Global economy is now undergoing several structural change. In a world of globalization, changing dynamics on one nation spread over other nation. Measuring economic performance of a nation involve analysis of economic performance in different dimensions. Some of the key economic indicators include GDP, unemployment, rate of inflation and others. Every economic aims to achieve a stable economic growth along with a low level of unemployment and stable price level. In order to achieve these objectives government supports using policy tools of fiscal and monetary policy.
Monetary policy works through adjustment in the supply of money by use of varying instruments like interest rate, open market operation and other money market tools. The paper conducts a study on economic environment of Australia. The robust uninterrupted growth history of Australia has always made the economy attractive to the researchers (Hellwig & McAllister, 2016). Special focus has been given on existing structural problems like crisis in housing market, contraction of manufacturing, low wage growth and rising debt of households. In reference to current state of the economy the framework of monetary policy has been critically evaluated.
Economic environment of Australia: overview
Economic performance of nation is measured in terms of indicators measuring economic performance in various dimension. These indicators include Gross domestic product, Unemployment rate, rate of inflation, trade balance, interest rate and others. The trend analysis of these indicators over a sufficiently long time period provides a brief overview of macroeconomic scenario in Australia.
Gross Domestic Product (GDP)
GDP is a proxy measure of produced output of the nation. This is the sum of monetary values of goods and services (Sloman, Norris & Garrett, 2013). An overtime increase in GDP indicates an increase in productive capacity of the nation. This is a sign of economic expansion.
Figure 1 shows GDP of Australia in the last ten years. In 2016, GDP worth 1204.62 USD billion, lower than that of 1345.38 USD billion in 2015. GDP of Australia constitutes 1.94 percent of total GDP of world economy. From 1960 to 2016, the average GDP in Australia is recorded as 401.44 USD billion (tradingeconomics.com, 2018). After reaching to the highest level in 2013, GDP in recent year has started to fall. This marks a deceleration of economic activity especially in mining, housing and construction sector.
Change in GDP from one year to another measure growth in GDP and is also considered as a measure of economic growth of a nation. When GDP increases at an increasing rate then the economy is said to progress rapidly.
As shown from the above graph the dynamic of economic growth in Australia has undergone several fluctuations. The peak and trough in economic growth indicates phases of recession and expansion. Growth in the past few years is found to be significantly lower as compared to that in the previous period. The economy quickly recovered shocks of global financial crisis in 2008 and constituted a sharp increasing trend reaching close to 5 percent (Nielsen, 2017). However, reaching peak in 2013, economic growth started to decline and remained around 2 to 3 percent.
Rate of unemployment is measure of labor market status. A person in the labor market is identified as unemployed if the person is incapable of finding a job despite being willing to do so. The employment level is an indicative measure of nation’s productivity and that of aggregate supply (Goodwin et al., 2015). The trend in measured unemployment rate of Australia is given below The recent unemployment rate in Australia is above 5.5 percent. The unemployment rate is quite high as compared to global standard. The economy has accounted a high jobless rate. Despite addition of 22,600 new job unemployment has still raised to 10,600. The average rate of unemployment in Australia is 6.88 percent. Following a deceleration in economic growth, people engaged in various sectors like mining, manufacturing and construction have lost their jobs (Gregory & Smith, 2016). High unemployment rate is not a healthy sigh for economic growth and productivity.
Trend in inflation rate indicates movement of average price level. Inflation measures the extent of increase in average price level. It is computed as a percentage change in consumer price index from one year to another reflecting change in cost of living in two different periods. Inflation has close association with both unemployment and economic growth (Sloman, Norris & Garrett, 2013). Lower unemployment leads to an increase in inflation. A low to moderate inflation support economic growth.Rate of inflation in Australia has shown a gradual declining trend. Inflation rate has remained within RBA’s targeted level of 2%. With a decline in consumption spending and a relatively slow wage growth inflation even fall below the targeted level since 2015. RBA then takes policy of monetary easing by keeping the cash rate to a considerable low level. This has contributed to an increases in price level to the targeted level of 2% (Berument & Froyen, 2015).
Structural problem in Australian economy
With a dynamic change in external and internal economic environment, some significant structural changes have been observed in the economy. Some problems that needs special attention include housing affordability crisis, contraction of manufacturing factor, slow growth of wages, increasing household debt and such others.
Housing affordability crisis
Houses in major capital cities of Australia has become increasingly unaffordable. Growing demand along with a relatively inelastic supply housing price soared in Sydney, Melbourne, Perth and other cities. One major factor responsible of growing housing demand in the low cost of borrowing because of the existing low interest rate. The RBA’s decision to keep the interest rate to a considerably low level increases investment demand in the property market (McLaren, Yeo & Sweet, 2016). Growing population and flow of immigrants also contribute to an increase in demand-side pressure.Contraction of manufacturing sector
The manufacturing sector has experienced a contraction as the economy makes a huge leap towards being a service dominated economy. The falling share of manufacturing causes thousands of people to loss their current jobs contributing to rising unemployment.As indicated from above figure, contribution of manufacturing sector of Australia has been declining since the early 2000s. The rate of decline increases particularly after 2010. Share of manufacturing in overall GDP of Australia was 6.5 % in 2013-14 (Bishop & Cassidy, 2017). The contribution reduced by more than half as compared to that at four decades back.
Low growth of wage
Slow wage growth appears as one severe problem for the economy. The nation has appeared to be locked under a situation of low wage growth and associated low rate of inflation (theguardian.com, 2018). Because of a low wage growth, the Australian households now have a lower disposable income.Wages on average grows at a rate of 3.5% since 2012. Wage growth remained stagnant around 2 percent since 2016 (reuters.com, 2018). The spare capacity of labor market held responsible for discouraging employer to pay a high wage. The jobless rate in Australia remained around 5.5 percent leading to a persistent problem of unemployment.
Business cycle experience of Australia
Business cycle reflects the alternative upswing and downswing in economic growth. The continuous expansion and recession are explained with four consecutive phase of business cycle expansion, boom, recession and trough. In times of expansion economic activity expands along with an expansion in economic growth and employment opportunity. Continuous expansion helps to achieve the extreme point of economic growth known as peak. After that, economic growth starts to fall defining period of economic recession (Goodwin et al., 2015). In recession, the economy contracts indicated by a contraction of GDP and employment opportunity. Persistent recession moves the economy towards economic trough where lowest growth point is reached.Current state of Australian economy can be described as having a high unemployment rate in the last couple of years. Australia is now recording a below trend growth rate. All these though indicates sign of business cycle recession but some parts of economy like non-mining sectors are experiencing a gain in business investment following a low interest rate (rba.gov.au, 2018). The economy thus forecasted to enter a new phase of recession supported by non-mining investment and service led growth.
Macroeconomic goals and monetary policy
Every economy tries to attain some major macroeconomic goals. The first and foremost important goal is to achieve a steady and sustainable economic growth. Steady growth indicates long-term trend growth without side effect of external or inflationary pressure. A sustainable growth implies attainment of economic growth for present generation without sacrificing growth prospect of future generation. Achieving stability in price level is another major macroeconomic goals. The targeted inflation rate varies across countries. For Australia, RBA targets in attaining a stable inflation rate lying between 2 to 3 percent. Besides this, operating at the level of full employment, maintaining stability in external and internal economy are included under macroeconomic goals of a nation.
In order to achieve the set of macroeconomic goals government takes some supportive measure using fiscal and monetary policy tool. Monetary policy is a demand sided policy that works through adjustment in supply of money and prevailing interest rate. The main objective of monetary policy is to attain a stability in price level. Both a persistently rising or declining inflation rate has detrimental effect on long-term steady growth rate. A stable price level on the other hand supports a stable growth rate in the economy (Goodwin et al., 2015). Through price level stability monetary policy aims to attain a steady economic growth. Monetary policy also helps to achieve fiscal objectives through managing public debt and government borrowing. Debt management policy is used to maintain a stability in government bond and security market.
Monetary policy and transmission mechanism
The effect of expansionary or contractionary monetary policy is first realized in money market in form of increasing or decreasing interest rate. The new interest rate then affects the aggregate demand and influence aggregate output and price level. During low inflationary pressure, the central bank adapts an expansionary monetary policy (Sloman, Norris & Garrett, 2013). An expansionary monetary policy is undertaken in form of increasing money supply.In the above figure panel (a) shows the effect of monetary policy on equilibrium interest rate. The impact on aggregate demand is described in panel (b). As central bank raises supply of money, the money supply curve shifts rightward (MS1 to MS2). Given the money demand, an increase in money supply lowers the interest rate from r1 to r2. A lower interest rate by reducing borrowing cost encourages investment. In addition, lower interest rate reduces saving by lowering opportunity cost of holding money (Sloman, Norris & Garrett, 2013). Increase in consumption and investment results in an increase in aggregate demand. This is shown in panel (b) of figure 8. As aggregate demand shifts rightward from AD1 to AD2, both output and price level increases.
Current Monetary policy framework of Australia
RBA publishes statement of monetary policy on quarterly basis. The statement provides rationale behind current monetary policy based on domestic and global economic condition. The main instrument used by RBA for tackling inflation and economic growth is the cash rate. It is the rate at which commercial banks borrow from central bank. In the global economy, most developed nations are now experiencing a robust growth with growth rate being above the trend growth (rba.gov.au, 2018). In order to support economic growth of Australia RBA has decided to maintain a relatively low cash rate. Over the last few years RBA continuously lowered the cash rate. Cash rate now remained steady at the level where is was in three years back. RBA has maintained the cash rate at 1.5 percent to expand output, employment and price level.The figure above shows a steady decline in cash rate. RBA expects the low interest rate would help to expand economic activity by encouraging business investment. The low interest rate is though successful in improving business investment but this is not without its side effect. Crisis in housing affordability and rising household debt are the direct consequence of low cash rate. The lower cash rate reduces cost of mortgage repayment and hence, encourages in investment in property market. This has pushed up housing price to a level than it is ever expected (Chen et al., 2018). The lower saving rate and increasing tendency of household to borrow significantly raises household debt as a percentage of GDP.
Monetary policy limitation
The current framework of monetary policy in Australia has put stress on maintain a low and stable interest rate. The policy of cutting the interest rate however works with a limited extent. In addition to achieving targeted inflation level, the low interest rate leads to some unwanted structural problem in the economy. Household debt has risen significantly (Brown & Gray, 2016). In the housing market, problem of housing affordability has come to the front. Declining saving rate results in rising household indebtedness. Growing household debt has now become a major concern than inflation targeting. This is the reason why some economists favor rule based monetary policy over discretionary inflation targeting. Under a discretionary monetary policy, there always remain an uncertainty regarding what interest rate the monetary authority sets in response to economic shocks (Goodwin et al., 2015). This in turn raises uncertainty in firm and business decision. Targeting only consumer prices instead of targeting overall price level narrowed the objective of monetary policy as a tool of economic stabilization.
The essay summarizes state of macroeconomic environment of Australia. Economic environment has been examined based upon performance of output, employment and price level. GDP is the indicator of output performance. From the historical trend in GDP it has been observed that the economy experienced a decline in the Gross Domestic Product since 2013 leading to a decline in economic growth. Despite job growth, unemployment has remained a major problem in Australia. So far as price level is concerned, inflationary pressure has remained under control following inflation targeting policy of RBA. RBA designs monetary policy to stabilize the economy.
The effect of changing dynamics of money supply affects interest rate in the money market and influences output and prices through affecting aggregate demand. The trend in historical cash rate shows a continuous declining trend reflecting an ease monetary policy. The low interest rate today has become less affective because of associated structural problem in form of rising household debt and rising property prices. The situation further worsens from gradual downturn of manufacturing sector. The interruption in robust growth path of Australia creates a room for criticizing current monetary policy advocating an alternative monetary policy.
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