China’s central bank wastes no time in easing monetary policy

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China’s central bank announced that it would cut the reserve requirement ratio (RRR) for banks to 16.5%. China has previously lowered its RRR and interest rates five times last year which has been its most aggressive use of monetary policy since the GFC. Cutting the RRR is expected to inject about $138 billion into the market.

How does this relate to the HSC syllabus?

  • Lowering the RRR by 0.5% to 16.5% means that Chinese banks are able to hold less money in its capital reserves and can lend more money to individuals and businesses. This means that individuals can more easily get access to consumer credit and housing loans while businesses can more easily access business loans (Preliminary Topic 5 – Financial Markets). With these cheaper financing methods, individuals and businesses can more readily consume and invest (respectively) which is expected to increase economic growth (Preliminary Topic 1 – Introduction to Economics; HSC Topic 3 – Economic Issues).
    • Stimulating growth through lowering the RRR is particularly important to China since its economic growth has been slowing. In 2015, China reported growth of 6.9%, the slowest pace it has observed for 25 years.
  • It is argued that lowering the RRR may not have a significant impact upon growth. Since China’s credit market is already extensive, additional funds that can be lent by banks could potentially be used to refinance old debt rather than spur investment. Therefore, aggregate demand would not increase and therefore economic growth will not increase (HSC Topic 3 – Economic Issues).
  • Adjusting the RRR is a form of monetary policy. Monetary policy controls the supply of money in an economy (Preliminary Topic 5 – Financial Markets; HSC Topic 4 – Economic Policies and Management). Since changes in the RRR allows banks to hold less capital reserves and supply more money in the economy, this policy can be qualified as monetary policy.
  • With the expectation that the CNY will depreciate and that the US Federal Reserve would follow through with its plan to tighten monetary policy, investors have sold the CNY and bought USD which has seen funds flow out from China (Preliminary Topic 5 – Financial Markets). As a result of these capital outflows, China has been facing liquidity issues from lack of capital in the system. Lowering the RRR is intended to alleviate pressure on China’s capital markets.
  • Reducing the RRR could put more downward pressure on the yuan since allowing firms to lend more increases the supply of CNY in the economy. An increase in supply of CNY will ceteris paribus cause a depreciation (HSC Topic 2 – Australia in the Global Economy).

GDP rises 0.6pc in September quarter, up 3pc for the year

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The Australian economy grew by 0.6% from the September quarter and 3% year on year. Lower savings ratios and strong retail consumption, especially in NSW and Victoria has supported growth. Exports, however, have suffered with Chinese demand for iron ore at its lowest point since the mining boom began. The terms of trade has fallen by 12% in the year. Expectation for fiscal consolidation following the cut has been cautioned against given nominal growth rates are still at the bottom end of the economy’s growth targets.

How does this relate to the HSC syllabus?

  • Short term economic growth is influenced by aggregate demand (AD) (HSC Topic 3 – Economic Issues). Recall that AD = C + I + G + (X - M)
  • A majority of the growth of 0.6% in from the September to December quarter was driven by household spending, or consumption (AD = C + I + G + (X - M)). The retail sector has published buoyant half-yearly results supported by households saving less of their incomes as record low growth (Preliminary Topic 2 – Consumers and Business; HSC Topic 3 – Economic Issues). This is because in the overall economy, as income rises, savings levels increase as a lower proportion of income is spent on autonomous consumption.
    • The national savings rate has fallen from last quarter to 7.6% to 9.1% in the year earlier.
  • Although an increase in consumer spending has bolstered growth in this period, it is not sustainable in the long term. Given that consumers are using their financial reserves, in other words using their wealth, to support spending in conjunction to their income there may be significant external stability issues in the future as Australia will have little funds to finance future investment (HSC Topic 3).
  • Australia’s terms of trade has fallen by 3.2% in the last quarter taking the terms of trade to its lowest point since the mining boom started, reflecting the falling prices of Australia’s exports in comparison to its imports. This has mostly been due to falling commodity prices. A decrease in the terms of trade implies that Australia’s trade balance or net exports is worsening which detracts from aggregate demand (AD = C + I + G + (X - M) (HSC Topic 3 – Economic Issues). As such net exports has been observed to contribute to increased economic growth but at a slower rate.
  • Weakness in net export figures demonstrate that Australia is transitioning away from the resources sector. Although growth figures appear strong over the quarter, Treasurer Scott Morrison cautions against government spending cuts which would decrease injections from government spending into the economy (Preliminary Topic 1 – Introduction to Economics; HSC Topic 3 – Economic Issues). This is because growth outlook remains weak as the economy transitions which will stall any fiscal consolidation efforts (HSC Topic 4 – Economic Policies and Management).

RBA leaves interest rates on hold at 2pc

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The RBA has kept the cash rate unchanged in March 2016 at 2%. With inflation remaining close to the 2-3% target, ‘improved labour market conditions’ and ‘reasonable prospects for growth’ in the economy. The Australian dollar has depreciated from highs in 2011 to a more internationally competitive rate.

How does this relate to the HSC syllabus?

  • One of the primary goals of monetary policy is to ensure price stability, that is, to maintain inflation within its 2-3% target range (Preliminary Topic 5 – Financial Markets; HSC Topic 4 – Economic Policies and Management). Given that Australia’s underlying inflation rate is 2.15% and is expected to remain low over the next year, the RBA tended towards implementing an accommodative monetary policy (. This means that at 2%, the RBA has the option to continue to reduce the cash rate if inflation falls below target in contrast to economies such as Japan which have adopted negative interest rates.
  • The rationale of macroeconomic policy such as monetary policy is to stabalise shifts in aggregate demand (AD=C+I+G+(X-M))(HSC Topic 4 – Economic Policies and Management). Given that the economy has shifted away from mining but non-mining investment has appeared to increase, Glenn Stevens (Governor of the RBA) has stated that there was ‘reasonable prospect for continued growth’ supported by the non-mining sectors.
  • The decision to keeping the cash rate stable was also been supported by ‘improved labour market conditions’ which indicates that the RBA is on course with fulfilling the economic objective of full employment in implementing monetary policy (HSC Topic 4 – Economic Policies an Management).


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 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.