FallSpring 08 10 25555 - Macroeconomics: Theory and Applications Question: a) Describe the Australian current economic situation and support your claims with economics indicators and variables. b) Outline the approaches taken by the Australian government (fiscal policy) and the central bank (monetary policy) and how they relate to the global financial crisis and the apparent recovery. c) The RBA has decided to put the cash rate of 4.5% on hold this month; why could this be a reasonable response given the issues and prospects facing the Australian economy? UTS The cash rate………………………………………………………………………. References…………………………………………………………………………15 2 ..1 Government approaches…………………………………………………...5 4.Table of Contents 1..11 6.8 6.3 Inflation targets………………………………………………………….. Executive Summary………………………………………………………………. Conclusion…………………………………………………………………………14 8. Table of Contents ………………………………………………………………….1 Unemployment…………………………………………………………….2 GDP and Consumption expenditure……………………………………….2 2.3 3..1 Australian GDP growth…………………………………………………..8 5.6 4.2 RBA approaches…………………………………………………………. Australian current economic situation………………………………………………5 4..13 7. Fiscal and Monetary policy in the Global Financial Crisis…………………………8 5..11 6.3 Inflation……………………………………………………………………7 5. Introduction…………………………………………………………………………4 4.2 Global GDP growth………………………………………………………13 6. the Australian economy has functioned in line with RBA expectations. An examination of economic variables and measures revealed that in essence. In keeping with the maintained cash rate and government relaxation of fiscal initiatives. 3 . Executive Summary This report seeks to examine the successes and failures of both the Australian government and the Reserve Bank of Australia (RBA) in their quest to usher the Australian economy away from the Global Financial Crisis (GFC). specifically with respect to the debt crisis in Greece and planned fiscal downturns in China.5% cash rate for the third consecutive month in light strong economic conditions. it becomes apparent that Australia is successfully withstanding GFC pressures. The economy is deemed to be functioning so effectively that the RBA did not adjust its rates to account for instable global markets.2. The RBA has thus maintained a 4. growth levels that continue to function close to trend and continued drops to inflation. Introduction The Australian economy has seen considerable strengthening borne from fiscal and monetary policy developments. 4 . the report first investigates economic indicators and variables to reveal a strong economic climate characterized by significant levels of growth. as well as reveal that its influence extends beyond the immediate flow off effect on interest rates. it points to the manner in which the Australian government and the RBA effectively exercised expansionary fiscal and monetary schemes. In an effort to discover this. Secondly. respectively. to inhibit the economy from falling into a global recession.3. the extent to which this has taken place lies in an analysis of the actions made by key economic players. Thirdly. however. it explores the way in which the RBA has employed a target cash rate to maintain low levels of inflation and sustainable growth. rather creating the base on which such rates are built on. 2010. fall 0. Moreover. 4. pp. in the context of the GFC.34% in 2011-2012 (Swan and Tanner. Australian current economic situation The Australian economy. and what they reveal about the way in which the economy has successfully functioned within the GFC. has seen a period characterized by sound economic management.7% in June and as of recently.8% in 2008. with flow-off effects on investment.34% in 2009 and then fluctuate at 5.36).1% in early 2010. This section seeks to explore the fluctuations in these indicators and variables. most of the growing up trend has been in the full-time employment (Statement of Monetary Policy.4. In spite of this. 2010. Graph 1 Source: RBA (2010) 5 . As shown in Graph 1.1 Unemployment First. we have seen significant increases in GDP growth (Statement of Monetary Policy. 2010. functioning in a period of limited access to credit. these variables have faced. Australia’s unemployment rate stands as one of the lowest among advanced economies.45). pp. and will continue to face. with predictions that it is to go down further to sit at 4. The GFC saw unemployment rates rise by 1. the unemployment rate stands as an obvious testament to the stability of an economy. instability.36). the employment rate increased by 0. We have seen a fluctuating unemployment rate cause inflationary pressures. Furthermore. pp. net exports and consumer sentiment. 2010.6%. 2010. Consumption expenditure saw marginal increases in 2009-2010.2 GDP and Consumption expenditure The first quarter of 2011 saw real GDP increase by 0. attributable to the flow-off effects of the government stimulus payments (Statement of Monetary Policy.Graph 2 Source: RBA (2010) 4. pp. 6 . pp.75% between 2011-2012 (Swan and Tanner.7% and real GDP forecast to increase by 3% in 2011 and continue to rise by 3. 2010. with increases set to continue to reach 2.1% and 0.29).5%. 2010).29). There are however still problems in falling export prices.3). 2010. The first quarter of the year saw total consumption increase by 0. (Statement of Monetary Policy. pp. Motor vehicle sales thus recovered there 20% fall and overall total consumption increased.1% in the year while motor vehicle sales to households grew over 10% in 2010.8% increases to the retail sales rate over the first and second quarters of 2010 respectively (Statement of Monetary Policy. pp.45). Graph 3 details the 0. holding negative effects in decreased profit earnings (Swan and Tanner. rising 3. 2010. Such could cause CPI inflation above 3% in the next year (Statement of Monetary Policy. It is forecast that underlying inflation will stand at 2. 2). many retailers have been reducing sales growth to react this regime (Statement of Monetary Policy.34% throughout the next year (Statement of Monetary Policy. 2010. pp. pp.4 Inflation Over the last year the underlying inflation rate has stayed steady as per the expectations of the RBA. This was caused by the result of the rising tobacco tax (Statement of Monetary Policy. Graph 4 Source: RBA (2010) 7 . pp. 2010. Of significance is that CPI inflation was over 3% in the past year (Statement of Monetary Policy. 2).Graph 3 Source: RBA (2010) 4. 2). the current inflation rate is low and is exspected to remain that way over 2012 (Statement of Monetary Policy. pp.2). However. pp.2). In addition. 2010. pp. 2010. Threatening this however are increases in the tobacco tax and cost of utilities. 2010.2). 5. GDP also increases. When the Government is increasing their spending and this spending is autonomous.2 RBA approaches During the recession. individuals within the economy will hold more cash making household spending and business investment more likely.1) This suggests that demand for money has increased and accordingly. the aggregate demand curve will shift up by $4. bond demand would be decreased.2 billion. When household consumption and business investment is increased. Such means that unemployment will be decreased. Fiscal and Monetary policy in the Global Financial Crisis Fiscal Policy is a procedure where the government manages government expenditure (G). 2010. Since GDP is driven by aggregate demand and the AD curve is shifted up. economic activity has progressed slowly and thus interest rates have seen cuts by the RBA by 1 percentage point. increase production capacity and prevent high levels of unemployment. This policy is necessary to toughen the financial system. housing. transfer payment (TR) and tax (t) to control the aggregate demand (AD) of the economy. 5.1 Government approaches With the economy still under recession. Monetary Policy is a procedure where the central bank manipulates the level of interest rate (i) in order to retain the stability of the economy. This is designed to create jobs which will be that will be in demand over the coming years (Coorey. 2010. Furthermore. 5.2 billion where $12. This policy controls the supply of money and its availability as well as its cost. the Government is spending $4. the interest rate (i). the increment for the demand of money will lead the LM curve to shift to the right. 8 . (Coorey. showing the effects of government expansionary Fiscal policy. pp.7 billion were to be given to a low and medium income earner and the other were spent for schools. This is illustrated in Diagram 1 below. When the interest rate sees decreases.1). pp. energy efficiency and infrastructure as well as reducing tax for small business. roads. This is seen in diagram 2 below. causing income to increase up to $950 for low to middle income earners. this means the GDP is also increased. The economic stabilizers were designed to counteract the fluctuations in economic activity without any direct intervention by policymakers. pp. 2008. the Government effectively deformed the competitive 9 . pp.Diagram 1 – Changes in Growth Source: RBA (2010) Diagram 2.1) states that the unemployment rate fell 0. 2010. To maintain economic stability.Changes in Interest Rates Source: RBA (2010) During the GFC the Government supported the economy by allowing the budget economic stabilizer to take control (Swan.7% during the GFC.1% to 5.67). Tanner (Combating the GFC – An Australian Perspective. 2009. During the economic recovery. pp. However. In light of fiscal policy withdrawals. a reduction in lending and credit rationing (Liddy. 6. are forced to operate with a higher funding cost and higher fees for wholesale funding guarantees to survive.5). pp. the Government pulled back stimulus measures to consolidate its fiscal position.8). forecasting the return of a budget surplus by 2013 (Swan. This essentially means that the Government had allowed for economic stabilizers to take charge of ensuring the economy attain economic stability. as the big four increase market share and pricing power. pp.nature of the banking industry. it can be said that the economy will be self-sustaining over the coming years of recovery. Also. 2010. As financial institutions struggled to obtain funding at the heart of the GFC.5% to 72% (Liddy. 2009. 2009. fiscal policy only further frustrated the oligopoly major banks held over the industry in a context where policy aimed at increasing funding access in investing $16 billion to the RMBS market (KPMG. Bad debt expenses on business loans have also increased in the GFC climate and thus lead to a fall in profit in the banking industry.2). 2009.8). pp. Since the Commonwealth Bank and Westpac took over St. Implications include that regional banks have been reduced to three main players. pp. Other institutions such as the Bank of Queensland. George and Bank West respectively. With a start to development of international wholesale funding markets that were triggered by the GFC. the government continues to deliver its deficit exit strategy. these main players increased their share of the retail deposit market from 61. The cash rate 10 .3). for example. This action included higher cost of debt. the availability of credit in the money markets is beyond achievable for financial institution (Liddy. This leaves an ever-present threat of takeover. the cost of the policy has prevented smaller institution from offering price-based competition. p.5% increase in real GDP in March to a 2. 2010.The RBA exercises manipulations to the cash rate in an attempt to reduce inflationary pressures and keep economic growth on target. demand. graph 5 points to a 0.7% increase over the year (RBA.31). 2010. that within the current monetary policy framework.1 Australian GDP growth Central to the RBA decision was that growth rates were increasing. around trend pace despite fading fiscal stimulus. Australian GDP growth is expected to stay close to trend (RBA. and expectations that underlying inflation will continue to stay in the 2-3% preferred target till mid 2011 (RBA. p. with a 2. it appears befitting that the cash rate stay on hold.8% increase in retail sales. in the event that increases in saving and modest spending do not continue as forecast. 6. 2010. Graph 6 points to the June quarter that saw the start of a pause on fluctuations in the cash rate experience a 0. As a result of significant growth in capital stock.1% rise in the March quarter (RBA.75%. However. specifically. Accordingly. household spending has seen marginal increases throughout 2010. reflecting the affectivity of expansionary policy as well as increased levels of household savings. that inflationary pressures have kept within RBA targets at 2. Thirdly. The decision to maintain the 4.5% rate was made for the third consecutive month with three key considerations in mind. Australia is one of few to record higher investment in GDP. Accordingly.31). In the context a broader global economy.5% increase in output compared to the September 2008 peak (RBA.30).30). and continue on hold. p. This is further evidenced in the 10% increase in motor vehicle and services retail sales in the June quarter. and looked to continue increasing. p. until global outlook becomes more apparent or inflation increases beyond suitable levels. p. First. as planned fiscal contractions begin to take place in trade partner nations including Asia and Europe.32). specifically within the resources sector. to account for the uncertainty in global GDP growth. centered on an increasing participation rate. significant inflationary pressures would arise. and in turn. allowing the sector to recover from the 20% dip during 2008-2009 (RBA. specifically in keeping with the downward trending 11 . 2010. following a 0. Second.32). A central consideration in the RBA decision to maintain rates would be concerns that a pre-emptive tightening of monetary policy would destroy confidence and demand. 2010. These investments to the resource sector coupled with employment growth then flow on as increases in income. 2010. p. as well as the labour force. p.32). Graph 5 Source: RBA (2010) Graph 6 Source: RBA (2010) Another foundation on which the RBA decision was based was continued growth in business investment. of importance in RBA considerations is that in the event that such private demand does not occur in the 12 . p. 2010.10).45).unemployment rate (RBA. such as in the $43 billion Gorgon LNG project and its associated expansions in capacity (RBA. and the way in which that would continue to drive growth in domestic demand (Swan. Such is in view of the positive outlook that tax incentives for equipment spending provided the business sector (Swan. 2010. 2010. However. the expected increases to resource exports to flow on from maintained increases to Engineering investment.10). And furthermore. 2010. p. p. 2010.2 Global GDP growth The volatile nature of the global financial market saw equity prices and bond yield levels decline.50). However.50). While the CPI jumped 0. the forecast reliance on the strength of growth rates becomes problematic. p. p.50). 2010. decreasing inflation rates beyond forecast levels and colliding with the RBA decision (RBA.forecast period. with expectations that underlying inflation remain as is (Swan. there exists a possibility of continued concerns in Europe and associated adoption of risk aversion strategies that could slow the global economy. 0. 7. 6. In play within the RBA decision were strong stress test findings for European banks and the implementation of polices seeking to curb inflationary pressures in China (RBA.22).6% in the June quarter. p. 2010. that China’s contractionairy policies may result in decreased commodity prices with flow off effects on resource investment (RBA. Conclusion It can be said that an analysis of current economic indicators. p. 6. specifically attributable to the European sovereign debt crisis and high growth rates in China (RBA. Furthermore.50).34% in the June quarter. In keeping with the inherent uncertainty that governs large-scale investments. 2010. the very fiscal initiatives that sought to increase the growth rate would do the opposite.3 Inflation targets This control of capacity utilization. a decrease in the issue of bonds and significant movements in the exchange rate.4% was attributable to the increase in tobacco prices (Swan.22). p. p. trends and policy 13 .5% in the September 2008 quarter to 2. and does not substitute now contracting fiscal investments. demand pressures and an appreciating exchange rate have resulted in underlying inflation decreasing from 4. Such lessened domestic inflation pressures as the May and June quarters of 2010 have seen banks regain funding access in domestic and international markets. 2010. 2010. decisions point to a mutual fact. https://online.edu. References • Coorey.uts. viewed 30 August 2010. P. It may be costly but it’ll work.au/webapps/portal/ frameset.jsp?tab_id=_2_1&url= 14 . 8. 2010. that with proper economic intervention the Australian economy has proven resilient in view of the GFC. viewed 30 August 2010 http://www. 2010. Statement of Monetary Policy. August. April 6.Banking. D. Keynote address. Reserve Bank of Australia (2010) Minutes of the Monetary Policy Meeting of the Reserve Band Board.au/ 201011/content/economic_statement/download/ES_Consolidated. The GFC. 2009. Managing Director Presentation. Regional banks. Australia: The Retired Westpac Officers’ Club. 2010.pdf 15 . Australia: Brisbane Young Club Young Executive Committee. Sydney.gov. 2009. W.pdf> [Accessed April 20]. 2010.au/Portals/0/2009_regionals_update. Sydney. credit unions and bulding socieies. Managing Director Presentation. • • • Reserve Bank of Australia (2010). pp. Economic Statement. Swan. KPMG Financial services. • Liddy. 3 August. • Liddy.kpmg.com. Available from <www. [online] March. 1-5. D. June 26. Keynote address. Australian banking industry. and Bank of Queensland.budget. 2009.%2fwebapps%2fblackboard%2fexecute%2flauncher%3ftype%3dCourse%26id %3d_1462_1%26url%3d • KPMG. Unprecedented times in financial services.