Analysis Of RBA Cash Rate, Inflation, And Unemployment Rate In Australia

Q1a. On 4^th Feb 2020, RBA made the following announcement: “At its meeting today, the Board decided to leave the cash rate unchanged at 0.75 per cent.”

https://www.rba.gov.au/media-releases/2020/mr-20-01.html

Using the Statistical Tables on the RBA website, find data on monthly Money Market interest rates. (In Column B of the relevant spreadsheet you’ll find data on the Cash Rate Target: monthly average, starting from August 1990 to January 2020).

Use this data to construct a graph of the monthly cash rate from August 1994 to January 2020. Use the graphing tool (line charts) in Excel. Please describe interest rate changes over this period, in particular the big drops, and briefly discuss the reason of the big drops.

Q1b. Please briefly discuss the relationship between inflation rate and unemployment rate over the period 1980-2019, by collecting data from the Australian Bureau of Statistics website. In particular, you can find unemployment and inflation rates from the following statistical series:

6202.0 Labour Force, Australia, and then select Table 1. Labour force status by Sex, Australia - Trend, Seasonally adjusted and Original. From here download the following series: Unemployment rate, Persons; Seasonally adjusted, for the years 1980 – 2019 in monthly frequency.

6401.0 Consumer Price Index, Australia, and then select

TABLES 1 and 2. CPI: All Groups, Index Numbers and Percentage Changes. From here, download the following series:

Percentage Change from Previous Period ; All groups CPI ; Australia ; Original, for the years 1980 – 2019 in quarterly frequency.

Now present the data for unemployment rate and inflation rates in a graph. From the graph, discuss the relationship between inflation rate and unemployment rate over these years.

Note that converting the monthly data into quarterly frequency is by taking only the monthly values corresponding to each quarter like, for example: take the data for March 1980, June 1980, September 1980 and December 1980 to get the quarterly series in 1980.

Q2. Because of Coronavirus outbreak, Australian economy was influenced heavily. Please use the Aggregate Expenditure function and the 45-degree line diagram to explain how the Coronavirus outbreak could affect Australian economy.

Q3. From Sep 2019 till Feb 2020, Australia experienced serious bushfires around the country. Please use aggregate supply and aggregate demand curves to analyze the impact of bushfire on the Australian economy and discuss what policies the government should use to stimulate the economy and its impact in the short and long run.

RBA cash rate trends and changes

Figure 1: Trend in monthly cash rate in Australia

(Source: rba.gov.au 2020)

The trend in monthly cash rate target of Australia shows that there is an overtime declining trend. In order to give the economy necessary stimulus through monetary policy, Reserve Bank of Australia continuously lowered the cash rate with cash rate declines sharply from 14.00 in August 1990 to 0.75 in January 2020. RBA adjusted the cash rate with economic upturn and downturn to ensure a stable economic performance. The trend shows some big drops in the cash rates each associated with event that could cause a significant economic downfall. The period since middle October 1990 to January 1992 was experienced a series of big cuts in the cash rate. Monetary stimulus through lowering cash rates were given during this time in order to rescue to the economy from severe recession started since September 1991 resulted from international stock market crash. Cash rate again followed a series of decline during the period October 2008 to May 2009. Cash rate during this time was lowered in order to counter the impact of Global Financial Crisis in 2008. RBA again took the decision of lowering the cash rate in May 2012 due to a decline in mining activity, tight labor market condition and fall in retail sales. Cash rate reached to 3.00 percent which was the lowest since 1990 (Kwek 2012). With expectation of a lower global economic growth RBA lowered cash rate from 3.00 in April 2013 to 2.50 in October 2013 till January 2015. In response to weak domestic demand, decline in commodity price and slowdown in China’s growth RBA cut Cash rate by 0.5 basis point in 2015 (rba.gov.au 2019). Because of a below average growth rate of Australian economy RBA since June 2019 continuously lowered the cash rate until it reached to 0.75 percent in November 2019 and remained unchanged till January 2020.

Figure 2: Trend in inflation and unemployment rate

(Source: Abs.gov.au. 2020)

Figure 3: Relation between inflation and unemployment rate

(Source: Abs.gov.au. 2020)

The trend in inflation and unemployment and that of scatter graph between inflation and unemployment rate reveals an overall inverse relationship between inflation and unemployment. From the period since 1980 to 2019, low unemployment rate is mostly associated with high inflation and vice versa. The negative correlation between inflation and unemployment can be explained with the theory of Phillips curve. This explains with increase in labor demand, unemployment rate falls. Higher demand of labor however increase wage resulting in wage push inflation (Heijdra 2017). Similarly, in Australia with increase in economic growth unemployment decreased which increased price level. However, because of inflation targeting policy of RBA since 1991, inflation remained within the targeted range of 2 to 3 percent while unemployment declined continuously.

Inflation and unemployment rate trends and their relationship

The Keynesian Cross Model explains macroeconomic equilibrium of an economy using the aggregate expenditure function and the 45⁰ line showing actual expenditure or income. Aggregate expenditure function of the model represents sum of consumption expenditure, investment expenditure, government expenditure and net export. Changes in any one of the expenditure components changes aggregate expenditure function and equilibrium. Because of coronavirus outbreak, cross country exchange of goods and services have ceased. This has caused a significant decline in trade volume. Now assuming Australia enjoy a current account surplus restriction on trade reduces trade balance of Australia. Decline in net export lowers aggregate expenditure. Interruption in supply chain due to disruption in import lowers production activities in the economy (De Vroey 2016). This increases possibility of unemployment in the economy. Outbreak of Coronavirus, also hurt confidence of consumers and investors lowering consumption and investment spending. The likely recession because of coronavirus outbreak thus lowers aggregate expenditure. Accordingly, aggregate expenditure function shifts downward. At the new equilibrium real GDP falls as illustrated in the following figure.

Figure 4: Impact of Coronavirus Outbreak on Australian economy

The upward slopping relatively flat line shows aggregate expenditure of the economy. Equilibrium occurs at the intersection of aggregate expenditure function and the 45⁰ line. Because Coronavirus outbreak, as aggregate expenditure lowers, aggregate expenditure function shifts down to AE_1. Equilibrium moves from A to B. Real GDP of Australia declines from Y* to Y_E.

Figure 5: Impact of bushfires on Australian economy

The figure above explains macroeconomic equilibrium in Australia. Suppose, the economy initially at the stable equilibrium at point A as obtained from intersection of aggregate demand, short run aggregate supply and long run aggregate supply. Now, bushfires in the economy has a destructive impact on productive capacity of the nation. It destroys capital stock of the economy in form of destruction of factories, equipment, land resources, property, roads and other assets (Butler 2020). Decline in productive capacity of the nation shifts the short run aggregate supply curve to the left to SRAS_1.  Short run equilibrium now shifts to B. At this point real GDP declines to Y₁ and price level increases to P₁. As real GDP falls below the potential GDP at Y*, there is a recessionary gap in the economy.

For stimulating the economy, government should use expansionary monetary and expansionary fiscal policies. Expansionary monetary policy can be taken by lowering cash rate, reducing reserve requirement or through open market purchase of government securities and bonds in order to inject more money in the economy. Expansionary monetary policy by lowering interest rate increases investment and boost aggregate demand. This helps to counter recessionary pressure and moves economic output towards potential output.

Impacts of Coronavirus outbreak on the economy and stimulus policies

Considering expansionary fiscal policy government should give fiscal stimulus to business and other affected areas. Tourism industry is one of the most affected industries due to bushfires and realized a significant hit because of decline in number of tourists. Therefore, government to give stimulus package to rebuild the industry (Heijdra 2017). Expansionary fiscal policy targeting particular areas are considered to have a more effective impact in rescuing the economy.

Besides demand side policy, government can also take supply side policies to stimulate economy’s output. This includes investment in infrastructure, rebuilding capital stocks and such other to boost output.

The impact of monetary and fiscal stimulus has been illustrated in the figure below.

Figure 6: Impact of fiscal and monetary policy stimulus

The immediate impact of fiscal and monetary policy stimulus is to shift the AD curve outward to AD_1.  Real GDP moves toward the potential GDP and price level further increases to P₂

The impact of supply side policies is shown in the following figure

Figure 7: Impact of supply side policies

The fiscal policy stimulus however can affect long run output due to its impact on the saving rate. National saving is the sum of private and government saving. Fiscal policy expansion reduces government saving meaning less fund available for investment. This can reduce potential output in the long term. Monetary policy though has not the impact of lowering national saving like fiscal policy, it however is associated with a higher inflation. However, since bushfires creates a recessionary pressure the impact the inflationary impact will be less than expansionary effect on output (Ehnts 2016). The demand side policies though move economic output towards potential output these however have some unintended consequence in the long run. The supply side policies however do not have such unintended consequences.

References 

Abs.gov.au. (2020). 6401.0 - Consumer Price Index, Australia, March 2020. [online] Available at: https://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/6401.0March%202020?OpenDocument [Accessed 17 May 2020].

Abs.gov.au. 2020. 6202.0 - Labour Force, Australia, Apr 2020. [online] Available at: https://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/6202.0Apr%202020?OpenDocument [Accessed 17 May 2020].

Butler, B. 2020. Economic impact of Australia's bushfires set to exceed $4.4bn cost of Black Saturday. [online] the Guardian. Available at: https://www.theguardian.com/australia-news/2020/jan/08/economic-impact-of-australias-bushfires-set-to-exceed-44bn-cost-of-black-saturday [Accessed 17 May 2020].

De Vroey, M., 2016. A history of macroeconomics from Keynes to Lucas and beyond. Cambridge University Press.

Ehnts, D.H., 2016. Modern monetary theory and European macroeconomics. Taylor & Francis.

Heijdra, B.J., 2017. Foundations of modern macroeconomics. Oxford university press.

Kwek, G. 2012. RBA lowers rates to GFC levels. [online] The Sydney Morning Herald. Available at: https://www.smh.com.au/business/banking-and-finance/rba-lowers-rates-to-gfc-levels-20121204-2aslb.html [Accessed 17 May 2020].

rba.gov.au 2019. Statement by Philip Lowe, Governor: Monetary Policy Decision | Media Releases. [online] Available at: https://www.rba.gov.au/media-releases/2019/mr-19-29.html [Accessed 17 May 2020].

rba.gov.au 2020. Statistical Tables. [online] Available at: https://www.rba.gov.au/statistics/tables/ [Accessed 17 May 2020].