a.) Which monetary policy is more effective in moderating the business cycle, tight or easy? Give reasons for your answers. b.) What is the current monetary policy stance of the RBA? What factors do the RBA take into consideration, before a decision is made as to whether to implement a tight or easy monetary policy? c.) Using AD-AS model, explain how interest rates affect the key macroeconomic variables.
a.) Comment on the recent factors that are affecting the value of the Australian dollar. Use diagrams to illustrate your answer. b.) Who gains and who loses when the Australian dollar depreciates? Justify your answer. c.) In your opinion, is a depreciating $A good or bad for the Australian economy? Justify your answer.
1. a) In order to moderate the business cycle, a tight monetary policy would be more effective in moderating the business cycles since it would prevent an overheating of the economy which could give rise to consistent high inflation and thus could ultimately pave way to recessionary conditions. Expansionary monetary policy even though helps in rapid growth of the economy and businesses cause money supply to increase which fuels inflation and erodes purchasing power in the long term. Tight monetary policy prevents this and hence leads to lower fluctuations in the business cycle albeit at the cost of the moderation of economic growth (Mankiw, 2012).
b) RBA currently is maintaining an easy monetary policy which is apparent from the cut of 25 basis points in the cash rate in February 2015 despite very low interest rates. The primary factors that RBA takes into consideration which deciding on the monetary policy are the GDP growth, related macroeconomic indicators, inflation, employment trends, global investment and growth prospects especially China (because the Australian economy is significantly dependent on mining) and US, housing prices, commodity prices particularly coal, oil , iron ore, aluminium and other minerals and also try to predict the likely movements in the above variables going forward in the near to medium term (RBA, 2015).
c) Interest rates have significant impact on the inflation level and real output level. If the interest rates decline, there is an increase in the aggregate demand which leads to inflation in the short term and thus increase in price level. Further due to easy availability of credit, investment cycle is enhanced which leads to an enhancement in the real output as well in the medium to long term. However an increase in the interest rates leads to decrease in aggregate demand which leads to deflation in the short term and adversely impacts the investment cycle and leads to decline in real output in the medium to long term (Dombusch, Fischer & Startz, 2012).
2. a) One of the major factors which have caused the depreciation of the Australian Dollar in the recent times is the decline in the price of commodities such as iron ore, coal, copper and uranium primarily due to a slowdown in demand in China which is the world’s largest consumer of many commodities and accounts for sizable exports from Australia. This has led to a current account deficit and thus increased demand of USD for covering the deficit. Additionally recovery of the US economy in the last year has additionally fuelled the depreciation of the AUD versus the USD. However the depreciation of AUD versus EUR and YEN has been lesser since the economies of Eurozone nations and Japan are underperforming (RBA, 2015). This depreciation of AUD is captured in the graph shown below.
b) When the Australian Dollar depreciates, it augers well for the exporters belonging to the mining and dairy industry as it increases the profitability and competitiveness of these businesses. However the various import based businesses would be hurt since imports would tend to get more expensive and thus the consumers may be hurt. Additionally inflow of foreign capital may be stalled but outflow of capital may increase since usually depreciation is associated with an underperforming economy (Mankiw, 2012).
c) I believe that a depreciating dollar is good for the Australian economy since it augers well for the various exporters particularly those belonging to the mining sector, dairy which forms a significant chunk of the Australian economy and exports and thus provide a boost to the economy which would also lead to a trade surplus and thus enhance the availability of financial resources for the government to deploy for fostering national growth (Dombusch, Fischer & Startz, 2012).
Dombusch, R, Fischer, S & Startz, R 2012.Macroeconomics, 10th edn, McGraw Hill Publications, New YorkMankiw, G 2012. Principles of Macroeconomics, 6th edn, Worth Publishers, London
RBA 2015. Statement on Monetary Policy, Reserve Bank of Australia, Available from: https://www.rba.gov.au/publications/smp/2015/feb/pdf/0215.pdf (Accessed on February 11, 2015)
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