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ECON1042 Macroeconomics

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Answers:

Key Points

1. The inflation target rate set by Australia is between 2-3 %(Reserve Bank of Australia 2017) while the inflation for June 2017-2017 has been 1.6.(Reserve Bank of Australia 2017) It seems to be crawling back to the target inflation rate (Graph 1). However, the inflation in Melbourne (2%) has been higher than some other regions in Australia while it has been moderate (1.8) in Brisbane. (Australian Bureau of Statistics 2017) This points towards greater economic performance in the states of Victoria and Queensland than some other states.
 
2. The inflation remained low due decrease in prices of tradeable commodities and subdued wages of workers. The underlying inflation was lower than the headline inflation. The inflation in non-tradeable goods is 2.7 and the inflation in tradeable goods is -1.1 % (Reserve Bank of Australia 2017)
 
3. The implementation of the increment of minimum wages under the Fair Wages Act(Reserve Bank of Australia 2017) may increase the real income of people from Victoria and Queensland. If the general price level is kept in check, some of the income may turn into investment in non-money assets like housing.
 
4. Dwelling purchases were an important contributor to the increase in CPI for Melbourne and Brisbane. However, these two cities could see an over-supply of housing apartments in the near future due to an abundance of housing projects in the pipeline which may be completed in the near future. This supply may remain high for the next two or three years.(Reserve Bank of Australia 2017)(Reserve Bank of Australia 2016) An increase in the interest rates may increase the prices of housing further. Lowering the cash rate may increase investment in housing, if the general price level is not allowed to grow. However, lowering cash rate may even encourage greater supply of housing projects and may lead to over supply too.(Reserve Bank of Australia 2015) Lowering houses prices is important as an increase in housing prices will prevent from population from settling here or drive away house buyers or rent seekers.
 
1. An increase in non-tradeable items implies greater domestic demand or a higher consumer spending. The non-tradeable inflation implies greater consumption of services such as hospital services, alcohol, tobacco etc.(Australian Bureau of Statistics 2017) However, an excessive inflationary trend in non-tradeable services must not be allowed that might affect the savings of consumers. As a general trend, there has been a deflationary effect due to reduction in travel expenditure. This is due to the seasonal nature of the industry. Once, the travel season gains momentum, hopefully non-tradeable inflation will be greater.
 
2. Moreover, a decrease in interest rates will increase spending and may increase the general price level. Hopefully, the trend of rise in retail goods and services will continue. However, a further increase in the general price level due to increased demand may reduce household savings and increase inflation rate beyond the target level.

Issues/ Options

1. Melbourne and Brisbane will experience a rise in housing availability due to many housing projects being in the pipeline which may lead to a possible over supply in the future. Melbourne, especially, has seen a housing boom since 2012.(Reserve Bank of Australia 2017)(Reserve Bank of Australia 2016) This may lead to the asset prices becoming lower. The rents for houses were seen to be in decline in Brisbane but remain stable in Melbourne.
 
2. The international prices for coal, iron ore and steel have increased and consumption has increased.(Reserve Bank of Australia 2017) Coal is one of the major exports of Queensland. This may spur demand for mining commodities, leading to a growth in the general price level of tradeable commodities, leading to a new cycle of job growths in the mining sector, demand for housing (rental as well as dwelling ownership) and a general increase in the price level. Wool and beef major trading commodities of Victoria. An increase in merchandise trade may lead to increased demand.(Reserve Bank of Australia 2017)

Attachments:

 
The Trend of CPI in Australia. Source Reserve Bank of Australia

Graph 1 CPI Trend Since 2010. Source(Reserve Bank of Australia 2017)   Reserve Bank of Australia, 2017

The IS-LM curve helps understand the changes in investment and consumption due to change in rate of interest.(Ahuja 2007)
 

Diagram 1 IS-LM Curve

The IS curve points out the total demand for investment and savings at a given rate of interest and at a given level of output.

The IS Curve would be defined as

In this case

Y = Income
 
if the aggregate consumer spending which is an increasing function of the total disposable income i.e the taxes subtracted from the income.
 
is the investment which is a decreasing function of
 
r = rate of interest set by Reserve Bank of Australia. This determines the money supply in the economy.
 
NX = Net Exports or exports minus imports.

An increase in investment at the given rate (r) or an increase in Net Exports or increase in consumption function tend to raise the Output

The LM curve helps determine the ‘liquidity preference of money’ for the curve. It gives an idea of how much cash balances consumers would be willing to hold as liquidity instead of investment or savings/ The LM curve is a set of points where every point is a combination of the demand for money at a given income. The Demand for money originates from the transaction motive (demand for money because consumers wish to hold cash for transaction) and speculative motive (demand for money because consumer are not sure about the value of money in the future. Mathematically, the LM is written as, Where
M =  Nominal Money Supply
P= Proce Level

In the above diagram, r is decreased to r1, the output as well as the price level may increase to  Y1 . Prices may leave out of the inflation rate target of the Reserve Bank of Australia. If the interest rates are increased, Y would decrease and so would the price level.

Bibliography

AHUJA, H. L. (2007). Advanced Economic Theory: Microeconomic Analysis. New Delhi, S Chand Publications.

AUSTRALIAN BUREAU OF STATISTICS (2017). Consumer Price Index, Australia, Jun 2017. [online]. Last updated 26 July. http://www.abs.gov.au/ausstats/[email protected]/0/938DA570A34A8EDACA2568A900139350?Opendocument

RESERVE BANK OF AUSTRALIA (2017). Box A: The Pipeline of Residential Dwelling Work. [online]. http://www.rba.gov.au/publications/smp/2017/feb/box-a-the-pipeline-of-residential-dwelling-work.html#fn3

RESERVE BANK OF AUSTRALIA (2017). Inflation Target. [online]. http://www.rba.gov.au/inflation/inflation-target.html

RESERVE BANK OF AUSTRALIA (2016). Statement on Monetary Policy – August 2016 Box B: The Housing Market. [online]. https://www.rba.gov.au/publications/smp/2016/aug/box-b-the-housing-market.html#fn4

RESERVE BANK OF AUSTRALIA (2017). Statement on Monetary Policy – August 2017 Box A The Recent Pick-up in Global Merchandise Trade. [online]. https://www.rba.gov.au/publications/smp/2017/aug/box-a-the-recent-pick-up-in-global-merchandise-trade.html

RESERVE BANK OF AUSTRALIA (2017). Statement on Monetary Policy – August 2017 Box C Minimum Wage Decision. [online]. https://www.rba.gov.au/publications/smp/2017/aug/box-c-minimum-wage-decision.html

RESERVE BANK OF AUSTRALIA (2015). Statement on Monetary Policy – May 2015 Box C: The Cycle in Dwelling Investment. [online]. https://www.rba.gov.au/publications/smp/2015/may/box-c.html

RESERVE BANK OF AUSTRALIA (2017). Statistical Tables. [online]. Last updated 27 July. http://www.rba.gov.au/statistics/tables/

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