Essay: Role Of Reserve Bank Of Australia In Current Economic Environment.

There are three assessment tasks. They are explained under Assessments on BlackBoard. They are also summarized below:

Task 1 consists of 20 MCQ questions. The exam will take place during week 5 and will be based on the first four weeks of learning materials.

Task 3 is take-home final exam (open book). This assessment task will be made up of short answer questions. The exam may cover all parts of the course. A sample exam will be provided on BlackBoard during the course. The final assessment will be available by noon on Friday before the exam week and must be submitted by noon on the following Friday.

Your essay should address the following four aspects/questions:

1) What role does RBA play in Australia? Discuss the tools available at the disposal of RBA to carry out its functions.

2) Discuss the current economic environment (inflation and interest rates) in Australia, monetary policy employed by the central bank, and effects of thosepolicies on financial markets including asset values and yields.

3) In the article, “Is the deflation bugbear heading down under?” (Fensom 2017), economist Paul Dales is quoted as saying, “an average inflation rate ofaround 2 per cent or below could mean that many economies, including Australia, are just one recession away from deflation. In other words, the next economic shock might not need to be very large to push inflation below zero". Explain the connection between recession and inflation. Why is deflation so dreaded? Comment by drawing on the experiences of other countries that have experienced deflation.

4) In the article, “Is the deflation bugbear heading down under?” (Fensom 2017) leverage dynamics are discussed. Use this as a starting point to explain how leverage matters for the economy.

Roles Played by the Reserve Bank of Australia

In the contemporary global economic scenario, the overall welfare of the population as well as the progress as well as overall development of any country considerably depend on the economic aspects and growth in the concerned country. The economic development of a country, on the other hand, substantially depends on the government of the country and its policy frameworks, their implementation and monitoring (Schumpeter 2017). The economic policies, employed by the government of different countries, can generally be divided into two broad types- the fiscal policies and the monetary policies.

The fiscal policies, referring to the government’s strategies regarding purchases, tax implementation and transfer payments, the monetary policies are mostly designed and implemented by the monetary authorities (the Central Banks in the countries in most of the cases) and are designed to influence the dynamics of the money market and monetary variables in the country, thereby influencing the economic growth and prospects of the concerned country (Stein 2012).

Thus, from the above discussion, it can be asserted that the monetary authorities in an economy play a pivotal role in influencing the changes as well as growth of the concerned economy. Keeping this into consideration, the concerned essay, tries to discuss about the significance and implications of the Reserve Bank of Australia, the roles played by the same, keeping into consideration the overall economic environment of the country and the monetary policy framework.

As can be seen from the above discussion, the Central Bank in a country, plays significant roles, especially in the aspects of monitoring and influencing the monetary side dynamics in the economy, thereby influencing the economy and its health as a whole. The Reserve Bank of Australia, in this context, is the central bank of the country, deriving its powers, authorities and functions from the Reserve Bank Act of 1959. The primary responsibilities of the apex monetary institution of the country are to contribute in the different economic welfare aspects like the currency stability, low levels of unemployment, prevention of high inflation and overall monetary and economic stability of the country (Wadud, Bashar and Ahmed 2012). The RBA, operating as an independent national monetary authority in Australia, play the crucial roles of conducting and implementing different monetary policies for economic stability and development of the concerned country, regulating the other banks and their operations and also providing different financial services, with the primary intention to maximize the monetary welfare of all sections of the population of the concerned country (Thebalance.com 2018).

Monetary policies- The economic growth of Australia is considerably influenced by the activity of the RBA of that of controlling the liquidity and money supply in the economy, as per the needs of the situations.

Regulation of banks- All the other banks in Australia come under the regulation of the RBA, which decides on the level of reserves which they need to keep as well as the rates of interests, in order to protect the interests of the depositors as well as to maintain financial stability in the economy (Wadud, Bashar and Ahmed 2012).

Tools used by the RBA

Financial Services- The RBA, being the bank for all other private banks as well as for the government, lend money and other financial assistance to the same as and when required.

Apart from these, the RBA also plays crucial roles in regulating foreign currency dynamics, exchange rates and the level of inflation in the country.

For controlling the liquidity in the economy, the primary tools used by the RBA are as follows:

Reserve Requirement- This is the amount of reserve which the RBA mandates for other banks to hold with them, which in turn enables the RBA to control the lending activities of the other banks.

Open Market Operations- The liquidity in the country is also controlled by the RBA through open market operation, by buying and selling securities and bonds.

Rate of Interest- The rate of interest is one of the primary tools used by the RBA to control the lending and borrowing activities, thereby controlling the rate of inflation in the country. While increasing the rate of interest helps the institution to prevent high inflation, decreasing the rate of interest helps it to boost investment and productivity in the country (Friedman and Kuttner 2018).

To provide financial services, the RBA also maintains foreign exchange reserves, to influence the exchange rates and domestic currency valuation. They buy and sell the same to influence the domestic currency-value appreciation or devaluation as and when required.

Australia, being one of the most developed and dominant economies across the globe, shows considerable dynamics in its economic environment and the country experiences its share of fluctuations (positive as well as negative) with time. One of the primary indicators of the dynamics in the economic environment in the country is that of the level of inflation prevailing in the economy over time, which in turn reflects the average price levels which the population of the country experience (Dyster and Meredith 2012).

A very high inflation indicates towards sufferings of the population of the country, in terms of decrease in their real purchasing power and consumption welfare. On the contrary, a very low rate of inflation indicates towards lack of economic activities, productions, income generation and an overall stagnating situation in the concerned economy.

Figure 1: Rate of Inflation in Australia (2013-2018)

(Source: Tradingeconomics.com, 2018)

The Australian inflation rate, can be observed to have decreased from 2014 to 2016, thereafter increasing to a visible extent. However, in the recent period, the rate of inflation in Australia can be observed to be remaining at 2% which is considerably low.

Another indicator for analysing the economic environment and dynamics in the economy of the country is the dynamics in the rate of interest of the country, usually determined by the Central Bank of the same, as much of the borrowing, lending and investment activities are subjected to the level of interests prevailing in the economy (Dyster and Meredith 2012). Keeping this into consideration, the dynamics in the rate of interest of Australia, in the recent period is as below:

Figure 2: Rate of interest in Australia (2013-2018)

Current Economic Environment of Australia

(Source: Tradingeconomics.com 2018)

The RBA can be seen to be decreasing the rate of interest and in the last two years, it has been static at a considerably low level (1.5%).

The evidences of low inflation rates in the country can be attributed to the inflation-targeting policies which the RBA has been taking since the 1990s, primarily in order to keep the rate of inflation between 2% to 3%. This has primarily been adopted by the RBA in order to decrease the high rate of inflation (as high as 16%) which used to prevail in the earlier periods in the country, thereby hurting the population and their economic welfare (Morningstar.com.au 2018). The RBA has been implementing these inflation targeting policies primary through domestic market operations and reserve requirement policies.

The excessively low rates of inflation and its potential threat of decrease in economic activity can be seen to be combatted by the RBA, in terms of low rate of interest in the economy in the recent periods. The RBA is deliberately keeping the rate of interest at 1.5% so as to boost the economic activities, investments, businesses and employment generation in the country, with the intention of boosting the productivity and the economic growth in the country.

The inflation targeting policy of the RBA, can be seen to be effective in the past few years, bringing down the rate from as high as 16% to not more than 4% in the last few years. However, the prolonged low rate of inflation (lower than the target rates), in the recent period, has led to the threat of a potential recessionary situation, if the trend continues to remain for the next few years (Del Negro, Giannoni and Schorfheide 2015). On the other hand, the low rate of interest in the country has to some extent helped in increasing the productivity in the country over the last few years, as can be seen from the dynamics in the unemployment rate:

Figure 3: Unemployment rate in Australia

(Source: Tradingeconomics.com 2018)

The unemployment rate in the concerned country had decreased from 6.3% (2015) to 5.6%-5.4% in the recent times, which can be attributed to the hike in investments in aspects of businesses, thereby increasing the employment generation, to some extent, in the country, in the last few years. However, the low rate of interests, coupled with the decrease in unemployment, led to the increase in the asset prices in the country, especially in the housing market as can be seen from the house price index:

Figure 4: Global and Australian House Price Index over the years

(Source: Businessinsider.com.au 2018)

Thus, it can be seen that the asset valuation in the country (especially in the housing market) has increased more than that of the global HPI, in the last few decades, which in turn can also be one of the reasons behind the implementation of inflation targeting policies on part of the RBA in the recent periods (Worthington 2012).

As can be seen from the situation in Australia, the level of inflation in the country has been remaining at a significantly low level (less than 2%) for a prolonged period of time (Morningstar.com.au 2018). This consistently low inflation in the country, provided the trends continue, can have the threat of creating a deflationary situation in the country, with the threat of the rate of inflation in the country falling below 0% in the coming years. This, if happens, can have immensely negative implications on the economy, in terms of creation of a recessionary situation in the country.

Monetary Policy Employed by the RBA

Recession, in an economy, refers to the temporary decline in the economic growth in a country, with reduced industrial and commercial activities and the effects of the same can be seen in the fall in the GDP of the country. In this context, the GDP dynamics of Australia are as below:

Figure 5: GDP dynamics in Australia over the years

(Source: Jericho 2018)

It is visible from the above figure, that both GDP and per-capita GDP of the country have been declining in the last few years, which coupled with the considerably low rates of inflation, pose the threat of deflation and a potential recession in the country. If the deflation materialises, it can lead to a reduction in economic and production activities, thereby decreasing employment generation and hampering growth in real wage, which in turn can reduce the aggregate demand, thereby decreasing the productivity further and this vicious cycle has the threat of to creation of recession, as was seen to happen in Japan in the past (Leduc and Liu 2012).

The otherwise progressing economy of Japan, could be seen to face an acute deflationary and recessionary situation from 1991, which got extended till 2007, thereby getting known as the “Lost 20 Years” (Ito and Mishkin 2018). During this period, following the bursting of an asset bubble, which led to consequent deflation, recession and stagnation of economic activities and growth, which in turn had immense negative and long-term implications on the economy, with the GDP falling, real wages decreasing by 5% and price levels remaining stagnant.

The article considered in the concerned assignment, talks about the leverage dynamics which can be seen to be prevalent in the economy of Australia, considerably influencing the business and investment decisions of the commercial scenario of the country. In this context, the notion of “Leverage” can be referred to the practice of the firms of that of borrowing capital from other sources, for the purpose of investing in the businesses and for increasing the asset base of the firms, thereby generating returns from the same (Thebalance.com 2018). This investment by borrowing, is primarily done to increase the potential returns of investments. The banking sectors of the countries, including that of Australia, also run extensively on this leverage mechanism.

Leverages have considerable impacts in the growth aspects of the commercial sectors of the economy as it multiplies the power of the money in the economy. Investment by borrowing helps in expanding different businesses, thereby generating more employment, productivity, further investments and long-term development for the economy as a whole (Chugh 2016). However, using debt as a source of financing, although helps in rapid growth of the businesses, also contributes in creation of greater risks for the businesses and economy as a whole and also creates more complexities in the financial instruments and their usage, thereby involving higher risks.

Conclusion 

From the above discussion, it can be concluded that the monetary policies and dynamics in Australia have significant contributions in the economic growth dynamics of the country and the RBA plays considerable roles in determining and implementing the same. The current economic conditions of Australia, however, faces a threat of deflation and recession, given the consistently low rates of inflation in the recent period. The leverage policy, in this context, plays a significant role in the investment dynamics in the business sector of the country.

References 

Businessinsider.com.au 2018. CLSA: Australia's housing market has peaked. [online] Business Insider Australia. Available at: https://www.businessinsider.com.au/clsa-australias-housing-market-has-peaked-2016-9 [Accessed 10 Aug. 2018].

Chugh, S.K., 2016. Firm risk and leverage-based business cycles. Review of Economic Dynamics, 20, pp.111-131.

Del Negro, M., Giannoni, M.P. and Schorfheide, F., 2015. Inflation in the great recession and new keynesian models. American Economic Journal: Macroeconomics, 7(1), pp.168-96.

Dyster, B. and Meredith, D., 2012. Australia in the global economy: continuity and change. Cambridge University Press.

Friedman, B. and Kuttner, K. 2018. Implementation of Monetary Policy: How Do Central Banks Set Interest Rates?. [online] NBER. Available at: https://www.nber.org/papers/w16165 [Accessed 10 Aug. 2018].

Ito, T. and Mishkin, F. 2018. Two Decades of Japanese Monetary Policy and the Deflation Problem. [online] NBER. Available at: https://www.nber.org/papers/w10878 [Accessed 10 Aug. 2018].

Jericho, G. 2018. Australia isn't in recession – but we might as well be | Greg Jericho. [online] The Guardian. Available at: https://www.theguardian.com/business/grogonomics/2018/mar/08/australia-isnt-in-recession-but-we-might-as-well-be [Accessed 10 Aug. 2018].

Leduc, S. and Liu, Z., 2012. Uncertainty, unemployment, and inflation. FRBSF Economic Letter, 28.

Morningstar.com.au 2018. Is the deflation bugbear heading Down Under? - Morningstar.com.au. [online] Morningstar.com.au. Available at: https://www.morningstar.com.au/stocks/article/Is-the-deflation-bugbear-heading-Down-Under/8994 [Accessed 10 Aug. 2018].

Schumpeter, J.A., 2017. Theory of economic development. Routledge.

Stein, J.C., 2012. Monetary policy as financial stability regulation. The Quarterly Journal of Economics, 127(1), pp.57-95.

Thebalance.com 2018. Meet the People Who Control the World's Money. [online] The Balance. Available at: https://www.thebalance.com/what-is-a-central-bank-definition-function-and-role-3305827 [Accessed 10 Aug. 2018].

Thebalance.com 2018. Risks and Rewards of Leverage. [online] The Balance. Available at: https://www.thebalance.com/leverage-investing-and-business-3306199 [Accessed 10 Aug. 2018].

Tradingeconomics.com 2018. Australia Inflation Rate | 1951-2018 | Data | Chart | Calendar | Forecast. [online] Tradingeconomics.com. Available at: https://tradingeconomics.com/australia/inflation-cpi [Accessed 10 Aug. 2018].

Tradingeconomics.com 2018. Australia Interest Rate | 1990-2018 | Data | Chart | Calendar | Forecast. [online] Tradingeconomics.com. Available at: https://tradingeconomics.com/australia/interest-rate [Accessed 10 Aug. 2018].

Tradingeconomics.com 2018. Australia Unemployment Rate | 1978-2018 | Data | Chart | Calendar. [online] Tradingeconomics.com. Available at: https://tradingeconomics.com/australia/unemployment-rate [Accessed 10 Aug. 2018].

Wadud, I.M., Bashar, O.H. and Ahmed, H.J.A., 2012. Monetary policy and the housing market in Australia. Journal of Policy Modeling, 34(6), pp.849-863.

Worthington, A.C., 2012. The quarter century record on housing affordability, affordability drivers, and government policy responses in Australia. International Journal of Housing Markets and Analysis, 5(3), pp.235-252.