Questions:
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 fluctuation in the economic activities within a period of time of a nation is referred to as the business cycle. It also refers to the upward and downward movement of the gross domestic product (GDP) of the country. (Analytics, 2015) Various indicators of the business cycle exist and are discussed below with respect to Australia:
The trend in GDP growth and the inflation rates of Australia is shown by the following diagram. The commonly used measurement of the economic growth of an economy is the GDP growth. GDP is defined as the value of all finished goods and services within an economy. According to the following diagram, the GDP growth of Australia for the year 1992 to 2014 is shown. It can be detected that around the year 2008-2009, Australia’s GDP growth declines and thereby the growth rate increased. The annual GDP growth rate in Australia for the year 2013 was 1.8%.
Source: (Rba.gov.au, 2015)
In the diagram below, the measurement of inflation is shown in terms of consumer price index (CPI) of Australia. Since inflation is defined as the overall increase in the general price index it is necessary to keep a check on inflation rate. In the fourth quarter of 2014, 1.70%of inflation rate was recorded. This shows that the inflation rate is under control in Australia. (https://www.tradingeconomics.com, 2015)
Source: (Rba.gov.au, 2015)
One of the economic indicators that affect the performance of the economy is unemployment. It is necessary to lower the unemployment rate in the economy. It was recorded in 2014 that the unemployment rate in Australia was 6.1%. The following diagrams give us a view of the employment as well as the unemployment rate and the participation rate of the Australian Economy.
Sources: (Rba.gov.au, 2015)
International trade has a significant role in maintaining the economic balance. BOP represents that the current condition of a country. It is necessary to achieve balance of payments in the economy. The current account balance and the trade balance of Australia are shown in the following diagram.
Source: (Rba.gov.au, 2015)
Considering the diagram shown below which shows the global business cycle map, we can see that Australia is in an expansionary phase.
Source: (Analytics, 2015)
2. a) Monetary policy plays an important role in maintaining the quantity of money circulating in the economy. This can be used to benefit the business cycle by altering the inflation and unemployment scenario in the economy. To moderate the business cycle, it is the role of the effectiveness of the monetary policy taken by the government. We can analyze the type of monetary policy that can be taken to moderate the business cycle. (Krugman and Wells, 2014)
An expansionary monetary policy, also known as easy money policy, is defined by increasing the money supply and decrease in the rate of interest in the economy. During recession, the expansionary monetary policy is implemented. The contractionary monetary policy, also known as the tight money policy is defined as the decrease in money supply and increase in the rate of interest in the economy. During inflation, contractionary monetary policy is implemented.
Considering the position of Australia in the world economy, a tight money policy or the contractionary monetary policy is required to be implemented for moderating the business cycle.
b) The current position of Australian economy can be characterized by moderate growth rate and decline in the investment spending. The expansion of the private demand can be expected to lower the growth below the trend. The inflation rate ranges between 2-3% and it is expected that there will be moderate growth in the wage rate. Now the Reserve Bank Of Australia (RBA), implements several monetary policies in the economy. In Australia, the monetary policy taken is accommodating in nature. (Krugman and Wells, 2014) The target cash rate set by the RBA was at 2.5%. Thus, RBA has extended a hand of support to promote growth of the economy and increase the demand. The decision of the RBA depends on several factors. These factors include inflation, exchange rate, growth rate and capital account which RBA takes into account for implementation of a tight or easy money policy. (Mankiw, 2013) (Rba.gov.au, 2015)
c) The following diagram shows the AD-AS model. The national output is measured in the X-axis and the price level is measured in the Y-axis. (Mankiw, 2013) It is known that changes in the aggregate demand is due to the changes in the rate of interest. An increase in the interest rate leads to a leftward shift of the AD curve and a fall leads to a rightward shift in the AD curve.
From the diagram it can be deciphered that as AD curve shifts to the left, the inflation as well as the national output decreases in the economy. On the contrary, a shift of the AD curve to the right causes the inflation rate as well as the national output to increase.
3. a) The factors that influence the Australian dollar value are inflation rates, confidence of the consumers, growth rate of the economy, performance of the stock market and the jousting market etc. the following diagram shows the changes that occur in the exchange rate market. (Mankiw, 2013) (Thebull.com.au, 2015)
It can be seen from the diagram, on increase in the demand for Australian dollar, the demand curve shifts upward and this causes exchange rate appreciation and there is an increase equilibrium quantity of Australian dollar. And when the demand decreases, the demand curve shifts downward which causes depreciation in the exchange rate and the fall in the equilibrium quantity.
The next diagram shows the changes in the supply of the exchange rate quantity.
From the diagram, it can be seen that an increase in supply S1 causes exchange rate depreciation and increase in the equilibrium quantity. A fall in the supply causes exchange rate appreciation and fall in the equilibrium quantity.
b) When there is depreciation, an increase in exchange rate above the equilibrium level (E*), then the value of the currency of country falls. This benefits the home country as export yields more while its import becomes expensive. Thus countries who import from the home country will lose and countries exporting to the home country will be benefitted.
c) If there is depreciation in the Australian economy then the exchange rate increases and the value of the Australian currency falls. This means that when Australia exports to other countries, it receives more money as exchange rate has increased. This also results in more exports. On the other hand, Australian imports become expensive as now Australia has to pay more for the same commodity bundle they purchased before the exchange rate depreciation. This will lead to a fall in import. Now as exchange rate increases, depreciation occurs, Australia export increases and import falls. This results in a trade balance surplus which is beneficial for Australia.
References
Analytics, M. (2015). Global Business Cycle Map | Moody’s Analytics Dismal Scientist. [online] Economy.com. Available at: https://www.economy.com/dismal/tools/global-business-cycle-map [Accessed 12 Feb. 2015].
https://www.tradingeconomics.com, (2015). Australian Inflation rate. [online] Available at: : https://www.tradingeconomics.com/australia/inflation-cpi [Accessed 12 Feb. 2015].
Krugman, P. and Wells, R. (2014). Macroeconomics in modules. 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 12 Feb. 2015].
Rba.gov.au, (2015). RBA: Interest Rate Decisions – 2015. [online] Available at: https://www.rba.gov.au/monetary-policy/int-rate-decisions/index.html [Accessed 12 Feb. 2015].
Rba.gov.au, (2015). RBA: Media Releases-2014. [online] Available at: https://www.rba.gov.au/media-releases/2014/index.html [Accessed 12 Feb. 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 12 Feb. 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 12 Feb. 2015].
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