other macroeconomic issues, such as, decreasing birth rate, rapidly aging
population, tightening Federal Reserve and a slowing international economy (Onyusheva, Naing
& Zaw, 2019) have also contributed in the economic slowdown. From 10% in 2011, the Chinese
economy experienced only 6.6% growth in 2018 (RBA, 2019).
China is the second biggest economy of the world and its slowdown has consequence on
the world economy. As China and Australia are strongly connected through trade relations, a
slowdown of the Chinese economy is expected to have a negative impact on the Australian
economy. As stated by Qi & Zhang (2018), China imports at least one-third of the total exports
from Australia, and, if the US government makes a deal to close the USD 400 billion trade gap
with China, Australia’s economy would likely to suffer. It is expected that in the deal with the

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US, China might settle to buy more American LNG, which currently constitutes a large part of
the Australian exports to China, and this decision would hurt the Australian economy, as seen in
case of coking coal exports of China. It is observed that the coal exports from Australia to China
declined 21% in 2019 while imports of Mongolian coal to China increased 47%. This had a
strong impact on the Australian coal mining industry (Stanway, 2018). If an agreement between
U.S. and China is reached, which would lead to an increase in the imports of American goods,
including LNG, by China that would help the U.S. to bridge the trade gap of USD 440 billion,
then that would cast a definite negative impact on the Australian economy through a reduction in
the total exports to China, especially for agricultural products and LNG (Wang, 2019).
Turner (2019) highlighted that with US imposing tariffs on Chinese products, the imports
of Chinese products would reduce in the US, which would affect the manufacturing and other
export sectors of China. On the other hand, due to Australia’s dependency on the Chinese
economy leads to uncertainty from the slowdown of China’s economy. Hence, according to
RBA, a 5% drop in the Chinese growth would result in 2.5% drop in the growth of Australian
GDP with equity and commodity prices taking a hit. RBA also mentioned that the Chinese
economy slowdown could affect the Australian economy via several channels, namely, trade,
equity price and aspects of the financial market, cash rate and exchange rate (Turner, 2019).
Trade relations are the most significant channel for affecting the Australian economy. As China’s
economy is getting affected due to trade war with the US, the less global trade and demand from
China and other nations, having trade relations with China, result in the fall in the GDP of
Australia by 1.3% over the next three years. After 2 years, the volume of the non-resource
exports would decrease by up to 1.5% relative to the baseline and after 3 years, the GDP would
be lowered by 0.3%. The manufacturing and service sectors of Australia get affected with the

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maximum impact reflecting strong demand from China for Australian manufactured food,
education and tourism. In December 2018, the exports of China fell by 4.4% and the imports fell
by 7.6% (Chau, 2019). Secondly, it has been observed that due to China’s economic slowdown,
the equity prices decrease by 10% in the first year, leading to lower household consumption as
well as wealth. This would reflect in the rise in the rate of unemployment by 0.9% and fall in the
inflation rate by 0.2% after 3 years. Thirdly, the slowdown in China affects the cash rate and
exchange rate of Australia. A negative shock from one economy hits the exchange rate of
another economy as the terms of trade falls and this puts a downward pressure on Australia’s real
exchange rate. RBA decreases the cash rate by 25 basis points, from 1.5% to 1.25% in a
modified monetary to maintain the economic growth even during the slowdown in China (Chau,
2019).
Thus, it can be said that China’s slowdown has cast a significant impact on the slow
growth of Australia. Trade, terms of trade, exchange rate, cash rate, commodity prices, equity
prices are some of the aspects which bear the maximum impact of the China’s economic
slowdown. The GDP of Australia is affected by these factors and thus resulting in inflation and
higher unemployment and to control this situation, the RBA took the decision to control the
monetary policy of Australia.
Weak level of consumer spending, investment and slow down of housing sector in Australia
The slow growth of the Australian economy can also be attributed to the weak level of
consumer spending. The economy recorded less than expected growth in 2018 due to a sharp
downturn in the housing market and dull consumer spending which raises a concern about the

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future direction of the economy. The yearly grow rate was recorded as 2.3% which is less than
the prediction of 2.5% (Smyth, 2019). It is assumed by the economists that the slower growth
rate of China is accompanied by the downfall of the domestic housing market in Australia, which
is affecting the economic growth of the nation. The household consumption was restrained,
reflecting 0.4% on the quarter growth in the 4th quarter of 2018 and this was the biggest fall in
the house prices since 1980s. The housing prices declined 9% in Melbourne and 10% in Sydney
in 2018 due to strict credit situations and unaffordability. The spending level of the consumers is
quite weak and the level of investment fell by 27% in the past year. Even in the rental market,
the rent inflation was less than 1%, which was lowest in the past 3 decades. In the first half of
2018, the consumption, dwelling investments and net exports were higher, while in the second
half, only the government expenditure, which was increased on the infrastructure, resource
exports and services, and all the other sections contributing in the GDP fell sharply, resulting in
slow down of the economic growth of Australia (Rumbens & Guttmann, 2019).
(Source: Rumbens & Guttmann, 2019)

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There was also productivity slump in the Australian economy, which recorded one of the
lowest values in the consecutive 3 quarters. Lower wage growth is hampering the productivity in
the market. The investment in the infrastructure is low too. Thus, a sharp slowdown in the
property market of Australia and lower level of investment and consumer spending have hit the
rate of economic growth in Australia in 2017-18. The increase in GDP was also very low, only
2.3% since mid 2017, which is less than the expected 2.5%. There was negative growth of 1.6%
in the agricultural; fishing and forestry sector in the last quarter (Hutchens, 2018). The
construction sector was weakened too. All these factors indicate that the annual growth rate came
down to 2.8% as compared to 3.4% in last quarter (Letts & Janda, 2019). It may lead to a rate cut
by the RBA to stimulate the economy.
RBA may reduce the corporate taxes and cash rates for adjusting the level of spending
and investment in the economy, to maintain a stable wage rate and stable inflation as Australia
was facing a per capita recession first time since 1980s (Reuters.com, 2019). Through the revised
rate cuts and flexible monetary policy, the Australian government attempts to maintain the
growth of the economy. As the GDP growth rate is going down due to reduced trade level with
China, slowdown in the global economy, slowdown in the housing sector, manufacturing and
mining sector, fall in inflation and increase in unemployment, the government needs to increase
the money supply in the economy for preventing further fall in the macroeconomic variables.
Thus, in order to achieve these objectives, cutting the cash rate by 25 basis points appears to be
an appropriate measure. By reducing the cash rate, the government will be encouraging
economic activities, such as, spending and investment in the economy. This will also help in
achieving currency stability, job creation and maintaining the commodity prices at a stable rate.

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The domestic market will be boosted with lower cash rate and the trade relations with other
countries than China may improve.
Conclusion
From the above discussion, it can be concluded that there are quite a few reasons for the
slower economic growth of Australia, which all have significant impact on various aspects of the
economy. On one hand, the trade war between U.S. and China threatens the Australian economy
to go through a major slowdown by affecting its trade relations with China, on the other hand,
the fall in the terms of trade, currency prices and trade volume affects the production, especially
in the manufacturing, mining and service sectors, resulting in the fall in the commodity prices,
rise in unemployment, lack of spending and investment in the economy and slump in the housing
sector. The GDP of the country is also growing at a decreasing rate, that is, at 2.8%, which is less
than the anticipated 3%. Thus, the Australian economy would face tough challenges to
implement substantial growth and in order to increase money supply into the economy, a cut in
the cash rate seems to be the appropriate decision by the RBA. It will be reduced by 25 basis
points from 1.5% to encourage more investment and spending in the economy, improvement in
the production and service sectors and stabilizing the currency prices.

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