Australian Economy Development - Essay Example

Before considering the last two years of the Australian economy, it is of essence to consider the background of the economy. This is in terms of how the economy was in year 2009 and the most likely monetary of fiscal policies that would have been applied to solve the situation. In year 2009, a leading forecaster anticipated that the economy of Australia would dip with regards to performance. One of the reasons why this forecaster expected such is because there was very slow growth in a closely related economy of China. According to Access Economists, an Australian research company, the prospects for the mining-oriented economy were that the performance of the economy would really become dismal. The prediction was that the central bank of Australia would be forced to bring into play an expansionary monetary policy that would have rates of interest lowered to 2.5% from 4.25% so as to trigger growth. (Foley, 2009) Just before looking at this policy, it is of essence to explain vividly what a monetary policy entails. The situation in the world since year 2008 has been very serious and many economies including North America and Europe experienced a major economic downturn. Generally, the whole world was experiencing one of the most serious economic recessions. Australia as an economy has been said by most economic analysts to have defied this downturn. However, it has been affected as well by this situation, to mention the least. Governments, through their central banks, use both monetary policies and fiscal policies to control the stability and growth of the aggregate economy. This study is about both of these economic policies and more particularly in the context of the Australian economy. The study will first tackle each of these policies in general to create an understanding of the same before narrowing down to the Australian situation. Monetary policy will be the first to handle before going on to the fiscal policy. Monetary policies are usually about two major categories. These are expansionary and contractionary monetary policies. An expansionary policy is generally an open-market buying while a contractinary policy is about an open-market sale. An expansionary policy involves lowering of rates of interest while a contractionary policy escalates interest rates. Increased interest rates (contractionary policy) mean that borrowing from banks will be more expensive and thus, there will be minimal borrowing, which reduces currency supply in a given economy. A reduction in interest rates (expansionary policy) means that borrowing from banks will be easier due to the low rates of interest. Thus, this increases currency supply in the economy. Graphs can be utilised to illustrate what has been explained earlier concerning monetary policies. This is as shown below; Figure 1: Monetary policies illustrated in graphs Interest rates S0 S1 Interest rates S1 S0 D D Bank Reserves Bank Reserves Expansionary policy Contractionary policy As shown by the arrows, an expansionary policy involves a lowering of the rates of interest and thus, a rise in the supply of currency while a contractionary policy does exactly the opposite. S0 shows the original currency supply while S1 is the new supply. D is the demand curve for currency. (Baumol and Blinder, 2010 pp270, 271) Despite the criticism by the International Monetary Fund, that Australia was using a bad approach (in year 2010) to the inflation levels by using a monetary policy that was based in inflation targeting, the Reserve Bank of Australia continued using this approach. At this point in time, the bank was applying a contarctionary policy. The Reserve Bank usually targets a range of inflation of around 2-3% while making these decisions of the monetary policy. It was to utilize the rates of interest so as to slower the overheating of the Australian economy. In 2010, the inflation target ranged between 1-2%. In order to control the condition of the recession effects, the Reserve Bank was applying a contractionary monetary policy where it was constantly raising the rates of interest. But according to the RBA, most of the negative effects on the Australian economy were due to the general international economic downturn as opposed to internal factors. Thus, as per the report analysed and that was dated 16th February 2010, RBA was applying a contractionary fiscal policy to counter the negative effects of the global recession. (Somerville, 2010) According to an article dated 6th July of 2010 by currencythoughts.com website, the monetary policy of Australia remained unvaried. The Reserve Bank maintained the OCR (Official Cash Rate) at 4.5% and this was the second month the rate remained so. Previously, according to the report, RBA maintained a continuous raise of the rates. That is from October 2009 through May 2010. According to the bank, future rates would be determined by the world growth trends as well as inflation. The time the subsequent adjustment would be made was not precise as per the Governor (Stevens) of the bank’s sentiments. The reason for not varying the monetary policy factors as per the article were due to the fact that the Australian economic growth was constant, the terms of trade were favourable, and the rates of exchange were stable at around AUD/USD $0.9382 to the higher and $0.8068 to the lower. (currencythoughts.com, 2010) Towards the start of March 2011, RBA still maintained the OCR at 4.75% that market its continuous pause on its monetary policy. Australia, according to the article date 1st March 2011, remained unaffected by the big recession that had hit the world since 2008. But, this according to the essay was due to the good job done by the government through the fiscal and monetary stimulus. The reason for not varying the monetary policy as per the article was due to the general outlook of the Australian economy. The economy was boasting the best terms of trade since mid-twentieth century. However, consumer expenditure as well as borrowing remained at a cautious level. Also shortage of skilled labour was not common over this period; inflation was still below the 2008’s peak and remained consistent as well. (currencythoughts.com, 2011) Further, Foley writes that due to the prospected fall in the Australian economy’s performance there would be more woes. These are with the inclusion of approximately 300,000 jobs’ loss besides the reduction of profits by half with focus on corporate profits. This was despite the Australian economy’s being considered as immune in comparison to their European and United States’ counterparts. (Foley, 2009) The reduction in jobs and the profitability of firms would call for the application of fiscal policies. Fiscal policies are explained as follows: Fiscal policies on the other hand involve adjusting of government expenditure as well as taxes so as to control the economy. There are two major fiscal policies usually in practice by global governments. These are; expansionary as well as contractionary fiscal policies. An expansionary fiscal policy is meant to reduce the levels of unemployment and to this the government in question raises its level of expenditure and/or reduces tax levels. This would result to a rise in real GDP that increase aggregate demand in the economy while in effect reducing unemployment. This may raise inflation levels, though. A contractionary fiscal policy would involve the exact opposite of the explained expansionary policy and its effect alike. This can be illustrated by the graphs below. Figure 2: Illustration of Fiscal policy Price level AS Price level AS AD2 AD1 AD1 AD2 Real GDP Real GDP Expansionary policy Contractionary policy An expansionary fiscal policy increases aggregate demand as shown in the first graph from AD1 to AD2. A contractionary fiscal policy works as shown in the second graph, by reducing aggregate demand. (Gwatney et al, 2008 pp242, 243) In year 2009, a fiscal stimulus was effected through a package set to create jobs and build the economy. This was announced in early February of 2009 and the revision was done in mid-February. The fiscal policy was subsequent not only to the government’s influence, but also to the non-government senators. This package was aggregating to about Australian $12 billion and it was divided to three major payments. One of the payments involved a back to school bonus. This package translated to Australian $950 for every child and it was for middle-income and low-income families that were getting Family Tax Benefit A and the age of schooling children was supposed to be from 4-18 years. The payment was set top cater for about 2.8 million school-going children. The other package was a tax bonus for the Australians who were working. It was based upon their 2007-2008 taxable income. The payment involved Australian $900 for people with taxable incomes of about $80,000 and below and $600 for those earning taxable incomes ranging $80,001 - $90,000. $250 went to the people earning between $90,000 and $100,000. This payment was to cater for approximately 8.7 million individuals. The last payment was single-Income Family Bonus. The amount was $900 for every family and this would go to the families that were bound to be given Family Tax Benefit B. The families that would fall under this benefit were about 1.5 million and these included couples with primary earners earning lower than $150,000 and the secondary earner less than $20,000 or single parents. The whole of the 2009’s fiscal stimulus is what has been explained earlier in the study as an expansionary fiscal policy. This is since by increasing the government expenditure and giving extra payments to the citizens, this would raise aggregate demand. (Leigh, 2009) Following the cash handouts by the Australian government, the situation in year 2010 was not much different. The suggestion by an article written in August 2010 was to use more monetary policy measures as opposed to fiscal policy measures. Even if the economy of Australia is yet to encounter the negative effects of the global economic crash, the suggestion is to the usage of more monetary policy than the fiscal policy. According to the article, even after the fiscal stimulus the debt/GDP ratio still remained at 6%, there were positive shocks still being experienced from China with regards to demand, and that people believe that the bubble of economic crisis was yet to burst in Australia. The highest risk was said to emanate from the Chinese demand, which could break the stability. Otherwise, the fiscal policy remained unchanged for year 2010. (Cowen, 2010) As per the sentiments by the Commonwealth Bank’s chief economist Blythe Michael, the Australian fiscal policy for the 2011/12 budget reflected a contractionary policy. This, according to him, has been the case for a while. The aim of the government is to ensure that the Australian economy remains on track so as to deliver the consolidation where the fiscal policy is applied together with the monetary policy. According to him, as he talks about the policy further, this should have been the policy that RBA should have applied even before instead of an expansionary policy. The forecast by RBA was likely to assume a bit of fiscal consolidation since this has been in the plans of the bank. James Craig, Commsec’s Chief Economist on the other hand said that the fiscal policy by the government has involved a maintained discipline on expenditure by the government, which means little is being spent by the government. Saving has, thus, been encouraged through this contractionary fiscal policy. The reduction in expenditure by the government would reduce the levels of inflation. This forms the biggest boom in the mining industry of Australia. The move would see the fiscal policy work well with the existing monetary policy. (Hess, 2011) Therefore, it is of essence to note that in the last two years, the government of Australia through the Reserve Bank has applied a contractionary monetary policy in 2009, and the monetary policy has not been changed over the years 2010 and 2011. On the other hand, in year 2009 the fiscal policy that has been used is an expansionary policy while in 2010 it remained unchanged. However, in 2011/12 budget, the government has applied a contractionary policy to reduce the levels of inflation and encourage saving. Generally, thus, these are the findings from the study. Reference list: Baumol, William J. and Blinder, Alan S. (2010). Macroeconomics: Principles and Policy. Edition 11. Cengage Learning. pp270, 271. Cowen, Tyler. (2010). Australian fiscal policy. Retrieved 31 October 2011 http://marginalrevolution.com/marginalrevolution/2010/08/australian-fiscal-policy.html currencythoughts.com. (2010). Australian Monetary Policy Left Unchanged. Retrieved 31 October 2011 http://currencythoughts.com/2010/07/06/australian-monetary-policy-left-unchanged/ currencythoughts.com. (2011). Pause in Australian Monetary Policy Continued. Retrieved 31 October 2011 http://currencythoughts.com/2011/03/01/pause-in-australian-monetary- policy-continued/ Foley, Meraiah. (2009). A Gloomy Forecast for Australian Economy in 2009. Retrieved 31 October 2011 http://www.nytimes.com/2009/01/20/business/worldbusiness/20australia.html Gwartney, James D. et al. (2008). Economics: Private and Public Choice. Edition 12, illustrated. Cengage Learning. pp242, 243. Hess, Steven. (2011). On Fiscal, Debt & Deficit Policy. Retrieved 31 October 2011 http://www.alp.org.au/agenda/budget-2011-12/budget-2011-endorsements/ Leigh, Andrew. (2009). How Much Did the 2009 Fiscal Stimulus Boost Spending? Evidence from a Household Survey. Retrieved 31 October 2011 http://andrewleigh.org/pdf/FiscalStimulus.pdf Somerville, Craig. (2010). Australia’s Monetary Policy: Right or Wrong? Retrieved 31 October 2011 http://www.reloadconsulting.com/business-blog/economy/australias- monetary-policy-right-or-wrong/ Read More