Econ11026 Assignment 3
Case Study
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Table of Contents
Introduction 3
Key terms in Macroeconomics 3
Functions of money and Reserve Bank of Australia. 5
Money Market Equilibrium 6
Economic Growth 6
Conclusion 10
References 11
Introduction
This case study is about the monetary policy decision made on 7th August 2018 in a media release by Philip Lowe, the Governor of the Reserve Bank of Australia (RBA). The Board made a decision on the cash rate unchanged at 1.5%. That statement of RBA was made on the base of the global economy conditions, domestic economy, the past year indicators, and the economic conditions in the emerging market. In addition, the weaker growth rate and the governmental actions of tightening some regulations to the financial stability in China also have significant influences on the economic performance of Australia. Along with the slight increase in commodity prices, there were positive changes in financial markets, international economic outlook and policy decisions in recent; but the monetary policy is still effective on a global scale.
In this case, GDP, inflation, accommodative monetary policy and low interest rates are the key factors in the rebalancing economy in the Australian region. The RBA took their careful consideration into the effect of exchange rate to the trading, how to manage exchange rate in the way it benefits to other factors.
The media release on 7th August 2018 concludes that the base of the RBA decision is sharing a major assumption that the economy performance will be better with the promising sustainable growth thanks to the ease of the monetary policy; the target inflation is expected under the control over the times.
Key terms in Macroeconomics
Macroeconomics is a study of economics with reference to general levels of output and income and to the inter-relations among sectors of the economy. The objectives of macroeconomics are full employment, economic growth, stable price, and stability of payment balance (Sloman, Norris & Garrett, 2014). It studies various economic indicators such as unemployment, inflation, economic growth, national income and gross domestic product (Mankiw, 2014). The economists often tend to be ready for future generation with sustainable economic growth when the growth rate is under management with no any economic problems (Layton, Robinson & Tucker, 2011).
Gross Domestic Product (GDP) is considered as the effective approach to measure one country’s economy. GDP is the total value of all final goods and services produced by all people and companies in the country within a time periods. There are two forms of GDP: nominal GDP (average price level at any year), and real GDP (how much prices have changed since a base year). As stated by Sloman et al. (2014), when calculating both nominal and real GDP it is warned to avoid double counting of intermediate goods.
Inflation is defined as the rate at which there is an increase in the general level of prices for goods and services in an economy over a period of time, and the purchasing power of currency is dropping as a consequence. The economy is influenced by inflation positively and negatively. Inflation helps reducing unemployment because of nominal wage rigidity, while the increasing cost of holding money and investment and savings discouragement are negative effects of inflation to the economies.
Unemployment means a situation in which people at working age is not able to get a job, but want to be in full-time employment. It is measured by the unemployment rate (i.e. the number of unemployed people divided by the number of people in the labour force). That might put a burden on the government revenues.
According to Sloman et al. (2014), money supply is the entire stock of currency and other liquid means circulating in one nation’s economy within a particular time. That includes cash, coins and balances held in checking and savings accounts; of all those, deposits in banks and financial institutions is the major in one nation’s money supply. Many economists pay their attention to the money supply and related policies via the interest rates controlling, the change of money flow in the economy. It is also assumed that money supply and interest rates are entirely independent regarding to monetary control and money supply is decided by the central bank while some agrees that money supply increases along with the higher interest rates (Sloman et al., 2014).
When the RBA unchanged interest rates, it is believed to be a further slowing in real household disposable income, but no meaningful improvement in household debt repayment performance. This decision also implies that the impact of the combined fiscal and monetary policy on household sector finances is still negative.
Graph 1: GDP growth of China, India, Japan, U.S.A, Australia (Source: World Bank)
The graph 1 illustrated the GDP growth in China, India, Japan, U.S.A, and Australia. China and Australia experienced a decline in comparison to other advanced economies. This might be the reason why the RBA keep its low interest rate. Due to the different effects of those macro elements in the domestic and global environment, the RBA did pay attention to the changes of those in strong economies such as U.S.A, Japan, China when deciding any policies to implement in Australia.
Functions of money and Reserve Bank of Australia.
Money is a unit of account because everything in the economy is quoted in terms of it. It has three main functions: a medium of exchange (purchase of goods and services can be made by the exchange of money), as a store of value (the value of assets, goods and services can be stored in the form of money), and as a unit of account (common measure of value to determine the rate of exchange between goods and services purchased by people) (McTaggart, 2013; Sloman et al., 2014).
The Reserve Bank of Australia (RBA) is the central bank. Deposits, loans and investment are acceptable in the bank. As an independent national authority, RBA makes monetary policy, manages banks and offers financial services in the way to stablize the nation’s currency, limit inflation and manage the unemployment (Duygulu, Afşar & Ozyigit, 2017). In addition, RBS’s duty is to keep a strong financial system and payment system, and to issue the nation’s banknotes.
Money Market Equilibrium
As a role of RBA, monitoring the interest rate in the Australian economy is based on the change of money supply and demand to an equilibrium in the money market. That equilibrium occurs at the interest rate at which the quantity of money demanded is equipvalent to the quantity of money supplied. This equilibrium is shown as r* via the drawn graph 2. It means that r* is the interest rate applied under the supply and demand of money conditions as illustrated in the graph. At any other interest rate, this condition no longer exists; in the money market, it will often force the interest rate to the equilibrium level.
Graph 2: Money Market Equilibrium (Source: transtutors.com)
Economic Growth
Economic growth is meant as an increase in the inflation-adjusted market value of goods and services over a specific period, and calculated by the percentage rate of increase in real GDP (Piętak, 2014). Economic growth is classified into two types: actual growth and potential growth. Actual growth is the annual increase in actual national output; and potential growth is meant as the annual percentage increase in the capacity of the economy at which economy can grow. In practice, potential growth is hard to calculate, thus actual growth is mainly used. A high interrelation exists among macro indicators. Economy growth impacts on unemployment; in other words, the unemployment rate reveals the health of economic growth. High unemployment leads to the lower economic growth in the light that consumers cannot purchase goods and service without income and the economy could not sustain itself in such condition. As stated by Sloman et al. (2014), the connection between unemployment and economic growth is really strong in the economic downturn period. Besides, exchange rates are greatly influenced by the changes of inflation. An increase in exchange rates results in a decrease in the rate of inflation. Assuming that export is increasing, the balance of payments is changes and national income rises.
Graph 3: What determines the Long Run Trend Rate of Growth? (Source: Economicshelp)
As seen from the graph 3, it is shown that there is an increase in LRAS and AD. The long-run growth is influenced by the growth of productive capacity. That is determined by the following elements:
Labour productivity (output per worker): impacted by education, training and skills.
Available natural resources: how easy to access such resources in the way of promote economic growth.
Labour force participant: volume of workers, and size of economic sectors. In Australia – a country of high development and industrialization, labor force participation is high due to low birth and death rates.
The flexibility of labour market, levels and quality of infrastructure and technology improvements.
By changing these variables, the growth of a economy could be changed. Physical capital, human capital and technological progress leave a direct impact on the economy, but somes variables have an indirect influence such as infrastructures created by the laws, government policies and institutions.
Australia’s economic growth has been fluctuated for 10-year period from 2008-2018. In the below graph, the real GDP growth rate in Australia from 2012 to 2017 dropped from 3.9% to 2.27%. Economists expect the GDP growth rate would be at 3%.
Graph 4: Australia real GDP growth rate (Source: Statista.com)
In Australia, the low interest rate of 1.5% is sustainable to achieve long-run economic growth. RBA believed that this low level of interest rate keeps supporting the economy in Australia with the objectives of unemployment reduction and gaining expected inflation return. With this monetary policy, RBA encourages businesses and households to invest their savings in risk assets with a higher return rate (Hutchens, 2018). In addition, business investment is a driving element to productivity growth, employment and wages growth in the long term. With the low interest rate, the Australian government hopes businesses to invest more. When the rate is at historically low levels, the economy will be in stable growth and keep the inflation in the expected rate.
The graph 5 showed that the unchange interest rate during last 3 years led to a decline in unemplyment from 6% to around 5.3%. It is expected to decline gradually towards 5%. According to the statement of RBA (2018), wages growth and tightening in labour market condition help households income growth increasing and encourage the consumption outlook.
Graph 5: Australia unemployment rate (Source: Tradingecnomics.com)
In the same time period, the inflation rate in Australia was ranged from 1%-2%.
Graph 6: Australia inflation rate (Source: Tradingecnomics.com)
The consumer price index in Australia in recent 5 years have an upward trend.
Graph 7: Australia CPI (Source: Tradingecnomics.com)
It is concluded that the unchanged low interest rate in three years gave a better economic performance to Australia with low inflation, steady economic growth in the long run.
Conclusion
The decision on interest rate is made to manage the rate of inflation and influential factors. The unchange interest rate of 1.5% will enable the Australia economy to grow and achieve the expected inflation. According to the case study, it is concluded that the macroeconomics is influenced by many various indicators within the business cycle. Aslo, to gain a sustainable economic growth, the central bank has its important role to monitor the financial conditions and policies. The low interest rates in Australia remains at 1.5% in the last three years. Thanks to such timely and proper policies, Australia has spent no economic downturn for the last 27 years. That is really impressive business performance in comparison to many developed nations.
References
Duygulu, A., Afşar, K., & Ozyigit, M. (2017). The New Function of Central Bank's as the Market Maker of Last Resort: An Evoluation on its Effects and its Results. Amme İdaresi Dergisi, 49(4), 85-115.
Hutchens, G. (2018). Interest rates: why the Reserve Bank of Australia has been cutting away. Retrieved from https://www.theguardian.com/australia-news/2016/aug/03/interest-rates-why-the-reserve-bank-of-australia-has-been-cutting-away
Layton, A., Robinson, T., & Tucker, I. (2011). Economics for today. South Melbourne, Vic.: Cengage Learning.
Mankiw, N. (2014). Principles of macroeconomics (7th ed.). South-Western College Pub.
Piętak, Ł. (2014). Review Of Theories And Models Of Economic Growth. Comparative Economic Research, 17(1), 45-60. doi: 10.2478/cer-2014-0003
Sloman, J., Norris, K., & Garrett, D. (2014). Principles of Economics (4th ed.). Pearson.