Investors fear rising US inflation will push yields higher

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Concerns that Trump’s election means increased fiscal spending in the US has brought on a sharp decline in the bond market. Investors are fearing soaring debts as Trump has laid out plan to reduce tax and invest millions into infrastructure and defence. The significant increase in expenditure is expected to ramp up inflation, especially since the US economy is already nearing full employment. Inflation is also expected to increase as a result of increased protection which would see higher tariffs being put on Chinese imports.

How does this relate to the HSC syllabus?

  • The US has been undergoing fiscal austerity which aims to reduce the budget deficit so as to decrease the public debt the economy bears (HSC Topic 4 – Economic Policies and Management). This position will be significantly changed as Trump’s proposal to increase spending is expansionary. Expansionary policy generally causes debt to increase as tax revenue decreases and expenditure increases. As such, it is likely that US public debt will increase which may affect its external stability (HSC Topic 3 – Economic Issues).
  • Increased spending is also expected to be significantly inflationary. As spending increases, aggregate demand increases, which causes output and price levels to increase (HSC Topic 3 – Economic Issues). Inflation is likely to be an issue in the US, especially considering that increased output means increased growth. Since labour is a derived demand, increased growth means that the demand for labour will increase. However, given that the US is close to full employment, increased demand for labour would not reduce unemployment, but increase wages as demand for labour becomes more competitive. Since wages are costs that contribute to prices, the increase in wages will lead to an increase in price levels, causing inflation.
    • Full employment does not mean that the unemployment rate is zero. At the point of full employment, cyclical unemployment is zero, but frictional and structural employment is above zero.
  • Higher tariffs on Chinese imports will also be productive of higher costs. This is because tariffs are costs imposed on producers which are usually passed onto consumers. This causes prices to increase, therefore causing inflation as price levels increase.

Obama administration suspends efforts to pass TPP

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Plans to get approval from Congress to ratify the TPP have been suspended after Trump won the US election. Any work to be done on the TPP is to be suspended until Trump assumes office. However, it is unlikely that the TPP will be ratified under a Trump presidency as he had made his opposition to the TPP clear on grounds that it would lead to more offshoring of work. Moreover, Trump has indicated that the will renegotiate NAFTA and adopt more stringent trading policies with China.

How does this relate to the HSC syllabus?

  • The TPP is a trade agreement between 12 countries which contains measures to lower tariff and non-tariff trade barriers. That is, it is intended that the agreement would foster free trade between the countries (HSC Topic 1 – The Global Economy). However, Trump’s advocacy against the TPP indicates that it is unlikely to get ratified by the US. If the TPP goes ahead without the US, it would mean that the US will not be able to access the benefits of the agreement. Moreover, the bloc may be able to impose more stringent protection policies on the US to trade with it.
  • The rationale behind not entering the TPP and renegotiating long standing agreements such as NAFTA is to protect US employment. Industrial states have been experiencing higher rates of unemployment as they were unable to compete with cheaper imports and offshoring of jobs to China and Mexico respectively. While protectionism may be good for the economy in the short term, it may be damaging in the long term. This is because industries may become complacent and not operate efficiently without competition. As such, productivity in the economy may experience a significant decline as firms face less competition.

High Court’s Brexit ruling adds to business uncertainty

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The High Court has ruled that Brexit cannot be triggered without Parliamentary vote, which has made the initiation of the Brexit far more uncertain. The ruling means that the timing of the Brexit is now also dependent on Parliament. This has led to negative outlooks for businesses in the UK which value certainty. Theresa May has indicated an intention to leave by the beginning of 2017. Trade talks have already begun with May entering into informal negotiations with India.

How does this relate to the HSC syllabus?

  • The uncertainty created by the High Court’s ruling could be extremely detrimental to the economy in the short term. As a result of uncertainty as to when the Brexit is occurring and the terms on which the UK will exit the EU, businesses are likely to postpone investment due to the high risk involved. A reduction in business investment will cause a decrease in aggregate demand, therefore causing economic growth to decrease as output decreases (HSC Topic 3 – Economic Issues).
  • Uncertainty may also affect the labour market as employers are less willing to hire new employees. Since employers do not know what business conditions will be like as the details of the Brexit are still being explored, they would be averse to hiring new employees so as to avoid any severance fees associated with making employees redundant if business later becomes unfavourable.

Theresa Dang THERESA DANG

Theresa Dang is an economics mentor at Keystone Education. She attended Sydney Girls High and achieved an ATAR of 99.70 in 2012. She is now studying Commerce and Law at the University of Sydney. She has experience in a global technology firm and a mutual fund.

Gary Liang GARY LIANG

Gary Liang is the founder and director of Keystone Education. He attended Sydney Boys High and achieved an ATAR of 99.95 in 2012. He achieved 5 state ranks in Mathematics, Mathematics Ext 1, Mathematics Ext 2, Chemistry and Economics. He is now studying Economics and Science (Advanced Mathematics) at the UNSW Australia, where he is the recipient of four scholarships.

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