Evaluation Of Macroeconomic Performance Of Australia: Real GDP, Inflation, Unemployment, Cash Rate, Exchange Rate And Net Export 1990-2015

Findings

Australian economy is considered as one of the strongest economies in global platform. This is a mixed economy having both a strong private and government sector. Economic prosperity of the nation is relied on the stable growth, continuous improvement in the status of employment, a stable price level and trade activities. In addition to a strong primary and industrial sector, the nation has a prosperous service sector. The service sector now contributes to more than two third of the nation GDP. Service sector with its contribution in GDP generates employment for a significant portion of labor force. In the secondary sector, important industries include mining, telecommunication and aviation industry.  Apart from the domestic sector, Australia has developed external sector and participate in unilateral, bilateral and multilateral trade. Australia has free trade agreement with different countries like New Zealand, US, Thailand, Chile, Japan, China and other European and Asian countries.

The economic prosperity and stability of Australia attracts attention of the researchers. The economic performance is evaluated by analyzing trend in real GDO growth, inflation, unemployment, cash rate, exchange rate and net export. Attention is also given on fiscal and monetary policy framework and outlook of the economy in future

The dynamics of economic performance depends on several aspects. Among them the one primary component if Gross Domestic Product. It is an aggregate measure of all the produced goods and services in the nation. Economic growth of a nation is defined as a continuous growth in the measured output level, which in turn is reflected in growth of GDP. GDP being an aggregate measure depends on different factor. The interest rate in the economy determines the level of investment (Hubbard and O’brien, 2015). In Australia, cash rate is the tool used by monetary authority to influence GDP. State of price level and employment are two other inter related variables and are related with economic output. Exchange rate determines the volume of trade and net export. Exchange rate and net exports both are important determinants of economic growth.

GDP is an accounting measure obtained by multiplying quantity of output produced with respective market price. Now when market price of current year is used then it is called nominal GDP. However, the problem with nominal GDP is that it does not take into consideration the effect of inflation. As a result, GDP is either overvalued or undervalued. In order to avoid this, market price of a fixed base year is used. This is known as real GDP. The historical data on Australia’s real GDP growth rate reveals an average growth rate 3.1 percent. The year 1991 seems to be the most prosperous year with growth being 5.01%. The economic recession in 1991 pulled down growth rate to a negative rate of -.38%. After drastic fall in the growth rate in 1991, it gradually revived with monetary policy easing and stabilized around 2 to 4 percent over the entire time range (Arndt, 2014). Having considered the general trend in GDP now focus is given on other indicators and their relation with real GDP.

Relation between Real GDP growth and economic indicators

The statistical relation between the variables are obtained from correlation coefficient.  The correlation matrix is  given below.

Correlation between GDP and five indicators
	Real GDP growth rate	Interest rate (Cash rate)	Unemployment rate	Inflation rate	Exchange rate (AUD/US)	Net export
Real GDP growth rate	1
Interest rate (Cash rate)	-0.08	1
Unemployment rate	-0.13	0.28	1
Inflation rate	-0.03	0.64	-0.23	1
Exchange rate (AUD/US)	0.20	0.04	0.26	0.08	1
Net export	0.23	0.26	0.55	-0.02	0.85	1

Figure 1: Trend in GDP growth and interest rate

(Data Source: data.worldbank.org, 2018)

The estimated correlation co-efficient between GDP growth rate and cash rate is -0.08. The correlation implies an inverse relation between growth and cash rate. The bank rate that central bank of Australia charges on loans commercial banks is known as the cash rate. This is an important monetary policy instrument of RBA (theconversation.com, 2018). In times of monetary easing, RBA reduces the cash rate. A reduced cash rate means banks now have to pay a small amount of repayment to the central bank and hence can charge a low interest rate on loan given. This enhances economic investment by reducing the interest rate or borrowing cost. The increased investment lead to economic expansion and enhances growth (Bernanke, Antonovics and Frank, 2015). RBA takes tight monetary policy to reduce inflation rate. For this RBA raises the cash rate and the economy contracts. This explains the inverse relation between GDP and cash rate.

At the beginning of the decade 1990, cash rate was nearly 16%. The excessively tight monetary policy push the economy towards an economy wide recession in 1991. The high cash rate was associated with a negative growth rate. Following recession RBA understands the need for monetary expansion and reduces the cash rate. In response to the expansionary monetary policy, real GDP has started increasing. Growth rate again fall during Asian crisis of 1997 (Cross and Poon, 2016). However, the impact was moderate then. In 2009, following global financial crisis growth fell to a very low level (1.81%).

Figure 2: GDP growth and unemployment rate

(Data Source: data.worldbank.org, 2018)

The state of employment depends on the output level of the economy. As output increases, existing production units expands or new units are created. This opens new job opportunities and reduce unemployment (Acemoglu, Laibson and List, 2017). The correlation coefficient between GDP and unemployment rate is obtained as -0.13. This means the standard relation between output and employment holds in Australia. From the above trend, it is seen that as economic growth recovered from 1992 onwards the unemployment rate starts falling.

The average unemployment rate in Australia is 6.77 percent. Since 1992, unemployment has gradually declined with economic expansion. In the last two-three years unemployment in the economy rose slightly. Despite creation of new job opportunities, there remains unemployment because of structural mismatch (Nguyen Van,  2016). As against a decline in full time employment, the part time employment increases. The participation among the labor force has increased significantly.

Real GDP and cash rate

Figure 3: GDP growth and inflation rate

(Data Source: data.worldbank.org, 2018)

The data collected on Australian economy has shown an inverse relation between GDP and inflation. The correlation between the two variables are obtained as -0.03. Generally, a rising price level is good for the economy (Dodge, 2016). A modest increase in the price level encourages producers to produce more and brings economic growth. However, if rising price increases household and public debt then it restricts economic growth. This is preciously what happens to Australia.

Inflation targeting is a part of RBA’s monetary policy. The Reserve Bank sets a targeted rate for price level along with full employment to ensure security and prosperity of people. The target is to maintain average CPI inflation of 2-3% (aph.gov.au, 2018). The inflation rate in the economy fluctuates around the targeted rate. The cost of housing, alcoholic beverages, tobacco and transport has increased. On the other hand, prices for food, non-alcoholic beverages, communications and household equipment have declined (tradingeconomics.com, 2018). There is an overall balance state in the price level.

Figure 4: GDP growth and exchange rate

(Data Source: data.worldbank.org, 2018)

Exchange rate shows the relative price between two country’s currencies. The price of Australian dollar relative to US dollar is taken into consideration. An increase in exchange rate means depreciation of Australian dollar (Currie, Nobay and Peel, 2015). This means now more AUD is needed to purchase one unit of US dollar. This reduces import and encourages export. As a result, trade balance increases and stimulate GDP growth. Hence, there is positive relation between exchange rate and GDP growth rate. The estimated correlation is 0.20.

The average exchange rate is 1.35. The exchange rate remains more or less stable for the chosen period. Australian dollar appreciated most in 2011-12 with rate being 0.97. In 2001, Australian dollar depreciated to 1.93.

Figure 5: Real GDP and net export

(Data Source: rba.gov.au, 2018)

Net export shows balance of trade that is export less import. A surplus in trade balance means a positive influence on growth while a trade deficit hampers economic growth. Therefore, a positive relation exists between net export and real GDP.

The real GDP has constituted an increasing trend. Australia has maintained positive trade balance from 1990 to 2007. From 2008 onwards, the country experiences a trade deficit. The trade deficit has resulted from an increase in volume of imports. The import of capital goods such as equipment used in telecommunication, intermediate goods and service imports have increased (Jiang et al., 2015). Sales of exported goods and services though have increased but not as much as import. This leads to a continuous deficit in the trade balance.

Real GDP and unemployment rate

Inflation and unemployment are the two important and inter related macroeconomic variables. There is a general and inverse relation exist between these two variables. Inflation is the continuous increase in the general price level. An increase in the price level encourage suppliers to produce more. An expansion of production increases factor demand (Argy and Nevile, 2016). When firms demand more labors then unemployment in the economy reduces. The proposition of inverse relationship between inflation and unemployment is made by A.W. Phillips and is known as Phillips curve.

Figure 6: Phillips curve relation

(Source: Bernanke, Antonovics and Frank, 2015)

The above figure explains the Phillips curve relation. Suppose initially the economy is at point A. The corresponding inflation rate is 2% and unemployment rate is 6%. As the economy moves from point A to point B, there is a decline in unemployment rate to 3% and increases in inflation rate to 5%.

Correlation between inflation and unemployment
	Unemployment rate	Inflation rate
Unemployment rate	1
Inflation rate	-0.23	1

The historical data collected on inflation and unemployment supports the Phillips curve relation. The correlation between the inflation and unemployment stands out as -0.23. This means as inflation rises unemployment declines and vice-versa.

Figure 7: inflation and unemployment trend

(Data Source: rba.gov.au, 2018)

At the beginning of 1990s, there is a clear negative relation between unemployment and inflation. In the recession year of 1991, there is a steep fall in the price level. As a result, unemployment in the economy rose above 10 percent. Then gradually price level improved and there is a decline in the unemployment rate. Unemployment has sharply reduced to a level of 4 percent from its earlier high level of 10.9%. However, a second wave of recession had come in 2008 (Berger-Thomson and Chapman,  2017). This time neither inflation nor the price level affected much. The price level continued to decline and finally settled at around 2%. This is due to the inflation targeting policy of RBA. Despite, low price level unemployment in Australia remained at a stable rate of 5-6%.

Australian government uses both fiscal and monetary policy tool to stabilize the economy. A tighter policy is undertaken to reduce inflation in the economy. During tight monetary policy, RBA raises the cash rates. When banks faced a high interest rate on borrowing from reserve bank then interest rate to general investors increases (Iyengar, 2014). Following this investment declines and aggregate demand reduces. This relaxes the pressure on price level. In 1980, Reserve Bank had tightened the monetary policy. The cash rate charged on loans had settled to a very high level. In the beginning of the decade 1990, cash rate remained to the high level. The cash rate during 1991 and 1992 were 15.23% and 10.64% respectively. However, the restrictive monetary policy during this time resulted in a severe recession. The government had no other option but to pull back the tight monetary policy and relied again on easing monetary policy. After achieving a stable state, in the middle of 2000s RBA slightly tightened monetary policy and raised cash rate to restrict the money supply (Mishkin, 2017). However, this policy did not last for a long period. In the phase of global financial crisis in 2008, RBA again resorted to a monetary expansion and set the cash rate to a historically low level.

Future prospects of the economy is based on accumulating present and past experiences of the economy. The average growth rate is happened to be 3.11% for the chosen period. Based on this, the future growth rate is predicted to be between 2 to 3 percent and between 3 to 4 percent thereafter (oecd.org, 2017). The monetary policy in Australia has remained unchanged with cash rate is at a flat level of 1.5 percent. The low and stable interest rate boost up household demand. Despite a slow expected wage growth, the aggregate demand will remain stable. The slow wage growth will likely to hamper domestic saving. Therefore, to encourage investment interest rate needs to be at a relatively low rate (Hatfield-Dodds et al., 2015). Investment is expected to rise in non-mining sector and construction. Australia with its strong domestic and external sector has minimized risk of future recession.

Conclusion 

The evaluation of economic performance of Australia has revealed a resilient nature of Australian economy. Despite turmoil in domestic and global economy, Australia has managed to maintain a stable growth rate. Overtime the nation has developed a strong and diversified industrial and service sector to support economic growth. The diversified sectors provide job opportunities to a number of unemployed persons and help to reduce unemployment rate. The monetary policy of RBA aims at maintaining a stable price level. To achieve this goal along with a targeted employment level RBA has reduced the cash rate to a significantly low level and keep its monetary policy unchanged for the last few years. As regards to the movement in exchange rate, there is a less volatile trend in exchange rate. Australia shares unilateral, bilateral and multilateral trade relation with different nations. However, in the last few years the economy has faced a trade deficit due to the growth in import as compared to exports. During 1980s, Australian government had taken a tight monetary policy which caused a severe recession in 1991. Later, Australia has overcome all the recessionary shocks and is expected to be even more prosperous in future.

References 

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