Questions:
Question 1
Using current economic data and analysing a number of leading, lagging and coincident indicators, determine Australia’s position on the business cycle. Justify you answer, including any relevant diagrams.
Question 2
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.
Question 3
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. The business cycle is the upward or downward movement of the gross domestic product (GDP) and it also refers to the contraction or the expansion period of a nation in terms of the fluctuation in the economic activities (Economy.com, 2015). So the business cycle is defined in terms of the period of recession or expansion and it represents the long-term-growth trend. There are various indicators of the business cycle and these can be discussed here for Australia.
GDP growth of Australia:
In the following diagram, the GDP growth trend of Australia can be shown along with the inflation rates. The GDP growth is the most common measure of the economic growth of an economy. GDP is the final value of all the goods and services of an economy. In the following diagram the GDP growth rate of Australia is shown from 1992-2014. It is seen that around 2008-09 there is significant fall in the GDP growth rate and after that the growth rate has increased. In 2013, the annual GDP growth rate of Australia was 1.8%.
Source: (Rba.gov.au, 2015)
Inflation:
In the following diagram the measure of inflation in Australia is given in terms of the Consumer Price Index (CPI). It is known that inflation is the increase in the general price level and thus the inflation rate must be controlled in the economy. In the fourth quarter of 2014, the inflation rate was recorded at 1.70%. Thus it is under control in the economy (Tradingeconomics.com, 2015).
Source: (Rba.gov.au, 2015)
Unemployment:
Unemployment in the economy can be considered as one of the economic indicators of the performance of an economy. Unemployment exists in an economy when people are without work while they are looking for work. It is very important to lower the unemployment rate in the economy. In 2014, the unemployment rate in Australia is 6.1%. In the following diagram the trend line for the employment rate and participation rate is shown along with the unemployment rate.
Source: (Rba.gov.au, 2015)
Balance of Payments:
The balance of payment position of a country also represents the present condition of an economy. It is known that trade is one of the driving forces of an economy and thus it is very important that the current account deficit is maintained for the economy. In the following diagram the current account balance and the trade balance is shown for Australia.
Source: (Rba.gov.au, 2015)
In the following diagram, the global business cycle map is shown. In the diagram it is seen that the Australia is in the phase of expansion.
Source: (Economy.com, 2015)
2. (a) In order to moderate the business cycle, it is very important to implement effective monetary policy by the government. The quantity of money can be controlled in the circulation with the help of the monetary policy and thus it can be used to stabilise the business cycle by changing the inflation and unemployment in the economy. Here it can be analysed what type of monetary policy can be more effective for the moderating the business cycle (Krugman and Wells, 2013).
The expansionary monetary policy or the easy money policy is characterised as the increase in the supply of money and decreased interest rate in the economy. The expansionary monetary policy is usually applied in case of recession.
On the other hand, the contractionary or the tight money policy is characterised as the decrease in the supply of money and the increase in the interest rate. This kind of policy s implemented for controlling inflation.
Here it can be said that, according to the position of Australia in the world economy, it needs to implement tight money policy rather than easy money policy for moderating the business cycle.
(b) The reserve bank of Australia implements various monetary policies in the economy. In Australia, moderate growth rate is seen and there is also a decline in the investment spending that is seen in the economy. The private demand is expanded and it is expected that the growth may be below the trend. The inflation is between 2-3% and it is expected that the growth in the wage rate will be moderate. The monetary policy that is implemented is accommodative in Australia (Krugman and Wells, 2013). The interest rate has been very low and the investors are expecting higher returns for their investment. Recently there has been trade of exchange rate at a lower level. The RBA has set the target cash rate at 2.5%. Thus it can be said that the RBA has provided the support for the growth of the economy and the increase in the demand. The RBA takes various factors into consideration before making any decision. These factors are the present inflation, exchange rate, and growth rate, capital account that can be taken into account for implementing tight or easy monetary policy (Mankiw, 2013).
(c) In the following diagram the AD-AS model can be shown. In the X axis, national output is measured and in the Y axis, price level is measured (Mankiw, 2013). Here it can be said that the changes in the interest rate can change in the aggregate demand curve. It is known that an increase in the interest rate leads to a leftward shift of the aggregate demand curve and the fall in the interest rate causes rightward shift in the aggregate demand curve.
In the diagram it can be seen that when the aggregate demand curve shifts to the left, it lowers the inflation rate as well as reduces the national output in the economy. On the other hand, when the interest rate increases and the aggregate demand curve shifts to the right, the inflation rate increases as well as the national output (Rba.gov.au, 2015).
3. (a) There can be various factors that can affect the value of the Australian dollar. These factors can include the inflation rates, confidence of the business units and the consumers, growth rate of the economy, performance of the stock market, and housing market (Thebull.com.au, 2015). Here it can be said that when there is positive impact on the economy then there can be changes in the exchange rate market as well. In the following diagram it can be seen that how the exchange rate market is affected and as a result the changes in the exchange rate (Mankiw, 2013).
In the above diagram, it can be seen that when the demand for Australian dollar increases in the market, the demand curve moves up and as a result the exchange rate appreciates and the equilibrium quantity of the Australian dollar also increases. On the other hand, when the demand for the currency falls, the demand curve moves downward and there is depreciation in the exchange rate and a fall in the equilibrium quantity. In the following diagram the shift in the supply curve is shown (Rba.gov.au, 2015).
In the diagram, it can be seen that as a result of the increase in supply (S1), the exchange rate depreciates and the equilibrium quantity increases and as a result of the fall in the supply (S2), the exchange rate appreciates and equilibrium quantity reduces.
(b) When the Australian dollar falls below the Equilibrium exchange rate (E*), then there is depreciation in the exchange rate of the Australian dollar. If there is depreciation in the Australian dollar then the foreign importers gain from such situation and the country itself loses. That means the countries that imports goods from the country will now have to pay less for the goods and services and thus they will benefit but the other country will lose.
(c) A depreciation in the Australian dollar means that the value of the Australian dollar will fall against other currencies. It will lead to several impacts on the Australian economy. Depreciation in the Australian dollars will lead to cost-push inflation in the economy as the imported goods and services will be more expensive. The export industry will flourish as the export will be cheaper from Australia. The import demand will fall in the economy. The wage rate may rise in the economy due to higher inflation. As a result of the depreciation, the economic growth can also increase if it is accompanied by lower interest rate as the export will increase and the imports will fall. Thus it can lead to benefit of the Australian economy if associated with effective policies.
References
Economy.com, (2015). Global Business Cycle Map | Moody’s Analytics Dismal Scientist. [online] Available at: https://www.economy.com/dismal/tools/global-business-cycle-map [Accessed 31 Jan. 2015].
Krugman, P. and Wells, R. (2013). Macroeconomics. New York, NY: Worth Publishers.
Mankiw, N. (2013). Macroeconomics. New York, NY: Worth.
Rba.gov.au, (2015). RBA: Chart Pack-Australian GDP Growth and Inflation. [online] Available at: https://www.rba.gov.au/chart-pack/au-gdp-growth.html [Accessed 31 Jan. 2015].
Rba.gov.au, (2015). RBA: Interest Rate Decisions – 2014. [online] Available at: https://www.rba.gov.au/monetary-policy/int-rate-decisions/index.html [Accessed 31 Jan. 2015].
Rba.gov.au, (2015). RBA: Media Releases-2014. [online] Available at: https://www.rba.gov.au/media-releases/2014/index.html [Accessed 31 Jan. 2015].
Rba.gov.au, (2015). RBA: Media Release-Statement by Glenn Stevens, Governor: Monetary Policy Decision. [online] Available at: https://www.rba.gov.au/media-releases/2014/mr-14-21.html [Accessed 31 Jan. 2015].
Thebull.com.au, (2015). Which factor do you think affects the Aussie dollar the most? – www.thebull.com.au. [online] Available at: https://www.thebull.com.au/experts/a/27950-which-factor-do-you-think-affects-the-aussie-dollar-the-most.html [Accessed 2 Feb. 2015].
Tradingeconomics.com, (2015). Australia Inflation Rate | 1951-2015 | Data | Chart | Calendar | Forecast. [online] Available at: https://www.tradingeconomics.com/australia/inflation-cpi [Accessed 31 Jan. 2015].
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