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Analyse the impact of current and forecast economic growth on the New Zealand economy.
Prior to the discussion on the impact of current and forecast economic growth on the NZ economy, there is a need to firstly go through some concepts and mechanisms in economy.
Gross Domestic Product (GDP) is a measure of economic growth. The economic growth of a country can normally provide advancement in all fields in that country. In general, GDP grows faster when businesses take on more labour, which in turn gives people more money to spend and leads to an increase in demand. By contrast, if there is no growth in an economy, businesses would be stagnant or even downsized, employment inactive or shrike and demand and people’s living standard adversely affected.
GDP is the money value of all final goods and services produced for sale within an economy over one year. There are three ways to measure GDP – the expenditure approach, the income approach and the production approach, and literally all three approaches lead to the same result. (Stewart & Rankin, 2008, P216). GDP includes exports but excludes expenditure on imports.
The value of GDP unadjusted for inflation, ie, measured in current rather than base-period dollars is called Nominal GDP, while the value of GDP expressed in based-period dollars, removing the effects of price changes is defined as Real GDP. In case the actual output quantities remain the same, a Real GDP will be unchanged but a Nominal GDP may increase or decrease in correlations to the rising or falling prices of goods. The growth in real GDP over a period is an indication of the performance of an economy and a better indicator of living standards is real GDP per capita, that’s real GDP divided by population.
In New Zealand, the price stability is measured by price index, that’s, a series of price measurements showing how the average price of a set of goods changes over time. Two most important price indexes are Consumers price index (CPI) ââ‚¬” a measure of the general level of prices of goods and services that households purchase, and producers price index (PPI) ââ‚¬” a measure not confined to those items bought by households and extended to all goods and services produced in NZ. Note that it is the percentage change in an index and the direction of the change that matters, rather than the index number itself.
Aggregate demand (AD) curve is the total output of goods and services that would be purchased at varying price levels (holding the money supply and other influences constant). It shows that when price index decreases the real GDP rises. Aggregate supply (AS) curve demonstrates the total output of goods and services firms are willing to produce at varying price levels (holding the money supply and other influences constant). It indicates that when the price index decreases the real GDP also goes down.
When combining the AD curve and AS curve together, it will form a AD/AS graph and there’s an intersection of the two curves which gives the overall equilibrium level of real output (GDP) and the price level. If a price level is above equilibrium level, there is more output being supplied than people want to buy. The excess supply will cause producers to drop their prices and hence the price level will fall back to equilibrium. The quantity of goods and services supplied will also contract. If the price level is too low, the demand for output exceeds the supply and a combination of rising prices and rising output will restore to the equilibrium level.
Economic activity experiences periods of growth and contracting at varying levels and these fluctuations form the business cycle. Periods of stronger than average growth are called a business cycle ‘expansion’, resulting in growing employment and rising price. The period of fastest growth during a cycle is called the ‘peak’ which usually occurs when the economy approaches the production possibilities frontier. Expansions are followed by times of slower than average activity or even negative economic growth. These periods are called ‘contractions’ and unemployment is likely to increase while prices may not be falling but is likely to rise more slowly than usual. The period of slowest growth during a contraction is called the ‘trough’ of the cycle. A period of at least six months of negative economic growth is deemed to be a recession.
Diagram 1.1 below is the New Zealand business cycle between 2008 and 2014, in accordance with the Budget Economic and Fiscal Update 2011. It shows that at the end of 2011, the New Zealand business is to be in business cycle ‘expansion’ that recovered in 2008, continuously expanded and is forecasted to reach ‘the peak’ by the end of 2012.
The NZ economy is forecast to reach the ‘peak’ of business cycle in mid 2012 when itââ‚¬â„¢s quarterly GDP increases by 1.3%, following an expansion of 0.8% in the first quarter of 2012. This is the period when the economy is close to the so-called potential GDP – the level of output which a nation’s economy can achieve if available resources are fully and sustainably employed, whilst strictly speaking, the potential GDP means the level of output attainable when cyclical unemployment is zero.
However, when the existing plant and machinery is used at close to full capacity, employing yet more labour will result in proportionately less extra output, not to mention the increasing demand of pay rise due to labour shortage, and hence diminishing profit. Further improvement in employment will come to an end, so does the increase of purchasing power (demand). As a result, production (supply) will become excessive and will not be sold unless prices are reduced. A combination of falling prices and output will bring the economy back to the equilibrium level.
In accordance with the Budget Economic and Fiscal Update 2011, the NZ economy is expected to gather momentum into 2012 and grow by around 4.1% to reach the peak, annual CPI will be well under control at moderate level of 2.4% and the unemployment rate will go down from 6.8% in 2011 to 5.7 by the end of 2012.
Nevertheless, there are a range of factors that may create a high level of uncertainty surrounding the sanguine economy outlook in the Treasury’s economic forecasts. Those factors may include the quantum and timing of reconstruction activity in Christchurch, Treasuryââ‚¬â„¢s monetary policy, consumer and business confidence and change of economy situations in other countries.
In summary, the New Zealand economy has expanded strongly from the global economic downturn between 2007 and 2009. The strategic earthquake in Christchurch in 2010 caused about 1.5 percent of the national GDP growth in 2011 while the rebuilding and reconstruction of earthquake activities are likely to trigger an economic revival that will reach the peak by the end of 2012 and continue to grow robustly into the near future.
During the second quarter of 2011, the NZ dollar depreciated in value against the US dollar.
a) Analyse the effects on the Current Account of the Balance of Payments when a depreciation of the NZ dollar occurs.
b) Analyse, with the aid of two separate graphs, the effect of the earthquake activity will have on the NZ dollar in foreign exchange markets.
Foreign exchange rate is the price at which one currency exchanges for another and features in all flows of money across international borders. New Zealand has adopted a floating exchange rate that is determined by market for foreign exchange and is measured by the trade weighted index (TWI) that is the value of the NZ dollar against a weighted basket of the currencies of its five largest trading partners, comprising Australia, USA, Europe, British and Japan.
The exchange rates are established by the demand for and supply of NZ currency that resulting in its fluctuation from minute to minute. An increase in demand for the NZ currency and/or a decrease in its supply will cause the NZ dollar to appreciate that is a rise in the price in terms of other currencies. Conversely, a depreciation of the NZ dollar will occur when the demand for it decreases and/or when its supply increases.
When a depreciation of the NZ dollar occurs, the NZ dollar exchange rate (TWI) will decrease, which in general encourages exporting whilst depresses importing. As such, the increased volume of exports increases the overall value of exporting while the decreased quantity of imports reduces their value. Together, the effect would be to improve the balance on merchandise trade (tradable sector) and thus lift the balance on current account of the Balance of Payments that observing an decrease of a current account deficit or an increase of a current account surplus.
According to the attached statement from Hon Bill English, the Minister of Finance, national GDP growth will be about 1.5 percent lower in 2011 solely as a result of the Christchurch earthquake. It also notes that the rebuilding and reconstruction effort will bring a sizable boost to the economy in 2012. (NZ HOR, 2011)
Therefore, the rebuilding and reconstruction efforts after Christchurch earthquakes are likely to lead to an economic revival or boom in New Zealand economy, in which there is hence a higher demand for imports. The payments of NZ dollar will have to be exchanged into foreign currencies, with the same effects on the supply curve to shift to the right or the demand curve to shift to the left and the equilibrium exchange rate depreciates.
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