RBA cuts interest rate to 1.5%
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The RBA has cut the cash rate to a historical low of 1.5% to stimulate the economy which is currently in a low growth, low inflation environment. In his statement, Stevens noted that the price pressures from the housing market have abated and bank lending policies have been tightened. One of the main goals in cutting the cash rate has been to depreciate the Australian dollar and prevent it from rising about the 80c mark.
How does this relate to the HSC syllabus?
- Cutting the cash rate is the use of monetary policy to stimulate the economy (Preliminary Topic 6 – Government and the Economy; HSC Topic 4 – Economic Policies and Management). Assuming that retail banks pass on the cut to consumers and businesses, a cut in the cash rate will make access to capital easier, resulting in increased consumption and investment. Since consumption and investment are factors in aggregate demand, aggregate demand would increase, resulting in increasing economic growth. An increase in aggregate demand will also cause an increase in price levels, causing an increase in inflation.
- This cut in the cash rate comes after the release of CPI figures in the previous week, showing the weakest inflation figures Australia has experienced in 17 years. Core inflation is currently 1.3%.
- Although use of monetary policy can theoretically support the economy, the effect of its implementation is being reduced by the fact that the big four retail banks have refused to pass the full cut to consumers and businesses. After the cut this month, the banks have passed on around 15 basis points.
- One of the factors that has made the Reserve Bank hesitate in cutting the cash rate previously was the rapid growth of the housing market which saw property prices escalate to unsustainable levels. Since monetary policy is a blunt instrument given that it indiscriminately affects all activity in the economy, a cut in the cash rate would support weak segments of the economy, but also fuel the already high growth in the property market (Preliminary Topic 6 – Government and the Economy; HSC Topic 4 – Economic Policies and Management). Stevens noted that with the property boom slowing, a cut in the cash rate would be more appropriate now to support the rest of the economy.
- Another reason for the cut in the cash rate was to depreciate the Australian dollar which was threatening to go above $US0.80. Given that the rest of the world has implemented significantly loosened monetary policy, with near-zero rates, negative rates and quantitative easing, Australia’s previous cash rate of 1.75% was considered relatively high. As a result, investors were moving their investments into Australia to earn a higher return, causing the Australian dollar to appreciate since Australian dollars are required to make investments in Australia. As a result, demand for Australian dollars increased, causing an appreciation in the Australian dollar (HSC Topic 2 – Australia in the Global Economy). Although a depreciation is predicted to occur in theory after a cut in the cash rate, the Australian dollar appreciated by 0.9% in the next day may be an indicator for the fact that Australia’s cash rate, at 1.5%, is still considered relatively high.
- Note that the Bank of England in the same week announced numerous monetary responses to the Brexit, including a rate cut and increased quantitative easing to increase the pass through of the rate cut to the banks.
- The government has been criticised for the supposed ineffectiveness of the loosened monetary policy stance as commentators suggest that the Reserve Bank is ‘being asked to do too much’. Since weak inflation figures is mostly attributed to low productivity growth which leads to low wage growth, the issue should be one dealt with via labour market reform (HSC Topic 4 – Economic Policies and Management).
Stephen Roach: how to get globalisation working again
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Stephen Roach suggests that globalisation has been suffering in recent times, as exemplified by Brexit and backlash against China. Growth in the volume of global trade has averaged 3% over 2009 – 2016 in comparison to the 6% observed from 1980 – 2008. One of the factors causing this shift is the disruptive low-wage technology brought on by China which can undermine the idea of comparative advantage. Furthermore, the development of technology, internet has shifted the idea of trade as a transfer of tangible goods, contemplated by earlier conceptions of globalisation, to the transfer of intangible goods proliferated by the internet.
How does this relate to the HSC syllabus?
- It can be argued that Brexit was a shift away from globalisation since Britain broke their ties with the EU, which has the immediate effect of voiding any trade agreement that it had with the EU and can no longer benefit from agreements the EU had with the rest of the world. As such, trade barriers are erected once again which limits free trade (HSC Topic 1 – The Global Economy).
- One of the factors that has been put forward to explain the slowing growth of globalisation has been China’s low cost production. Since other economies struggle to imitate China’s low cost base as a result of labour market policies, there has been a preference for Chinese manufactured goods which are sold at lower prices. Significantly, economies have been increasingly voicing their displeasure with China as a result of their steel dumping which has been hurting domestic steel producers (HSC Topic 1 – The Global Economy).
- Proliferation of the internet and technology has intensified the speed to which economies now need to trade. This implies a need for changes to the labour market and labour market policies to adapt the economy’s production to world demand. Such policies involve job-search assistance to reduce the amount of frictional unemployment in the economy to shift labour quickly to where it is required (HSC Topic 4 – Economic Management and Policy). Moreover, relocation allowances may be required to increase labour mobility in response to the rapid changes in the global economy.
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.