Australian Economic Indicators - Economics Assessment

Economics Assessment

Case Scenario/ Task

Prepare a report on the current state of the Australian economy and its management by the Federal government. You need to do this by examining the following four economic indicators - economic growth (GDP), unemployment, inflation and trade (including the terms of trade, the current account, net foreign debt and the value of the Australian dollar). In your report you are expected to outline the target values for these economic indicators as well as the trend in these economic indicators over the last 10 years. Finally, you should outline the current macroeconomic policies of the Federal government and RBA where you think these policies may relate to these four economic indicators and comment on whether you see these policies as suitable in the present economic environment. Given your analysis, you are expected to conclude your report with policy recommendations to achieve targeted economic growth, unemployment, inflation and trade outcomes.

Presentation of report

The report should not exceed 1500 words. This word limit does not include the abstract, tables, graphs and reference list.

The report should be word processed using a font size 12 with 1.5 line spacing.

Structure of report

Your report must include:

• an appropriate title
• an abstract (sometimes called an executive summary) summarising the report
• an introduction in which you briefly explain what you are going to address in the report and why
• the body of the essay broken into sections with appropriate section headings
• a brief conclusion that should summarise your analysis and your predictions and recommendations
• appropriate referencing and a reference list as required.

Although the requirements for presentation and structure may appear pedantic, they are not. In the business world you may often find yourself involved in writing a report – perhaps even for multilateral and government organisations such as the IMF or OECD. We suggest that you devote some time to developing this skill. Your future career can only be enhanced by your ability to communicate effectively in writing.

Introduction:

In this paper we are going to discuss about the four main indicators of economic development in Australia and they are GDP, Inflation, unemployment and trade. Over the past ten years these four indicators have been changing in the economy and more particularly after the global financial crisis these indicators have been very volatile and heading the economy towards recessionary trends. And the monetary authority RBA and Australian Government are working their best towards boosting the economic growth by expansionary monetary policies and expansionary fiscal policies. This assignment focuses on explaining the current trends of all the four economic indicators in the Australian economy and how the policies have changed to bring about changes in these indicators towards the targeted levels.

Economic Indicators:

Gross Domestic Product:

GDP is the total value of goods and services that are produced in the domestic territory of an economy during a period of time (usually a year). It is the value added of goods and services from all the sectors of the economy. GDP is calculated using three methods: the value added method, expenditure method and the income method (Layton and Robinson, 2012). The difference between the potential GDP and actual real GDP tells us whether a economy is heading for a recession or depression or whether it is in an expansionary phase heading for a boom. The Australian economy has been in positive GDP growth rate since 1991 (when it was worst hit by recession). The GDP annual growth rate of Australian economy is shown using the bar graph below (Rate, 2016).

Before the global financial crisis, the economy reached its highest growth rate of 5% in the year 2007. After the global financial crisis, the Australian economy could not reach that target of 5% and its growth rate has been around 3% (with an exception of 4.5% in the first quarter of 2012) Over the past two to three years, the economy has been growing very slowly as shown in the graph above. This is mainly because of the falling productivity in the mining/sector industry and heavy dependence of GDP growth on that industry. Only in the recent years, the government has been making substantial investments in other sectors such as service sector, tourism, other industries, etc. This has led to the slow growth in the economy as the unemployment is still stagnant at the rate of 5.5% to 6 % as shown in the next section.

Unemployment and Inflation:

The relationship between unemployment and inflation is explained by the short run Philips curve which was explained by A.W.H.Philips and he goes on to explain the fact that there is an inverse relationship between unemployment in an economy and inflation. This is true based on the data of the Australian economy. We can see from the two graphs of unemployment and inflation in the Australian economy and find that unemployment has been on the increase for the past few years and that inflation has been decrease during the same period. (Inflation_Rate, 2016) (Unemployment_Rate, 2016)

This inverse relationship between unemployment and inflation is depicted in the diagram below and the SRPC (short run Philips curve) shows the fact that when the unemployment rate is increasing in the economy, its inflation rate is very low.

In the above diagram, we can see the inverse or negative relationship between the two economic indicators – inflation and unemployment in the Austrlaian economy and increasing unemployment rates and low level of inflation suggests the fact that the economy is heading towards recession and such a situation has to be corrected towards expansionary policies (Miller, 2012). The negative relaitonship between the two indicators is explained as follows. When an economy experiences expansionary phase, there is more demand for goods and services produced in the economy and as such aggregate demand goes up and this causes the price level to increase and simultaneously the suppliers in the economy increase the supply and productivity of their plants by increasing the variable inputs (which is mostly labour, as capital cannot be increased in short run). This generates more employment in the economy and hence reduces unemployment rate. Similarly when contraction takes place, the aggregate demand goes down causing the price level to go down and suppliers restriciting production and unemployment becomes more. In the Australian economy, as the GDP growth rate is below the targeted level, and the economy is facing lower consumer confidence, the aggregate demand is lower, resulting in lower inflation rate and higher unemployment rate. The decrease in aggregate demand is also because of deficit in the balance of trade(BOT) and net exports going down. As the aggregate demand (AD) includes net exports as a component, any negative BOT affects the AD very badly.

Balance of Trade:

During the years 2010 and 2011, the Australian dollar was strong in its value and hence high prices of exports from Australia led to trade surpluses as shown in the above area graph (Trade, 2016). After those two years, the decrease in the exports of commodities and continuous increase in value of imports, led to the consistent balance of trade deficits over the past four to five years. This was also augmented by the depreciation of the Australian Dollar against other currencies (Husted and Melvin, 2012). The exports and imports of Australian economy is shown in the following graphs.

We can see that over the past two years the exports of commodities has decreased by nearly $2000 to $3000 million AUD as shown in the figure above. As metallic ores and metallic scrap account for 29% of the Australian exports, these exports have come down over the past two years due to stagnation in the mining sector (Exports, 2016)

The imports of Australian economy have increased over the years from the start of this decade in 2010 as shown in the above graph. And the main commodities that are imported include industrial machinery and transport equipment which account for nearly 40% of the Australian imports. Since the exports are on a declining trend and imports are on the increasing trend, there are consistent BOP deficits from the year 2012 in the economy (Imports, 2016).

Monetary policy of the RBA:

The monetary authority of Australia, the Reserve Bank of Australia, has been taking up expansionary measures to prevent the economy from going into a recession following the global financial crisis. This is shown by the declining cash rate in the economy over the past eight years as shown in the graph below.

The cash rate which has high influence on the interest rates of the economy, was at 5.25% in 2008 and it has consistently reduced over the years to nearly 1 to 1.5 % in 2016 (RBA, 2016). The main idea behind reducing the cash rate is to reduce the interest rates which would boost the private investment spending in the economy and consumer spending and as a result aggregate demand could shift to a point near full employment equilibrium. Aggregate demand of the economy is a summation of four components namely consumption expenditure (which is influenced by income and other factors), investment expenditure ( influenced by interest rates), government expenditure ( autonomous) and also net exports. In order to boost or increase the aggregate demand, the monetary policy of reducing the cash rate would decrease the interest rates or borrowing rates of the investors which would increase the investments in the private sector. IF the fall in the interest rates induces investments, this would shift the aggregate demand in the economy as shown in the figure below.

In the above figure, we can see that the potential full employment of the economy is at Yf where the Long run aggregate supply is vertical to the y-axis. The aggregate demand is much lower at AD1 intersecting the short run aggregate supply curve AS at price level P1. Here the real output is at Y1 which is much lower than the full employment output Yf. However, expansionary policies (whether monetary or fiscal policies) would shift the aggregate demand to the right as shown in the above figure. The aggregate demand would shift to AD2 resulting in an increase in output from Y1 to Y2 level of output and there is increase in the price level (inflation rate) from P1 to P2 and hence there would be a reduction in unemployment rate.

Recommendation for the policy makers and conclusion:

In the light of the prevailing situation in Australia of the stagnant GDP growth rate at 2.5%, the declining inflation rate and increasing unemployment rate, it is the concern of both the monetary authority and government to take to expansionary measures that would boost the economy out of the recessionary trends in business cycles. And for this purpose, the expansionary fiscal policy of autonomous investments by the government in other sectors of the economy and expansionary monetary policy as highlighted above must be taken up to prevent the economy from going into stagnation and recession. Only the helping hand of the government can take the economy out of recessionary trends in the business cycle, if the cash rate reductions do not bring in or increase private investments in the economy.