Causes And Effects Of Global Financial Crisis, RBA’s Monetary Policy, And Sino-Australian Relationship

US Housing Market and Global Financial Crisis

Questions:

1.What was the main cause of the Global Financial Crisis (GFC) and why it has spread Internationally? Do you believe that it could have been prevented?

2.One of the tools Australia and many other countries have used to fight the recession trends was to cut cash rates. The Reserve Bank of Australia has itself cut the cash rate from 6.75% in January 2008 to 2% in January 2016. Why do you believe central banks all over the world are using this tool to fight the recession in their Economies? Do you believe it has been efficient in Australia and globally?

3.The article has mentioned the slow down in the Chinese Economy and its Impact on Australia. Why do you believe Australia cares so much about what is happening in China?

1.The global financial crisis is believed to start in July, 2007 with credit crunch. The loss of confidence by the US investors led to the liquidity crisis. For this reason, US Federal Bank injected a huge amount of capital into the financial market. However, in 2008, the situation got much worse as the stock market crashed around the world. What follows in turn, has been discussed in the following section.

Sub-Prime Crisis:

According to the critics, the main reason for the global financial crisis is due to the fact that borrowers were not being able to repay the mortgage loan (Hass and Lelyveld 2014). Housing market in the US had suffered largely as most of the home owners who had taken their mortgage loan were unable to repay. As the large number of borrowers defaulted on loan, it was quite difficult for the bank to obtain those loans from them. As housing collapse, this situation acted as a trigger for global financial crisis. Moreover, another main reason for global financial crisis is because of three rating agencies Standard & Poor’s, Fitch, and Moody’s failed to organize subprime security as investment grade. This would further trigger the crisis as those famous rating agencies were paid to rate securities (Hass and Lelyveld 2014). Thirdly, due to the higher food and petrol prices in the summer of 2008, it led to the crisis of market led growth which in turn led to the global financial crisis. Therefore, in total, 2008 global financial crisis occurred due to the convergence of different forces along with social, economical and political (Vazquez and Federico 2015).

Spread of Financial Crisis and Decrease in Aggregate Demand

Financial crisis spread like epidemics. Several countries were affected due to the US financial crisis. Foreign banks bought collateralized debt. Many of these loans were rebundled and sold to the various financial institutions across the world (Vazquez and Federico 2015). Moreover, all the international banking systems are internally linked. If some bank started losing money, it has the impact in their international banking system. Therefore, it was difficult for firms and consumers to borrow from the banks. This reduction in lending led to the further decrease in aggregate demand (Claessens and Van Horen 2015). Therefore, those countries do not have any exposure to subprime lending also affected by this credit crunch. On the other hand, during this recession, global export fell. Countries experienced a drastic reduction in exports. This would spread to the global recession. Further, this financial crisis, negatively affected the consumer led to the lower financial growth (Hass and Lelyveld 2014).

The US Federal Reserve and then Bush administrator could have been prevented the global recession if they considered the early warning signs. In the late 2006, for the first time, the commerce department revealed that housing rate dropped by 28% in that year (Milner, Niven and LaMontagne 2015). However, the US government were unable to predict that the further slump of home sale in the coming few months as it did not happen since great depression. In fact, as per the Beige report, the Fed claimed that their economy is strong enough to combat with the price slump (Milner, Niven and LaMontagne 2015). In that year, for the second time Fed government ignored the warning (Claessens and Van Horen 2015). This time it was the inverted yield curve for US treasury notes. Inverted yield treasury notes refer when short-term treasury notes are higher than the long term treasury notes. Normally, the yield curve was inverted shaped before the past recessions of 2001, 1991 and 1981(Milner, Niven and LaMontagne 2015). Critics ignored this sign as interest rates were comparatively lower than in the prior recessions. They assumed that housing price would again increase as Fed cut down the interest rate. However, this was not the case.

2.The Reserve Bank of Australia had announced to cut down the interest rate by full percentage points in order to combat the global financial crisis. Their lending rate was lowered by full 100 basis points since 1992. Due to the cut in the cash rates, all the major Australian banks lowered their home loan rate by 80 basis points (Goh et al. 2015). The reasons behind the steep cut in the interest rate have been discussed in the following section. The continuous rise in the stock market due to the drastic cut in the interest rate helps to stimulate the Australian market. The S&P/ASX200 share index fluctuates around 3% before closing to 1.7% points (Goh et al. 2015). Wall Street and major European markets dipped overnight on growing concerns of a sudden breakdown in the global economy (Allen 2016). Australian dollar which has increased to around 10 US cents has been reduced to 2 US cents due to the cut in the cash rates (Lins, Servaes and Tamayo 2015). Another tool used by the RBA to cut the cash rate is by buying the treasury securities. As the price of bonds and securities increased, demand for this product also increased which pushes up the price. In fact, as per Lee McPheters, a research professor and director of W.P. Carey School of Business at Arizona State University, when the securities’ price increases, the fixed return as a percent will be lower (Justiniano, Primiceri and Tambalotti 2015). Although government uses several tools in order to control the interest rates, it does not control it. During the recession period, consumers tend to save more rather than spend the entire money.  As a result of this, demand for credit falls and that in turn leads the RBA government to cut the cash rates. Apart from that, RBA government cut the interest rate due to the fear of deflation. As per the Australian Bureau of Statistics, inflation increased about 1.7% per year (Justiniano, Primiceri and Tambalotti 2015). For this reason, RBA government concerned about the rising Australian dollar resulted of cutting the interest rate by full basis points (Bordo and Haubrich 2017).

RBA’s Monetary Policy and Interest Rates

As per the RBA’s policy of cutting down the interest rate to a record low helps to come out of global recessions; however, on the other hand, as per the Keri Phillips reports, Australian economy went towards a rough phase due to the cut in the cash rates. Australian Central Bank, RBA has been responsible for the charge of monetary policy since the financial deregulation in 1980’s. Through adjusting the interest rate they adjust the money moving into the economy. The main objective of the RBA’s cash rate cut is to stimulate economic growth (Bordo and Haubrich 2017). The reason is as the money is now cheaper to borrow; people will spend more money on consumption and investment. On the other hand, most economists estimate that 3% growth is needed to restrict the employment rate from rising. However, lowering down the interest rate to 2% results the expected rise in the unemployment rate (Goh et al. 2015). In fact, data shows that unemployment rate in Australia were at the highest level in the last 13 years (Lins, Servaes and Tamayo 2015). The figure also revealed that more than 28000 full time jobs were lost due to this, although this loss in the full time jobs was partially offset by the part time jobs. This cut in the interest rate also has an effect on the country’s currency. As currency rate decreases due to the cut in the cash rates, exports are more competitive. Therefore, in the global financial crisis scenario, other countries along with Australia tried to cut down the cash rate in order to expand their exports.

3.Sino-Australian relationship defines the relationship between Commonwealth of Australia and China (Greenglass et al. 2014). This relationship between the two nations has been growing continuously over the decades in terms of political, economic and social aspects. Australian economy has been able to survive the global financial crisis followed by huge supportive programs from China. Since the collapse of Lehman Brothers, Chinese economy has boomed and Australian economy had been hugely assisted from them. Australian business made huge profits from international trade deals with China in mining and agricultural sector. China also invests a huge amount in Australian economy and Australia exports more than 30% to China (Justiniano, Primiceri and Tambalotti 2015). Therefore, China’s economic slowdown definitely affected Australian economy in a number of ways. Due to the Chinese economic downturn, international trade between the two countries might reduce, in fact Australian economy may face an oversupply of goods which means that Chinese investors abandoned from the Australian asset. In fact, Australian tourism economy could take a huge hit if Chinese consumer decides to reduce its spending (Feenstra, Li and Yu 2014). Therefore, it is necessary for the Australian economy to diverse its economic relationship with China in the sense that they should reduce their huge of Chinese mining resources.

Impact of RBA’s Monetary Policy on Australian Economy

China being the biggest Australian trading partner, accounted for 34% of their export in agricultural and energy-related products and services (Borio 2014). In fact, over the last decades, Australian ranked as second in terms of Chinese direct investment. In fact, they receive $80bn in Chinese oversees direct investment (Borio 2014). 

Moreover, Chinese investment in Australian real estate sector has been increased over the last couple of years. As per the KPMG report, Chinese real estate investment has been increased to AU$ 6.85bn in 2015 (Philippon 2015).  Although this real estate investment was solely focused on one Australian state New South Wales including Sydney which accounted for the total of 94% (Drezner 2014). Renewable energy and healthcare both are the China’s next target market. In addition to this, Sino-Australia free-trade agreement has been signed on December, 2015. Based on the report, Australia’s duty free exports constituted for more than 86% (Feenstra, Li and Yu 2014). The same report estimated that it would increase to 94% in 2019 and further 96% in 2029 (Feenstra, Li and Yu 2014). Apart from that, Australian educational sector also have a huge impact on Chinese economy. As per the International Institute of education, more than 90,000 Chinese comes to Australia for the educational purpose (Borio 2014). Those students studying in Australia helps to stimulate the relationship cross-border business opportunities between the two nations.

Australian mineral and mining sector are the mostly impacted from Chinese economy. In fact, the value of energy and minerals export from in Australia which was only 57% in 2007 has been increased to around 80% in 2009 (Philippon 2015). Although Chinese manufacturing sectors fell drastically due to the global recessions its general energy and minerals needs from Australia increased rapidly more than its economy (Drezner 2014).

References:

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Baker, S.R., Bloom, N. and Davis, S.J., 2016. Measuring economic policy uncertainty. The Quarterly Journal of Economics, 131(4), pp.1593-1636.

Bordo, M.D. and Haubrich, J.G., 2017. Deep recessions, fast recoveries, and financial crises: Evidence from the American record. Economic Inquiry, 55(1), pp.527-541.

Borio, C., 2014. The financial cycle and macroeconomics: What have we learnt?. Journal of Banking & Finance, 45, pp.182-198.

Claessens, S. and Van Horen, N., 2015. The impact of the global financial crisis on banking globalization. IMF Economic Review, 63(4), pp.868-918.

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Milner, A.J., Niven, H. and LaMontagne, A.D., 2015. Occupational class differences in suicide: evidence of changes over time and during the global financial crisis in Australia. BMC psychiatry, 15(1), p.223.

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