Business Economics The Australian Economy

Question: Discuss about the Business Economics for The Australian Economy. Answer: Introduction The Australian economy remains sluggish significantly in the second quarter of the year 2016. In Q2, GDP grew 0.5% quarter-on-quarter, in Q1. This bad quarterly result was due to inferior private consumption and a pessimistic role from the external sector. Nonetheless, this result has marked 25 years of growth without a recession. Early data for Q3 implied a mild improvement over the previous quarter, with unemployment falling to a new low level of 5.6% and business confidence coming back to its long-term average in August. However, the continuing enhancement in consumer confidence simplifies slightly in September. Meanwhile, the government and the opposition in the newly-formed legislature have approved upon AUD 6.3 billion in savings in the federal budget (Focus Economics, 2016). Source: Reserve Bank of Australia (RBA) Graph 1: RBA Cash Rate (%) The graph above shows the monetary policy rates that were prevalent in the last 6 years. We see that since 2012, there has been a continuous reduction in the monetary policy rates. Policymakers have been more inclined towards monetary easing and pursued accommodative policy. The falling trend was prevalent until July 2013 after which the policy rate remained stable for almost a year and a half. Post which, the government further reduced the policy rate till Jul 2015 followed by a stable policy rate. It was only in the beginning of the year, policymakers felt the need to further cut the rate in order to support the recovery process of the economy. In September 2016 monetary policy meetings, the policymakers have decided to keep the policy rate constant at 1.5% after a continuous reduction since Jan 2016. This report deals with the discussion of the inflation and monetary policy since last 5 years (from 2012 till 2016Q2) which would aid in explaining and providing justification to the above policy cuts undertaken by monetary policymakers in detail. Inflation and Monetary Policy: 2012 Thanks to the great trade linkages between Australia and Asia, particularly China, the Australian economy has been growing way faster than other developed countries. Growth rate increased from 2.75% in 2011 second half to 4 % in 2012 first half on the account of greater private domestic demand and higher exports. There has been easing in the inflationary pressures falling in between target band of 2-3% mainly because of decline in the prices of the tradable goods on the account of appreciation of the exchange rate. Furthermore, Reserve bank of Australia reduced the policy rate by 150 bps since November 2011. RBA tried to remove mildly restrictive monetary policy as the inflation moderated at the end of 2011. However, as the global economic outlook deteriorated in 2012 along with anticipated weaker domestic demand with projected inflation in line with the target inflation, RBA decided to move towards a flexible and accommodative monetary policy. Interest rate for borrowers, an indicat or which tells us about the overall viewpoint of the economy, are slightly below their medium term averages. This step by the RBA was highly commended by the IMF staff. They believed that this step was broadly accurate, given fiscal adjustments, strong Australian Dollar and no inflationary pressures. Australian economy was weaker than anticipated in 2012. It was estimated that GDP growth would be slightly below 2.75% before it picks up in 2014 upto 3%. These revisions was done by taking into account a hike in the mining investment which was higher than expected but lower than the previous level (around8percentof GDP rather than around9percent).This change suggests the reassessment of spending strategy in terms of coal and iron ore sectors and a re-evaluation of the profile for expenditure on some large and complex LNG projects. Inferior interest rates, increasing rental yields and a development in circumstances in the conventional housing market are likely to maintain mounting dwelling investment. Business investment apart from the resource sector, which has been low, was probably expected to gradually recover over the next two years, though business surveys suggested subdued growth in the near term. It was expected that inflation may remain within the inflation target range over the next two years (IMF, 2012). Inflation and Monetary Policy: 2013 Favorable economic growth, resilience financial sector, low public debt and inflation closer to the target level are some of the significant characteristics of the Australian performance during 2013. Not only this, their performance was also aided by the strong policy frameworks. With inflation rates within the target, monetary policy has remained accommodative. Following expansionary monetary and fiscal policies, the economy has improved in last few quarters. In August 2013, RBA reduced the policy rate further by 25 basis points in order to sustain growth in the economy and at the same time, examine that the inflation outlook remain in line with the Banks inflation target. This led to reduction in the policy rate as low as 2.50 per cent, after a reduction of 225 basis points when compared with where it was two years before, along with all time lowest borrowing rates for decades. Post August monetary meeting in 2013, there has been sufficient indications that this cumulative easing in monetary policy has proved to be beneficial for the activities in the interest-sensitive sectors. Monetary policy takes a time lag, and so does the impact of the reductions in the policy rate on activities that are yet to further have to run. The incentive is evidently seen in case of the housing sector, where prices have speed up a little in recent months, borrowing is growing a little quicker and construction indicators moved up faster. Moreover, household savers were more inclined to move towards those assets which have higher returns and risk, and business and consumer confidence have moved up to a greater point above average levels. So although it is forecasted that the growth will remain slightly below trend for a while, there are high chances that private demand will strengthen beyond the resources sector in course of time. Inflation outlook seemed to remain consistent wi th the medium-term target. It was also believed that after August, it was a good idea to keep the policy rate constant at a given level however not closing the option for further reduction that might aid the economic activity to be in line with the inflation target provided, given the substantial degree of monetary policy stimulus that had already been put in place, it was appropriate to hold the cash rate steady, but not to close the substantial degree of monetary policy is given. The Board continues to evaluate the outlook and regulate policy as and when required in order to foster sustainable growth in demand and inflation outlook to be consistent with the inflation target over the course of time. Therefore, it is because of these reasons, we see in the graph 1 that the policy rates are kept constant at 2.5% for quite a long period of time till 2014(IMF, 2013). Inflation and Monetary Policy: 2014 Overall Australian economic activities remain in line with the Banks target of 7.5 % irrespective of the weak property sector adversely affecting the growth of industrial production. The growths in Australias major trading partners have been around its expected average. There has been substantial fall in the commodity prices along with iron ore and oil prices on the account of increase in the global supply including Australia. However, prices of the base metals have increased. Thus, Australias forecast of terms of trade has been very low. Financial markets remain volatile and its volatility has increased during that period. There has been reduction in the global bond yields. Its financial conditions have remained accommodative. There has been reduction in the lending rates for both business and household. There has been 5 % depreciation in the exchange rate although Australian Dollar remains high by historical standards. Exports start to expand continuously in 2014 as new capacity co me in line. Non mining business investment was reduced. Strong expansion in dwelling investment is most likely to happen due to greater approvals and other strength. CPI inflation declined in Sep. 2014 mainly due to the removal of carbon price on utility prices as well as reduction in the prices of the tradable goods. It was believed that this reduction was highly unexpected and would be volatile given that prices may pick up due to the depreciation in the exchange rate since 2013. Moreover, lower wage cost was also one of the major reasons behind low inflation. The policy rate remained unchanged at its then lowest level for almost over a year along with a slight reduction in the interest rates paid by borrowers over this period. This low level of interest rates have positive impact on the economy, causing a lift up in the expansion of non-mining activity through strong development in dwelling investment as well maintaining growth in household expenditure . Moreover, the conditions are supportive for a robust expansion in non-mining business investment. Regardless of the depreciation of the exchange rate, the Australian dollar remained well above the estimates, mainly given the additional fall in the significant commodity prices over the course of that year. Thus, the exchange rate posed less backing than it would generally be anticipated in order to achieve a balanced growth in the economy. Against this background, a very accommodative and easy monetary policy would be prevalent which would sustain total demand which would eventually help in sustaining growth in the mean while. In the meantime, inflation was anticipated to be line with the banks target of 23percent over the next two years. Given that opinion, the Board's verdict at its meetings has been that monetary policy is suitably designed to promote sustainable growth in demand and inflation outlook to be consistent and be within the target band. Hence, the most practical path probably was a period of stability in the interest rates (RBA, 2014). Inflation and Monetary Policy: 2015 A strong track record in terms of economic growth, per capita income and fiscal situation has been observed in case of Australian economy. GDP rose as fast as twice compared to their competitors. Per-capita income stood at USD 61,000 in 2014 (highest in the world) and last but not the least, net debt stands at 15% of GDP when for G20 economies, it stood around 80 percent of GDP. Ideally speaking, Australia hasnt witnessed any recession in the last 25 years. Moreover, prosperity in the global demand for resources (mainly strong growth in China) and migration (contributed a rapidly increasing population of 1.5% a year) have fostered economic growth of Australia. Furthermore, one cannot deny the credit that goes to sound policies and framework for the reason behind strong performance. A flexible exchange rate, a flexible labor market, reliable monetary policy and credible financial sector led to higher growth of the economy. However, the economy is witnessing a transition as the economy experiences a slump in the growth rate where it grew at 2.5 % in 2015Q1 on account of the weaker domestic demand, falling investment (both public and private),slower recovery in non-resource investment, fall in the commodity prices almost by one-fourth since 2014 (Iron ore prices have reduced more than one-third). Declining mining investment and sharp fall in the terms of trade are the major macroeconomic challenges along with slower potential economic growth. The country has experienced largest plunge in the last 150 years in terms of terms of trade which contributed to falling income, rise in unemployment (around 6%, which is way higher than US and UK). All these have contributed to low nominal wage rate and low inflation (IMF, 2015). On the back of low inflation and enervating outlook, Reserve bank of Australia further loosened its present accommodative monetary policy by reducing 50 bps since Feb. 2015 (RBA, 2015). This had led to rise in housing investment, capacity utilization and business prospects. Consumption growth continued to be moderate suggesting feebler income growth and a rebound in the falling household savings rate. However, low interest rate has increased the assets prices. Moreover, it has become difficult for fiscal consolidation and rising public debt from a lower level. Thus, these recent cuts are yet materialized through to the economy. On the back of weaker medium term prospects, inflation rate remains within the RBAs target of 2-3%. Hence, with positive and accommodating monetary policy along with productivity increasing reforms, it is expected that domestic demand as well as business investment might pick up. To re-energize the economy, there is a need for sustainable domestic demand, rise in the productivity. Monetary policy has been accommodative and could become more in the coming times. However, fiscal policy imparts a substantial negative whim. According to IMF report, monetary policy should further ease provided the recovery is less than the expectations given financial stability remain constant (IMF, 2015). Inflation and Monetary Policy: 2016 The Australian economy has been witnessing a structural adjustment because its prospects are threatened and challenged by three main reasons: 1) falling mining investment; 2) low commodity prices; and 3) slow down in the economic growth of China. During the domestic change procedure, the Australian economy is looking out for different sources of growth such as from non-resource investment, household expenditure, and last but not the least, the services sector. Not only this, it is tuning with the weaker terms of trade and expanding its trading partners. Against the demanding background, accommodative monetary policy will play a significant role in sustaining the domestic side of the economy. It is anticipated that nations real GDP growth will average around 2.6% y/y in 2016-17 (Scotia Bank, 2016). In the recent monetary policy meeting, RBA keeps its policy rate stable in September 2016 after reducing the policy rate further by 25bps to 1.50% in Aug. 2016( from 1.75% ) on the account of low inflation, sluggish income growth and easing concerns regarding Australias housing market. Constant policy rate is also due to positive growth provided by Chinese economy. Moreover, a resilient aversion to the stronger Australian dollar which would otherwise constrained the ongoing structural adjustments, causing an end to the boom in the resource investment. The inflation reduced to 1% y/y in 2016Q2 from 1.3% y/y in 2016Q1. It is expected that the inflationary pressures would remained subdued on the back of labour cost gains, reduced cost pressures globally. Mainly, their decision showcases concerns of the policymakers in regard with ambiguous global economic scenario, subdued inflationary pressures and challenges faced by the economy due to the Australias major transition. However, policym akers dont seem to worry regarding preserving monetary policy space for any unanticipated shocks to the economy externally. Moreover, initially policymakers were afraid that low interest rate might have led to the unfavorable impact on the housing market. Now, they have strengthened supervisory and lending measures which have led to the more cautious attitude among the lenders. Such developments along with moderation in the real estate pressures have made RBA to conclude that low interest rate will not lead to the rise in the housing market prices. This has further set the path of the monetary easing. The immediate reaction was seen in the currency rate when the Australian dollar depreciated against USD (AUD dropped roughly below 0.75 USD) when the policymakers announced the cut and after which it slightly recovered. This monetary easing did not impact Australian equity market as the index went down by 0.8% on that day where losses were noted for almost many sectors. In regard to inflationary pressures, consumer prices increased to 0.4% q/q in 2016Q2 on the back of significant increase in health, clothing and footwear, transport and alcohol and tobacco prices. Consumer prices reduced to a 17years low level of 1 %, falling from 1.3% in 2016Q1. Moreover, it remains well below the Australias inflation target of 2-3%. In 2016Q1, inflation reduced from 1.7% 2015Q4 to 1.3 % on the account of falling prices of fuel, fruits and international holiday travel as well as accommodation. These reductions were partially offset by the increase in prices of the secondary education, pharmaceutical products and medical services (IMF, 2016; Focus Economics, 2016; RBA, 2016). Conclusion This essay discusses in details about the monetary policy actions undertaken by the Board in terms of interest rate cuts. Weak Commodity price, subdued economic growth in China, low oil prices, weak private demand were some of the factors behind the rate cuts undertaken in the past few years. It further points out that the Bank may further opt for reduction in case the situation demands so, given that the impact on housing market due to reduction in the interest rate has little or no impact. References Focus Economics. [online] Available at: https://www.focus-economics.com/countries/australia/news/monetary-policy/rba-leaves-rates-unchanged [Accessed 16 Oct. 2016]. Anon, (2012). IMF. [online] Available at: https://www.imf.org/external/pubs/ft/scr/2012/cr12305.pdf [Accessed 16 Oct. 2016]. Anon, (2014). IMF. [online] Available at: https://www.imf.org/external/pubs/ft/scr/2014/cr1451.pdf [Accessed 16 Oct. 2016]. IMF, (2013). Australia-2013 Article IV Consultation Preliminary Concluding Statement. [online] Imf.org. Available at: https://www.imf.org/external/np/ms/2013/112013.htm [Accessed 16 Oct. 2016]. Anon, (2016). Reserve Bank of Australia. [online] Available at: https://www.rba.gov.au/monetary-policy/ [Accessed 16 Oct. 2016].