Australian Economy Post-Mining Boom Decline

Introduction

The Australian economy has been performing well since the 2008 Global Financial Crisis. However, the Gross Domestic Product (GDP) growth rate showed a significant decline after the end of the mining boom (2014). In this essay, the current Australian economy situation and the current exchange rate of the Australian Dollar (AUD) against United States Dollar (USD) will be interpreted, followed by the causes of the decline in the exchange rate and the impact of the exchange rate. Then, the government and the Reserve Bank Australian (RBA)'s response to the exchange rate will be discussed. Finally, the recommendations for both government and RBA will be illustrated to maximize the capitalization of the current economic situation.

1.1 Current Economic Climate

The global economy shows a growing trend since 2016, and the GDP growth rate is at 3.2% (The World Bank, 2018). The Australian economy is benefitting from the growing global economy, where it has continually grown since 2016 and the current GDP growth rate is around 1% (Trading Economics, 2018). However, it is relatively low compared to other economies (4.1% for the USA, 6.7% for China) and the world average (3.2%) (Trading Economics, 2018). Inflation rate has steadily grown since July 2017 and the current inflation rate is 2.1%, which is just above the floor of the target range of 2-3% (Reserve Bank Australia, 2018). Other economic indicators also proved this growing trend, where the unemployment rate fell to a six-year low of 5.3% (Tranding Economics, 2018). This year, economic growth is expected to accelerate. Upbeat business confidence together with monetary policies that are accommodative should buttress non-mining business investment. Export growth is expected to be fuelled by sustained overseas demand for commodities. At the same time, after a subdued first quarter, consumer spending is expected to gain steam and this will be underpinned by accelerating wage growth and job creation that is steady. The outlook could however be clouded by falling house prices and high debt levels. GDP is expected to expand 2.9% this year according to Focus Economics and 2.7% in 2019. Despite the general growth trend, some indicators remain of concern such as the wage growth which rests at near historical low of (2.1%), which might aggravate the household debt pressure (Letts, 2018). In addition, the recent US-China trade war and the sluggish Chinese economy may lead to a decrease in the demand of Australian export goods and services, which ultimately decrease the demand of Australian dollar and leads to a lower exchange rate. Furthermore, since 2016, the Reserve Bank Australia (RBA) set the cash rate at a historically low 1.5%, the expansion in the money supply might also be responsible for the low exchange rate.

1.2 Hypothesis (do you believe the government & RBA has done enough)

At the current low exchange rate stage, it is important that both the government and RBA develop appropriate fiscal or monetary policies to either fight with the low exchange rate or capitalize on it to develop the economy of the country. If appropriate policies are implemented, the Australian economy will be stimulated and the demand for AUD will slightly move up which might result in a higher exchange rate.

Developments in the Australian Dollar

Graph1 – The exchange between the Australian Dollar (AUD) and (American Dollar) USD.

As Graph 1 shows, the exchange rate between the Australian Dollar (AUD) and the American Dollar (USD) decreased significantly from 2014 to 2016 (from nearly 0.95 to under 0.7). Between 2016 and 2018, the exchange rate fluctuates increased slightly, but relatively stable (between 0.73 and 0.81). However, since 2018, the exchange rate falls from 0.81 (early 2018) to around 0.72 in 14th August 2018.

Causes of the Sustained Depreciation of the Australian Dollar

There are many factors that would influence the exchange rate such as the level of economic performance, domestic commodity prices and the supply and demand of the AUD. Traditionally, AUD is compared against USD, as the American economy is considered to be one of the strongest economies in the world. The exchange rate between AUD and USD refers to the amount of USD that 1 AUD can buy. Demands and supplies of both AUD and USD could influence the exchange rate (between AUD and USD). If the supply of USD increases, then the exchange rate increases. If the supply of AUD increases, then the exchange rate decreases. If demand for USD increases, the exchange rate decreases. If demand for AUD increases then the exchange rate increases. In section 2.1 the impacts of the commodity price and interest rate will be examined through the analysis of supply and demand of USD and AUD.

Impact of Commodity Prices

The relationship between the commodity prices and the exchange rate follow the following mechanism, if the commodity price increases, it reflects there is an increasing demand of Australian export goods, leading to a rise in the demand of AUD and the value of AUD will appreciate. Conversely, a lower commodity price reflects the lower demand for Australian goods, results in a lower exchange rate. The Australian economy is traditionally relying on exporting goods and services. In 2017, the exports consist of over 20% of national GDP growth and the commodity exports accounted for 17% of GDP growth (Thirlwell, 2017). Thus, the change in the commodity price, especially the export goods will largely affect the level of performance of the Australian economy. The major export goods are natural resources (45% of total export goods), which include iron ore, natural gas, and gold (Thirlwell, 2017). Each of them has seen the price decreases since January 2018. For example, the iron ore price decreases significantly since January 2018 (US$76.34 per ton) to (US$66.1 per ton) (Trading Economics, 2018). Similarly, the gold price also showed a decreasing trend since February 2018, where the gold price has fallen by AU$ 82.67 per kilogram (from AU$1706.12 per kilogram to AU$1623.45 per kilogram) (ABC Bullion, 2018). The decrease in the export goods prices reflects there might be an excessive supply of the export goods or a decrease in demand for Australian goods. Less demand for Australian goods means there is less demand for AUD, which will make AUD depreciate. In long-term, the decline in the demand for Australian exports may cause the price of exports to decrease. To businesses, it means a lower profitability capacity and less business confidence, the result may be reflected on a sluggish economic growth, a weaker economic growth will also diminish the value of AUD.

Graph 2 – Price of iron ore in USD from May 2017 to May 2018.

Graph 3 – Price of natural gas in USD from August 2017 to August 2018.

Graph 4 – Price of gold in AUD in 2018.

Impact of Current Interest Rates

The cash rate sets by RBA will influence the market interest rate. The cash rate will directly affect the supply of AUD, the market interest rate will indirectly change the level of demand for AUD through investments and spending. The importance of the cash rate can be assessed through the supply of AUD and USD, where a low cash rate increases the money supply and depreciate the value of AUD. Conversely, a higher cash rate tightens the supply of AUD and increase the exchange rate. The Australian cash rate has remained at historically low, 1.5% for the last two years. In the central banks modern history, this is the longest pause, amid sluggishness in wages and inflation. Compared to the Federal Reserve rate (2%) (Trading Economics, 2018), the Australian interest rate is relatively low. The tight supply of USD will increase the price of USD, which results in a sustained pressure on the AUD, and as such remaining low. The economy of Australia is continually supported by the low interest rates. Conditions in the housing markets of Melbourne and Sydney have continued to ease and measures nationally of inflation of rent have remained low. A decline has been observed in housing credit growth to a 5 ½ annual rate. Largely, this is as a result of declined demand from investors due to changes in the dynamics of the housing market. Further, progress in taming inflation and reducing unemployment is expected. However, this progress is expected to be gradual. Another approach of illustrating the influence of cash rate on the exchange rate is the demand of USD and AUD. A low cash rate tends to lead the market interest low and a low market interest rate restrains the opportunities of foreign investments. In other words, a lower demand for AUD. According to the supply and demand graph, a decrease in the quantity of demand for AUD will result in a lower market price, which means the value of AUD will depreciate. In addition, the Tax Cut policy released by the Trump government maximizes the profitability level of American businesses and enhance the increasing trend of the foreign investments in America. As a result, the demand for USD increases, leading to an appreciation in the value of USD and lower AUD to USD equivalent.

Implications of the Sustained Depreciation of the Australian Dollar

There are lots of aspects that would be influenced by the fluctuation in the exchange rate. Nationally, after a long time period of a persistent low exchange rate, the industry structures might shift, due to the change in the demand for export goods and services. The economic growth might, therefore, be affected. Internationally, the fluctuating exchange rate will affect the trade patterns, as the price of import goods and services in equivalent to AUD varies. The direct effects of exchange rate movements is that these movements bring about changes in the prices of services and goods that are produced in Australia relative to the prices of services and goods produced from overseas. A depreciation of the Australian Dollar leads to a reduction in the number of foreign currency required to purchase a given amount of Australian Dollars. As such, the services and goods produced in Australia become cheaper when compared to similar services and goods produced from abroad. For example, if there is a decline in the value of the Australian Dollar, those tourists who visit Australia would be required to change less foreign currency so as to pay for their accommodation and meals. All countries desire to be paid in their own currencies for example A$s, US$s, Yen or Euro. As such, it is necessary to sell currencies that is S, or bought D in the markets of foreign exchange. In doing this, the point of equilibrium is the determining point for the exchange rate which is the price of the Australian Dollar. At this point, the quantity of dollars supplied is equal to the quantity of dollars demanded. In markets like this, excess selling of the Australian Dollar would lead to its exchange rate going down, while excess buying would make the exchange rate to go up. As such, the exchange rate acts as an indicator of Australia`s success in paying its way in international transactions.

Structural Changes in the Australian Industry

One obvious result of a lower exchange rate is attracting more foreign buyers to purchase Australian export goods such as iron ore, gold, and services such as education and tourism. Therefore, stimulating the growth in the export sector. Meanwhile, the imports goods and services will be more expensive for Australian businesses. For example, one of the major imports, petrol showed a significant rise in price (146.6 cents per litre) and it is at the highest level since 2014 (Scutt, 2018). In short-term, the increases in petrol price is likely to impact industries that use petrol as one of the main productive resources, the result will be an increase in the cost of production and diminished profitability levels. Other industries related to petrol might also be affected, such as car retailers, as people tend to buy fewer new cars when the petrol prices are high, which will decrease the number of sales. In long-term, the unbalance between the export and import sector may shift the Australian economy to a two – speed economies situation and possibly lead to a high structural unemployment rate, which is largely consisted by the unemployment in the sector that depend on imports. In contrast, a shortfall may occur in the export industry. Thus, the source of economic growth may migrate to the export industry.

Balance of Payments

A fluctuating exchange rate does not help to sustain the balance of payment, as the amount of foreign payments varies correspondingly to exchange rate. If the exchange rate increases, the payment nominated in a foreign currency will not be worth as before in terms of AUD and vice versa. The current low exchange rate means Australia has to pay more foreign debts in Australian dollars, as the majority debts are nominated in foreign currencies such as USD and EUR (Trading Economics, 2018). As Graph 5 shows, Australian current account balance is at -10.5 billion (Trading Economics, 2018). The balance of the current account consists of net goods and services and net primary income. The surplus in the goods and services balance is not enough to cover the deficit in the net primary income. As previously discussed, a lower exchange means Australian exports are more attractive and therefore, the income from exporting goods and services will increase. On the other hand, Australian has traditionally relied on the inward foreign investment to meet the shortfall between domestic saving and investment (Riley, 2018). Thus, if the profit remitted to overseas equity investor and leaders are expressed in AUD, the Australian businesses would pay less. Conversely, if they are nominated in foreign currencies, such as USD, then it will be even more worthy in term of AUD. If the surplus in the net goods and services account is larger than the deficit in the net primary income account, then the overall current account balance will be in surplus and vice versa.

Graph 5 – Current account balance (Australia)

Australian Living Standards

Australian citizens’ living standards is another area that would be influenced by the fluctuated exchange rate and the effects could be examined through both short and long terms. It is obvious when the exchange rate is high, the import goods and services will be more expensive for Australian buyers. The top import goods are petrol, cars, and computers, which all are necessaries for daily life. Thus, in short-term, most Australians might suffer from an increase in the cost of living and have less available money to spend elsewhere, which could be seen as a threat of the level of living standards. Similarly, import services will also be more expensive in terms of AUD. For example, the higher costs for overseas holidays might prevent some Australians from traveling abroad, which may lead to a decrease in the level of happiness and entertainment, a non-material measurement of living standards. On the other hand, as section 2.2.2 discussed, the long-term effect might be the industry structural change and the growth of the import sector might be restrained. It is possible that employment in the import sector will face a threat of unemployment and a loss in income, which will significantly lower the standard of living in both material and non-material measurements. The secular sluggish in the growth of the import sector may influence the overall domestic economic growth. If the economy does not perform well, then everyone in the economy will basically experience a declined living standard. However, if this unemployment could grasp an opportunity and migrate to a similar industry within the export sector, then they might experience a slight increase in the standard of living, if not decrease significantly. In contrast, the growth in the export sector resulting from the low exchange rate will contribute to a more profitable business condition for the export sector, it is likely that the benefit will be passed onto the employees with a higher level of wages or salaries. Thus, it is hard to draw a conclusion if the level of living standards will decline for them. Accordingly, an absolute consensus of whether the overall living standards will decrease could not be drawn.

The Australian Government’s Response to the Sustained Depreciation of the Australian Dollar

A sustained low exchange rate might aggregate the pressure on economic growth. It is important that the government intervenes in the economy before the change in the economy occurs. However, due to the time lag involved within in the decision-making and implicating process, the interventions by the government could be argued as a source of instability. Thus, developing an appropriate policy is vital to minimize the instability. In section 3, the responses of the Australian government to the sustained depreciation of AUD will be examined through two priorities, including economic growth and full employment.

Appraisal of the Effectiveness of the Federal Government’s Response

Key Economic Objective: Economic Growth

The mechanism between fiscal policies and economic growth is that, if an expansionary policy is introduced by the government, then the economy will be stimulated. Conversely, if a tighter fiscal policy is implemented, then the economy will sluggish. The government has recognized that travel and tourism is one of the backbone industries that supports the domestic economic growth, it contributes to 11% of the Australian GDP in 2017 (World travel and tourism council, 2018). China is now Australia’s largest source of short-term visitor arrivals, with total short-term arrivals over the past 12 months at 1.39 million (Scutt, 2018). Recently, the expansion in the number of Chinese middle–class enables more Chinese tourists to visit Australia. Currently, the low exchange rate provides the foreign customers with cheaper Australian goods and services. It is important that the Australian government maximize the capitalization of this advantage. The goal of boosting the travel and tourism can be achieved through many different approaches. For instance, infrastructure investment, border administration regulation, and tourism market promotion. An example of promoting the development of the tourism industry is an expansionary fiscal policy provided by the Queensland government. This policy delivered a $ 330 million investment package on managing the climate change and maintaining marine and island ecosystems in the Great Barrier Reef over five years (Queensland Government, 2018). In general, the level of entertainment and attraction of the Great Barrier Reef will be improved, which is very likely to drive up the number of tourists. An increase in the level of associated expenditure (travelling, accommodation and food expenditures) is always combined with the rise in the frequency of travelling and it will be reflected on economic and employment growth of directly related industries, such as accommodation service, transport services and indirectly related industries such as retail traders and food suppliers. The statistics also proved this phenomenon, where Australian retail sales rose by 0.6% in February 2018, the largest percentage increase since November 2017 (Scutt, 2018). With the benefit of an increase in the number of sales, the industries mentioned above will be more profitable. Furthermore, the federal government will also share the advantages of the boosting traveling expenditures through an increase in the Goods and Services Tax and Business Tax from the industries directly or indirectly related to tourism and travel. The benefit of the extra government income could be passed on to invest public infrastructure and medical cares, which will ultimately stimulate the economic growth. However, these benefits on the economy might be achieved over a long time period.

Key Economic Objective: Full Employment

The relationship between the employment rate and economic growth follows the following mechanism. If the economy performing well, then the employment rate will rise. If the economic growth rate slows down, then the employment rate may decline. In order to further capitalize the current Australian economy and create employment opportunities for both the export and import sectors. The Australian government signed several Trade agreements to enhance the economic growth trend. For example, Australia hosted a meeting of Association of South East Asian Nation (ASEAN) leaders and the ten members of ASEAN announce a commitment to maintain free and open trade in the region in the face of rising US protectionism (Riley, 2018). This agreement will larger benefit the Australian economy through a rise in the net goods and services balance, as 70% of Australian’s trade within the Asian region. Furthermore, the Australian government also committed to another trade agreement with another 11 countries within The Trans-Pacific Partnership Agreement (Riley, 2018). This agreement also provides a substantial market access covering goods, services, and commitments on regulating foreign investments. By removing the trade barriers among countries, the volume of Australian exports will be guaranteed, combined with the current low interest, the growth in the export sector will be further enhanced and there might be an increase in the demand of labour force. On the other hand, the price of import goods is also guaranteed by the trade agreements, as the abolishment of the extra tariff might alleviate the higher costs resulting from the low exchange rate. Thus, the pressure on the import sector might be mitigated and the employment rate of the import sector could be sustained. In addition, the possible unemployment arisen from the import sector might fulfil the shortfall in labour force within the similar industries from the export sector. For example, employees who used to work for the petrol import companies might be able to transform to the natural resource export companies. However, according to the statistics, it is hard to define the unemployment rate within the import sector and the transition elasticity between industries. Thus, the trade agreement will increase the job opportunities within the export sector, but the employment statistic within the import sector remains to be assessed.

The Reserve Bank of Australia’s (RBA’s) Response to the Sustained Depreciation of the Australian Dollar

Despite the fiscal policy being implemented by the Australian government, the monetary policies set by the Reserve Bank Australia could be another approach to capitalize on the current exchange rate and drive up the level of economic performance. In section 4, the effects of the RBA’s expansionary monetary policy will be interpreted through the economic objects of price stability and external stability.

Appraisal of the Effectiveness of the RBA’s Response

Key Economic Objective: Price Stability

The price stability is achieved through a moderate increasing in the inflation rate and driving up the inflation rate from the floor of the target range 2-3%. If the RBA decides to increase the cash rate then the inflation rate will rise, but the exchange rate will depreciate, as the money supply has expanded. Thus, the RBA face a trade-off of whether to maintain inflation rate or fight with the low exchange rate. The RBA has decided to maintain the cash rate at a historically low level, 1.5% since 2016. The expansionary monetary policy will result in a higher inflation rate, as the increase in the quantity of demand for goods and services will trigger the price to rise. It seems that RBA guaranteed the domestic inflation rate by implementing the expansionary monetary policy. However, the decreasing trend of the exchange rate will be emphasized, as a result of the expansionary money supply. According to the previous discussion, import industries use import goods as the main productive resources suffer from a low exchange rate. This is because the imports are more worth in term of AUD. The increase in the cost of production will be reflected as a higher market price, which can be seen as a source of price instability and the inflation rate of the import goods may rise. On the other hand, the low exchange rate will increase the demand for Australian exports. In long-term, if the growing trend of the demand continues, the price of exports will also show an increasing trend. In other words, the inflation rate might rise.

Graph 6 – Australian import price.

The RBA has decided to maintain the cash rate at a historically low level, 1.5% since 2016. The expansionary monetary policy will result in a higher inflation rate, as the increase in the quantity of demand for goods and services will trigger the price to rise. It seems that RBA guaranteed the domestic inflation rate by implementing the expansionary monetary policy. However, the decreasing trend of the exchange rate will be emphasized, as a result of the expansionary money supply. According to the previous discussion, import industries use import goods as the main productive resources suffer from a low exchange rate. This is because the imports are more worth in term of AUD. The increase in the cost of production will be reflected as a higher market price, which can be seen as a source of price instability and the inflation rate of the import goods may rise. On the other hand, the low exchange rate will increase the demand for Australian exports. In long-term, if the growing trend of the demand continues, the price of exports will also show an increasing trend. In other words, the inflation rate might rise.

As Graph 6 shows, the import price increased significantly since July 2017 (from 102.1 to 110). Graph 7 and Graph 8 show, both export price and domestic inflation rate show a slight increase. Thus, the RBA’s decision of keeping cash rate low guarantees the domestic inflation rate, but the instability is introduced to the import inflation rate.

Key Economic Objective: External Stability

Year in year out, Australians are involved in transactions that are international with different people from all the corners of the world. The external stability objective, is seen as an economic situation that is desirable in a general sense whereby, Australia is able to pay its way in its international financial transactions, without such payments overseas, that is, debts, for different items like interest and imports on overseas borrowing which brings about downward pressure that is undue on the countries exchange rate, that is, the value or the price of the Australian dollar whenever it is swapped for different currencies. High domestic interest rates are capable of increasing the GAD and NFD. Whenever interest rates are raised by the RBA in a bid to slow spending, this usually brings with it mixed effects on external stability as was witnessed between 2001 and 2007. Even though high interest rates can contribute to reduction of the cyclical cycle in the GAD, they also bring about additional structural problems. On the other hand, when the interest rates in Australia are lower when compared to overseas interest rates, the probable returns here for foreign investors are not as good and as such the value of the A$ goes down. With the lowered value of the A$, exports become more attractive when compared to imports and as such the NFD and GAD becomes even smaller. Additionally, lowered interest rates for business overdrafts lower the production costs for different local firms. This increases the competitiveness of the country’s exports against its imports, which cuts on Australia`s structural GAD.

The common indicators of external stability include;

The size of the balance of payments of Australia on current account, that is reflected in the GAD`s size.

The Australian Dollars level of exchange rate.

The burden and size of the net foreign debt (NFD) of Australia.

Conclusion

In summary, the Australian economy shows a slightly increasing trend since 2016, by taking the growing advantage of the growing global market. However, due to the instability and uncertainties international market, such as the US-China trade war. The low exchange rate between AUD and USD reflects these uncertainties. The possible effects of a low exchange rate on the national economy, include structural changes, the balance of payment and standard of living are also interpreted in this essay. From all evidence offered, it may be reasonable to draw the conclusion that the fiscal and monetary policies set by the government and RBA have sufficiently capitalized the current situation of the Australian economy, where exchange rate is relatively low.

Recommendations for Australia’s Current Economic Situation

Australia’s Current Economic Outlook and Trends in the Australian Dollar

The low exchange rate might still be sustained in the near future, as the tightened monetary policy is still in play. However, in the long-term, the exchange rate might start to recover from the rise in the demand of the exports and this might lead to an increase in the price of the AUD. It cannot however be concluded to be an absolute outlook of the exchange rate, due to the arisen uncertainties globally including the US-China trade war and instabilities within the national economies, for example, the recent transition from the Turnbull government to the Morrison government. In general, the outlook of the exchange rate between AUD and USD remains to be assessed.

Recommendations for the Federal Government

According to the previous discussion, the industries that rely on import goods will suffer from the low exchange rate. The associated results include a rise in the unemployment rate and sluggish growth within these industries. In the long term, the underperformance of these industries may threaten the performance of the overall domestic economic growth. To maintain the employment rate and achieve the aim of full employment, it is recommended that the government should rebate the income tax for the import industries. Although it seems a cost for the government as the government revenue decreases, the advantage is expressed through a higher profitability level. As a result, the unemployment rate in these industries might not rise significantly and fewer people would suffer from unemployment and lose the source of income. Furthermore, it is recommended that the government should provide training to adopt workers for the exporting industries, the export sector is largely benefited by the low exchange rate and it is growing rapidly. If more labour forces are able to enter the growing export sector, it is possible that the export industries will fully perform.

Recommendations for the RBA

In brief, the Australian economy has been performing well since the 2008 Global Financial Crisis (Although the GDP growth rate slowed after the mining boom). The exchange rate slightly increased since 2016, reflecting that the Australian economy is performing well. However, the recent fall in the exchange rate since January 2018, might be a result of the expansionary monetary policy and uncertainties of the global trend, such as the US-China trade war and the sluggish Chinese economy. In order to enhance the growing trend of the economy and further capitalize the low exchange situation, it is recommended that the RBA should maintain the cash rate at 1.5%. Although it seems that RBA loses the opportunities to fight with the low exchange rate by implementing the expansionary monetary policies, the low exchange rate will attract foreign buyers to purchase the Australian exports, thus, leading to a higher demand of USD. In long-term, if the growing trend of the demand trend continues, the exchange rate will slightly drive up. Furthermore, people tend to spend more when the interest rate is low, which will result in a higher demand for goods and services. A higher demand will cause the inflation rate to increase and move up from the floor of the target rate.

References

Riley, T., 2018. Trends in Australian's trade and foreign investment, s.l.: Tim Reiley Publication Pty Ltd.