Cash rate on hold in April

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The RBA left the cash rate on hold in its meeting in April at 1.5%. Softened conditions in the labour market including employment and wage growth was highlighted as a concern that requires support of a low interest rate environment. This has been somewhat undermined by lenders who have raised their mortgage rates against investors. Housing prices and increased household borrowing were also cited as concerns.

How does this relate to the HSC syllabus?

  • The RBA references the improving conditions in the global economy, including a pick up in global trade and production. Due to the increasingly integrated nature of the global economy as a result of trade, economic growth is largely influenced by trends in the global economy (HSC Topic 1 – The Global Economy). The improvement in the global economy has caused commodity prices to rise due to increases in demand (Preliminary Topic 3 – Markets), which has contributed positively to Australia’s trade balance, balance of payments and economic growth.
    • Although Australia is transitioning from an export base predominantly consisting mining to services, mining still makes up a large proportion of its composition of trade.
    • Australia’s trade balance surged to a surplus of $3.6b in February which was supported by increases in the value of coal and iron ore by 4% each. Note that the surplus was also driven by a slump in import prices by 5%.
    • An improvement in the trade surplus contributes to an increase in aggregate demand given that AD = C + I + G + (X – M). An increase in aggregate demand, ceteris paribus, leads to an increase in output and therefore, economic growth (HSC Topic 3 – Economic Issues).
  • The RBA noted that headline inflation has risen in most countries, although core inflation remains low. Core inflation refers to the growth in price levels, excluding volatile items such as food and energy prices (HSC Topic 3 – Economic Issues). Higher headline inflation has been attributed to an increase in commodity prices which generally have volatile prices.
  • Despite concerns about rapidly increasing housing prices, the RBA has consistently kept the cash rate on hold due to soft inflation and labour market. This is indicative of monetary policy as a blunt policy instrument (HSC Topic 4 – Economic Policies and Management; Preliminary Topic 5 – Financial Markets). Unlike microeconomic policy, monetary policy cannot target certain industries. Therefore, if the RBA were to tighten monetary policy to limit the increase in housing prices, it would also exacerbate the problem in labour markets.
  • Whilst monetary policy is intended to stimulate the economy through offering lower borrowing rates, it is rendered less effective if the transmission mechanism does not operate properly. The transmission mechanism has been made less effective as banks are starting to increase mortgage rates for investors regardless of the cash rate, to maintain their profit margins. This means that investors face higher borrowing rates and are therefore less inclined to borrow and spend, leading to less growth.

Malcolm Turnbull backs RBA warning as household debt hits new record

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Household debt has reached 190% of disposable incomes, a record high. High household debt and higher borrowing costs, in conjunction with lower wage growth and higher costs of living are posing significant threats to the economy.

How does this relate to the HSC syllabus?

  • Households are borrowing at faster rates than their incomes are growing, which is a significant issue as debts are repaid with income. This implies that the rate of borrowing in Australia may be unsustainable. The issue is further exacerbated by the fact that borrowing costs are expected to increase. Regulators such as APRA are imposing higher capital requirements on banks to ensure that banks do not default if borrowers are unable to pay back their debts (Preliminary Topic 5 – Financial Markets). This means that banks are not able to lend as much, causing a decrease in supply of borrowable funds, leading to an increase in borrowing rates (Preliminary Topic 3 – Markets).
  • Ability to repay debt is currently based on the increasing value of property which is adding to individuals’ income and wealth (HSC Topic 3 – Economic Issues). If a housing crisis emerges, the ability to repay debt decreases, which puts lenders at risk of default as observed by the events of the GFC.
  • Higher indebtedness of households may have an adverse effect on the overall economy in the medium to long term. When households become conscious the increased burden of servicing debt, they may rein back consumption sharply. Given that consumption makes up around 60% of aggregate demand, such a reduction in consumption will significantly reduce aggregate demand, causing a decrease in economic growth.

Australian migrants may be encouraged to move to regional areas

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The Australian government is considering measures to encourage migrants move to more regional cities to assuage the problem with overcrowding and rising house prices in cities such as Sydney and Melbourne.

How does this relate to the HSC syllabus?

  • Increases in housing prices have been due to increased demand for property (Preliminary Topic 3 – Markets). This has caused housing affordability to decline, contributing to a decline in purchasing power parity in Australia (HSC Topic 1 – The Global Market). The issue is worsened by the fact that supply cannot keep up with demand as construction is time consuming and cities are at capacity.
  • Moving migrants to regional cities can help to ease the price pressure on the housing markets as it reduces the demand pressure for housing in the city (Preliminary Topic 3 – Markets). The move to regional cities may also be beneficial for unskilled migrants as it opens up employment opportunities which is significant given that unskilled migrants are a group that experience higher rates of unemployment (Preliminary Topic 4 – Labour Markets).

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, a mutual fund and a bulge bracket investment bank.

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