ECON311 Macroeconomic Policy

The Governor of Australia recently expressed satisfaction at Australia growth rate in the first two quaters of 2018, while expressing concerns over the unstable global economy which could hampler this growth, precisely the impending trade war between China and the US, the threat of protectionism (Shane, 2018) and the increase in tariff barriers , in world trade in general, and growing volatility in the financial markets. This paper is a glance the current economic situation of Australia , domestic and internationally as well as the possible impact.

Australia has had the strongest growth in GDP in the last two quarters and compared to the last few years and is project to grow by 3% in the year 2018 (OECD Data, 2018) .  A rise in the GDP would imply a rise in infllation as well as arise in wages. Wages in Australia have remained stagnant in the last few years and were beginning to become a cause of concern. (OECD, 2017)

The declining growth in unemployment should, hopefully raise the Aggregate Demand within the country further (Illustration 1). An increase in the wages shall help induce greater consumption demand within the economy. However, at the current rate, the consumption demand in Australia is not a cause of concern as the Australian household debt in already among the highest in the world at 211% of the world. (OECD Data, 2018) Unless some measure to introduce savings are induced, this household debt may rise further. Hence, a monetary policy of cheap money should be abandoned by Reserve Bank of Australia to give way for higher interest rates. Since the inflation has been rising and is within the inflation target of Australia, there are no expected harmful effects to be experience to inflation targeting.

Illustration 1: Unemployment Rate in Australia since 2016 (Source: OECD Data, 2018)

In the past few years, Australia has been following an expansionary monetary policy in order to maintain inflation levels and GDP growth rates.  Hence, interest rates in Australia have remained consistently low in the last few years. The impact of low interest rates should have led to a high demand for investment. (Illustration 1). This demand has been channeled into the housing sector. A consumer led spending growth in the housing sector has led to a boom in the housing sector. On the other hand, the mortgages on houses, along with cheap credit for consumption purposes have led to a high spending among consumers and greater household debt. Lower interest rates do not spur the consumer to save more. Hence, it is time that monetary policy for Australia must take a somewhat reverse path and should be aiming at raising interest rates.

Illustration 2: The Dangers of Aggregate Demand (AD) moving beyond Sustainable supply (Full employment)

Source: Adapted from (Samuelson & Nordhaus, 2004)

If wages, consumption demand and aggregate demand rise further, it will push the economic growth beyond the sustainable supply level of full employment. Full Employment is usually considered to be at 5%. In the current scenario, if Australian Economy pushes any lower than 5% employment, it would be dangerously close to pushing past the Aggregate Supply and experience high inflation, macro-economic instability and rising asset prices. Hence, there is a case for a tighter monetary policy. (Mankiw, 2009)

Australia had also accumulated high budget deficits following the Global Financial Crisis of 2008-2009 as the national policy required to have expansionary policies. However, measures have been taken to reduce budget deficits and have yielded good results since 2017. Australia may not need expansionary policy at this stage. Hence, it would be a economically viable to have lower budget deficits. If the current policy of lower budget deficits is continues, it is expected that Australia may have a budget surplus in the fiscal year od 2020-21.

In the last few years, globalism has seen a decline in popularity. The US voted to elect Donald Trump, partly based on his promises of laying more tariffs on imports, while Britain voted to exit the European Union, a move now known as 'Brexit'. This may lead to the rise in protectionism as Britain would no longer be obliged to follow the policies of European union while the USA is on the brink of a trade war.

US president Trump has voiced concerns on the trade deficit that USA has been posting consistently against China in the last few years. As a protective measure, the US has introduced trade barriers against Chinese imports in the form of tariffs. (Shane, 2018) These tariffs, among other products, are have been levied in a greater measure on metal ores and meat products from China. (Federal Reserve Bank of St. Louis, 2017) The levy against metal ores is specifically expected to affect steel product imports from China. China, in retaliation, has introduced  higher tariffs on US imports leading to what can be characterised as as a “Trade war“. This trade war cannot exist in a vacuum and shall have far reaching effects, including on countries like Australia, which as both China and USA as a significant trade partner. On one hand, this rise in protectionist policies“(Shane, 2018) On one had , the situation present opportunities, in order to allow Australia develop better trade ties with both nations. On the other hand, the complex global supply chain would get disturbed. Australia's iron ore exports to China could be negatively affected due to a fall in demand for Chinese steel goods. (Shane, 2018)

Protectionist tendencies are not just limited to the trade war between USA and China. In 2017, USA aalso, pulled out of the Trans Pacific Partnership which could have helped open up US markets to Australia further. (Sherwood & Iturrieta, 2018)

The rise of protectionist tendencies by USA which has been a traditional trade partner to Australia his concerning. However, as it stands in the current situation, Australia has a Free Trade Agreement with USA (Department of Foreign Affairs and Trade, 2018)  which may allow it to take advantage of the deteriorating ties between USA and China. Additionally, being a part of the TPP should also be able to insulate Australia from the rising uncertainty in tariffs. Hence, while the rising protectionist waves may be a threat, they may also, signal newer opportunities for Australia.

Australia is a highly globalised country and hence, incidents in the global financial markets would tend to threaten the Global Financial uncertainty. The value of Australian bonds and foreign investment in Australia could  have an impact due to uncertainty in both developed and developing countries. (Reserve Bank of Australia, 2018)

Australia's financial system is particularly closely tied to the financial system in New Zealand where Australia's big four banks operate. High Household debt (particularly the debt from the housing mortgages and dairy sector) in the New Zealand could lead to accumulation of Non Performing Assets within the Big Four Banks, all of which own subsidiary bank in New Zealand.There is a risk of the contagion spreading to Australia through the Big Four.

APRA must fulil a greater role by adopting stringent measures to ensure that the crisis of New Zealand in contained in New Zealand. Australian banks have been consistently opening more and more to global investment since the 1980s and it is time to re-assess the policy of greater globalisation of Australian banks  (Reserve Bank of Australia, 2018)

Other key causes of concern Financial instability in  the corporate sector, particularly the large sums of perceived bad debts accumulated by Chinese firms  affect import demand from China in Australia. Debts by Chinese markets could have an indirect impact too as defaults by Chinese borrowers may make the world capital markets more volatile(Reserve Bank of Australia, 2018). Further, currency depreciation or devaluation from China and other emerging Markets could further impact the export earnings for Australia. Other emerging markets such as Venezuela, Turkey, etc. Are experiencing significant cises, some of which may lead to depreciation or devaluation of local currencies. (Miller & Robins, 2018) The uncertainty faced in these markets, may snowball into a currency crisis, which could further lead to a larger financial crisis.  China is the apparent weak link that could pass the contagion from these markets on to Australia. (Reserve Bank of Australia, 2018) (Miller & Robins, 2018)

Australia has over 2 trillion Australia Dollars tied up in pension funds that are closely ties to the global capital markets. Assets tied in pension funds have been experiencing high growth rates. The investment of these pension funds was largely in domestic housing sector in Australia, in the past. The investment allocation has been moving towards equities as a recent trend. Australia faces risks from both ends, in this case. (Willis Towers Watson, 2018)

Factors such as the sovereign debts in countries like Greece, Italy and Turkey too could pose a threat as there is a risk of a global Financial contagion that could be triggered by events of defaults by these countries. Sovereign debts in these countries could cause crises within the global capital markets. Australia has links to these crises due to government borrowings in Australia as well as pension funds. Similarly, financial institutions in the UK face risks concerning uncertainty surrounding Brexit and are these financial institutions could then transfer the risks on to the Australian financial markets.  (Reserve Bank of Australia, 2018) (Miller & Robins, 2018)

As seen above, the US economy is operating at nearly full employment level and is growing. If the Aggregate Demand pushes further than the sustainable supply levels, inflationary pressures and macro-economic instability will rise in the economy. Furthermore, the fiscal stimulus provided by the recent tax cut, may increase the money supply into the economy, leading to an expansionary effect as shown in Illustrations 2 and 3. This may lead to further inflationary pressures. (Bachman and Majumadar, 2018)

Illustration 3: Inflation in USA between Jan 2011 and May 2018

Source: (OECD, 2018)

As seen in the illustration above, the inflationary pressures are rising. It is possible that the USA, too, may adapt contractionary measures, which may lead to a reduction in consumption in the US market and thus, affect the demand for Australian goods. Furthermore, uncertainty in the US markets may lead to crises in the financial markets, especially the equity markets. (Bachman and Majumdar, 2018) As explained above, the Australia is closely tied to the global financial markets and the risks of contagion spreading to Australia looms large.In addition, the state of USA is precarious. On the other hand, growth forecast has been cut due to fiscal uncertainty. This presents a very uncertain picture for Australia.

The Australian economy, in its current state, can be characterised into a growth phase. Australia is expected to grow at a higher pace than in the recent past.However, owing to the GDP growth,  Australia faces a set  of challenges, both from the domestic economy as well as from world economic factor. However, each of these challenges presents a unique set of opportunities for the Australian market to grow.

Australia also, faces risks from global financial markets, impending trade wars and the rising protectionist sentiment in the world, and uncertainty in the world markets sure to uncertainty is US economic condition.

The most imminent threat however, currently , seems to be from the New Zealand which is closely tied to the Australian banking system. More stringent norms under the Australian Prudential Authority might be necessary to contain an impending crisis that may emerge through the largest banks of Australia.

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