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Impact of International Economic Turbulence

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Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Published: Thu, 19 Oct 2017

  1. The cut in interest rates will shift the aggregate demand curve to the right. The reduction in the interest rate will reduce the cost of borrowing for households and businesses. These lower rates should encourage households and businesses to increase their level of consumption and increase the level of investment spending in the economy.

The increase in government spending on infrastructure will shift the aggregate demand curve to the right, because the level of output increases as well as the price level. The long run supply curve will also sift to the right and the short run supply curve will shift to the left, because the government spending on infrastructure would increase the levels of productivity and employment levels in the economy.

(c) An increase in international economic turbulence

The increase in international economic turbulence will shift the aggregate demand curve to the left, as consumption and investment decline due to the lack of consumer and business confidence. The short run supply curve would shift to the right because the price level is lower than expected and costs have fallen in the economy.

The appreciation in the foreign exchange rate of the economy’s currency will make imports more cheaper for the economy and exports would be more expensive to send to foreign economies, therefore some businesses who import goods to use in their production, the costs would fall, causing the short run supply curve to shift to the right as prices for good fall. Also, due to the decreased demand for our goods the aggregate demand curve would shift to the left, as there is a decrease in the price level.

  1. The ABC News Fact Check article relates to fiscal policy of the macroeconomics course, as it examines whether or not Australia has a tax revenue problem. (See Appendix 1 for article.) The article examines the following comment by Dr Cassandra Goldie, Chief Executive of the Australian Council of Social Services (ACOSS), she states, “clearly revenue is a problem, we’re still one of the lowest taxing countries in the OECD.”[1] ABC examines her comment by comparing Australia’s tax level as a percentage of GDP to other countries as well as the OECD average. In 2011 Australia’s tax revenues was 26.5% of GDP, when it was compared to the OECD average for 2011 was 34.1%, which is significantly lower the OECD tax revenue average.

Currently the tax revenue has been declining over the last decade due to a series of tax cuts and the Global Financial Crisis. Australia’s tax revenue has also been impacted by the high Australian dollar, as it has weakened our exports to other countries (the balance of trade has been impacted). During this period the federal government has increased government spending. From 2002-03 to 2012-13 federal government spending grew by 45.2%.[2] Over the past decade, half of the federal government’s expenditure came from growth in social security payments. According to Dr Rafferty, there has been a cyclical mismatch in government revenue and government expenditure. This means that government revenue and government expenditure have been going against the normal business cycle.

Over the last few years there has been debate about whether or not the federal government should increase tax revenue by increasing the taxes or cut government expenditure. According to the federal government’s Mid-Year Economic and Fiscal Outlook statement; “The heavy lifting to achieve a surplus must come through expenditure restraint as a rising personal income tax burden would also have negative impacts on workforce participation.”[3] Therefore the federal government believes that cutting government expenditure would have a less an impact on the economy than raising taxation revenue to balance the budget.

In conclusion Australia does have a tax revenue problem, as tax revenue has declined in the last decade; however during this period government expenditure has been increasing. Therefore balancing the budget needs to be achieved through both increasing the taxation revenue and reducing government spending.

  1. The inflation rate for the first quarter of 2014 is 2.90%. In Australia one of the measures that is used to measure inflation is the changes in the Consumer Price Index (CPI). The CPI measures the cost of living as experienced by a typical household. The CPI is based on a market basket of goods and services which include:
  • Food and non-alcoholic beverages
  • Alcohol and tobacco
  • Clothing and footwear
  • Furnishings
  • Health
  • Transport
  • Communication
  • Recreation and culture
  • Education
  • Insurance and financial services

The reason why the CPI figures may be inaccurate is because of the following issues:

  • Substitution bias – people do not always buy the same quantity of goods and services when they go shopping.
  • Increase in quality bias – for example technology improves over the period
  • New product bias- New products are not included in the basket of goods, as the market basket of goods and services is updated every six years by the Australian Bureau of Statistics.
  • Outlet bias – people change their shopping habits – e.g. they might shop online for goods and services.
  1. If people decide to save more of their current income, this would cause the level of consumption to fall, which would cause a decrease the economy’s GDP. The level of savings would decrease because the level of inflation would rise. This rise in inflation would make the value of savings decrease as the inflation increases in the economy. If the economy experiences a sustained rise in the private investment spending, this would cause the equilibrium income to increase and therefore the income will go up.
  1. An economic contraction is a phase in the business cycle when activity is slowing down. During a contraction the production levels fall and unemployment rises as businesses reduce staff levels. An economic expansion is a phase in the business cycle when activity is increasing. During an expansion production levels are growing and unemployment falls as businesses increase the staff levels.

Appreciation is the rise in value of an asset or currency, e.g. when one currency rises relative to another. Depreciation is the fall in value of an asset or currency, e.g., when the asset falls in value.

A trade deficit is when a nation’s import of goods exceeds the exports of a nation’s goods during the financial year. A budget deficit is when a government’s expenditure is greater than its tax revenue.

  1. The Reserve Bank would use an expansionary monetary policy to counter a contraction in the business cycle or counter a recession. By using an expansionary monetary policy they would increase the monetary supply in the economy and lower the interest rates to stimulate the economy.

The Reserve Bank would use a contractionary monetary policy to counter the inflationary problems of the business cycle expansion or boom. By using a contractionary monetary policy they would decrease the monetary supply in the economy and increase the interest rates to reduce the level of inflation in the economy.

Monetary policy is more effective when the economy is in a business cycle expansion or boom, as both consumer and business confidence at a higher level and there are inflationary pressures in the economy. A contractionary monetary policy would decrease aggregate demand by increasing the interest rates to slow down the inflation levels.

The government would use an expansionary fiscal policy to correct problems of a contraction in the business cycle or a recession. Expansionary fiscal policy includes a combination of increases in government purchases, decrease in taxes or an increase in transfer payments. Expansionary fiscal policy is intended to stimulate the economy by increasing the aggregate expenditure and aggregate demand. Expansionary fiscal policy is aimed at reducing unemployment.

The government would use a contractionary fiscal policy to correct the inflationary problems of a business cycle expansion or boom. Contractionary fiscal policy includes a combination of a decrease in government purchases, an increase in taxes, or a decrease in transfer payments. Contractionary fiscal policy is intended to restrain the economy by decreasing aggregate expenditure and aggregate demand. Contractionary fiscal policy is aimed at reducing inflationary pressures in the economy.

Fiscal policy is more effective when the economy is in a business cycle contraction or recession, as both consumer and business confidence is at a low and there are deflationary pressures in the economy. An expansionary fiscal policy would stimulate the aggregate demand by increasing government spending.

  1. Demand pull inflation occurs when the aggregate demand increases for goods or services and the production for goods and services fails to meet this increase for aggregate demand. Government would respond to the increase for goods and services by increasing the amount of money available in the economy and increase government purchase. Exports may possibly increase as well. Demand pull inflation would cause the price levels to increase dramatically and cause inflation to rise quickly in the economy. An example of demand push inflation is when there is excess demand for labour in the economy and the economy is at full employment. The real GDP would increase, therefore increasing the price level and inflation begins to rise, which begins the cycle of price rises and inflation rises due to the demand pull.

Cost push inflation arises when there is a negative impact on the supply of goods or services, that causes a decrease in the aggregate supply. The decrease in aggregate supply would increase the wage rate or increase the price of raw materials. Cost push inflation would cause the price levels to increase dramatically and cause inflation to rise quickly in the economy. An example of cost push inflation is when cyclone Larry destroyed the banana crops in northern Queensland, leaving a short supply of bananas in 2006. The prices of bananas across the country increase by 400% to 500%. The impact of the price rise in bananas caused inflation to rise. The short supply of bananas would cause the real GDP to decrease and the price level rises as the aggregate demand for bananas increase.

It would be difficult to establish the cause of inflation would be demand pull or cost push, as both types of inflation can occur at the same time. For example an increase in wages is an increase in the cost of supply, which shifts the short run aggregate supply to the left. The wages increase would also increase the households’ income, where they would be able to spend more, which shifts the aggregate demand curve to the right.

  1. In the last 22 years the Australian economy has experienced economic growth. According to Battellino (2010), Australia’s economic growth has been unprecedented in Australia’s economic his and among other developed countries during this period. During this period there have been some periods where the economic growth has slowed down, but by the end of these slow periods the growth was still in positive territory.

The reason why Australia has had a growing economy over the last 22 years is because of the following:

  • In the last nine years China’s emergence into the world economy, Australia’s location and the composition of exports was ideal for China’s growth.
  • Before the emergence of China, we were mainly exporting to Japan and other Asian countries who have been buying our commodities. However in some instances in the last twenty two years these countries we were exporting to had periods of economic turbulence which slowed down our exports.
  • The floating of the Australian Dollar has countered the various external events that could have had the potential to damage our economy. E.g. the Dot.com bubble
  • The federal government over this period have made some significant changes that have improved our economy during this period:
    • Changes to the competition and industry policies, which has made the business sector more competitive.
    • Labour market reforms that have given the market greater flexibility to change with the economic conditions without producing large levels of unemployment.
    • Made various reforms to the financial system, which has made our economy more attractive to foreign investments.
  • In recent years our economy has been near full employment.
  • Business have been employing more labour and investing more capital to increase production levels.
  • The level of business investment in business has risen to a high level of GDP.
  • The federal government’s budget finances during this period have greatly improved and during the Global Financial Crisis the government stimulus had kept our economy growing instead of having negative growth e.g. Ireland was impacted by the global financial crisis and their economy went into recession.
  • Monetary policy has kept the level of inflation relatively low; so that businesses and households could plan or take up their economic activities.
  • Australian households’ level of savings has been substantially higher.
  • The mining boom has also contributed to the economy’s level of savings.
  • Australia’s terms of trade has increase over the last ten years.

These factors have contributed to Australia having an unprecedented period of economic growth in the last 22 years.

  1. Economists study the economic indicators to interpret the current or future economic possibilities of the economy or the economic health of the economy. A leading economic indicator is statistics that occur before an economy event and are used to predict changes in the economy. Some of the economic leading indicators are:
  • S&P/ASX 200
  • RBA Commodity Prices Index
  • Housing Approvals
  • Westpac – MI CSI Expectations Index
  1. The fall of the Australian Dollar by 12 cents against the US Dollar affects the Australian economy directly through the changes in demand for our exports in overseas markets and our demand for imported goods from overseas markets. The currency movement of the Australian Dollar also affects the amount of money that flows into and out of the Australian economy.

The fall in the Australian dollar against the US dollar has the following consequences due to the currency movement:

  • . The majority of retail goods that are imported, their costs would vary with the value of the currency movement of the Australian Dollar.
  • The higher costs of inputs that result in the fall of the dollar would offset some of the expansionary impact of increased export competitiveness.
  • The value of the dollar effects the consumer price inflation mainly on the cost of imported goods.
  • Inflation also indirectly effects the cost of imported goods used in production

The fall in the Australian dollar against the US dollar has the following benefits due to the movement in currency movement:

  • Australia’s exports are more competitive overseas
  • Increased local demand for locally made goods.
  • It has an expansionary effect on the economy.
  • Makes local goods and services cheaper.
  • Benefits the industries that have an exposure to import competition.

The fall in the Australian dollar against the US dollar has the following costs due to the currency movement:

  • Higher import prices can lead to inflation rising in the economy.
  • Changes in the terms of trade
  • Higher cost of imported goods that cannot be produced in Australia.
  • Imported capital goods used for production cost more.
  • Higher costs to business who use imported goods in their products

[1] ABC News Fact Check, 8 May 2014

[2] ibid

[3] ABC News Fact Check, 8 May 2014


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