Introduction to Australian economy and its structure

Australian economy is one of the highly developed nation of world. The economy has the structure of a mixed market economy. The economy has recorded an uninterrupted growth rate for the last few decades making it 14 largest economies in world. The economy is largely dominated by the service sector. Service sector alone contributes 61.1 percent of total GDP. More than 70 percent of the labor force is engaged in service sector. Because of the widely spread market structure it has become an attractive export destination. The nation has a huge stock of natural resources with mining industry has made a significant contribution in GDP. Both manufacturing and service sector are the main pillars of economic resilient in Australia.

Gross Domestic Product (GDP) of an economy is a measure of monetary valuation of goods and services produced in a nation. GDP is one important attribute of economic growth. An increasing trend indicates toward an economic growth. There are several components determining GDP of a nation. Some are directly linked with GDP while others have an indirect connection (Hubbard and O’brien, 2015). The economic variables having direct or indirect relation with GDP growth rate are interest rate (cash rate), inflation, unemployment, exchange rate and net export.

The data for last 26 years on each of the above-mentioned indicators are collected. The basic statistics of the variables are summarized as follows. Real GDP is a GDP measure that is computed using a fixed base year. This is an inflation-adjusted measure of GDP. The rate of change in real GDP between two consecutive years is called growth in real GDP. The average real GDP growth in Australia is 3.11%. During this span, the highest growth rate is accounted in 1999 with a growth rate of 5.01%. The nation accounted a negative growth rate of -0.38% in 1991.

The interest rate that Reserve Bank of Australia charges on loans given to other banks in the economy is known as the cash rate. The cash rate for the chosen period is averaged at a rate of 5.63%. As shown from the data the highest cash rate is charge in 1990 with a rate of 15.23 and recently in 2015, the cash rate reached to a recorded low level of 2.13%.

As far as unemployment rate is concerned, the average unemployment rate is 6.77%. The unemployment rate reached to its peak level in 1994 and lowest rate of unemployment is recorded in 2008 with a recorded rate of 4.40%. Australia has maintained a more or less stable price level with inflation rate averaged around 2.73%. For the given time period the inflation rate was stared with a highest rate of 7.27% in 1990. In the same decade, in 1997 the price level has reached to its lowest level of 0.25%.

Components that determine GDP

The next two variables considered are exchange rate and net export. These two variables are inter related. In times of currency depreciation, export increases and import decreases causing a rise in net export. The exchange rate between Australian dollar and US dollar are taken. Australia and US share a strong trade relation (Berger-Thomson and Chapman 2017). The average exchange rate between the two nations is 1.35. Australian dollar highly appreciated in 2011 and 2012. During this time Australian dollar valued 0.97 per unit of US dollar. In 2001, Australian dollar depreciated maximum with exchange rate being 1.93.

Australia is engaged in trade relation with many nations. The average trade balance in the chosen period is 20.310 billion AUD. Australian enjoyed a maximum trade balance of 66.706 billion AUD in 2001 following high depreciation of exchange rate. There is a trade deficit of -51.198 billion AUD because if high imports resulted from currency appreciation.

Correlation between GDP and five indicators
	Real GDP growth rate	Interest rate (Cash rate)	Unemployment rate	Inflation rate	Exchange rate (AUD/US)	Net export
Real GDP growth rate	1
Interest rate (Cash rate)	-0.08	1
Unemployment rate	-0.13	0.28	1
Inflation rate	-0.03	0.64	-0.23	1
Exchange rate (AUD/US)	0.20	0.04	0.26	0.08	1
Net export	0.23	0.26	0.55	-0.02	0.85	1

Cash rate in Australia is the rate at which reserve bank lends to commercial banks. A low cash rate means commercial banks can borrow from the reserve bank at a cheap rate (Bernanke, Antonovics and Frank, 2015). This increases the availability of loanable funds in banks. Interest rate being the cost of investment, a low interest rate is expected to increase investment in the economy and hence, GDP. Therefore, usually an inverse relation exists between cash rate and GDP growth rate.

The Australian economy has maintained a standard growth rate. The economy advanced a growth rate of 0.6 percent in the last quarter of 2017. The positive contribution in growth is coming from non-dwelling construction sector. The construction sector added on an average 0.9 percent in growth. The component of GDP such as household consumption and export has made respective contribution of 0.1 percent and 0.4 percent. The contribution from government expenditure is relatively less showing a weak fiscal policy.

Cash rate is a monetary policy tool of reserve bank of Australia. The trend shows as cash rate starts decreasing GDP growth rate increases. The low cash rate is an indicator of expansionary monetary policy. The cash rate has a continuous declining rate. In order to stimulate economic growth, RBA has lowered the interest rate as much as possible (McCombie and Thirlwall, 2016). In 2015, the cash rate was as low as 2.13 percent and is the lowest in its 26 years period. The low interest rate by boosting economic growth provides a great support to the economy.

Basic statistics of GDP growth rate and other economic variables

The status of employment in an economy depends on the production activity, which is indicated from the GDP. The growth in GDP implies an expansion of productive activity creating new sources of employment opportunities (Heijdra, 2017). Therefore, there should be an expected inverse relationship between the two variables. The estimated correlation coefficient between GDP growth rate and unemployment rate is -0.13. This implies an increase in GDP means a decline in unemployment rate and vice versa.

The GDP growth rate and unemployment rate moves in opposite direction. As the GDP growth rate increases, the unemployment decreases. With economic growth, the employment in Australia has increased significantly. Total employment has increased to 12.44 million rising nearly by 34.7 thousand. The unemployment has mostly reduced due to an increase in part time employment rate (tradingeconomics.com, 2018). The participation rate among the labor force increases by 0.2 percent. The participation rate has increased above the expected rate.

Inflation rate captures the rise in general price level. A low to moderate inflation is good for economic growth. When price level increase because of stimulation in demand then this encourages producers to produce more. However, if inflation is caused from rising cost then this is not beneficial for the economy (Mankiw, 2014). A high debt associated high inflation rate hampers economic growth. The correlation between GD growth and inflation from historical data of Australia turns out to be -0.03. Though inflation is supposed to increase GDO growth rate but in case of Australia, the relation does not hold because of high debt.

The inflation rate and GDP growth rate is moving in the opposite direction. The inflation rate is currently in a historically low level following RBA’s expansionary monetary policy. The RBA has set the cash rate to a recorded low level because of a weak growth in the domestic economy. The price level in Australia is moving at a relatively slow rate. The fall in prices observed for food and non-alcoholic beverages, cloth and footwear, household equipment, services, communication, and furnishing (Shafiullah, 2014). Some products such as tobacco, electricity, alcoholic beverages and transport. However, there is an overall declining trend in inflation.

Exchange rate is the value of one country’s currency measured in terms of currency of some other country. An increase in exchange rate means depreciation of domestic currency. When currency depreciates then export becomes cheaper. A rise in export means an increase in net export, which in turn implies a growth in GDP (Hartwell, 2017). The correlation coefficient between growth and exchange rate is 0.20. This implies a positive relation between growth and exchange rate.

Impact of cash rate on GDP growth rate

The value of Australian dollar in terms of US dollar is stabilized between 1 to 2. The trend in GDP growth and exchange rate though is not similar but positively related.

Net export shows the trade balance that is export earnings less import spending. A positive trade balance implies export earnings exceeds import spending. This adds to economic growth of the nation (Gregory and Smith, 2016). The correlation between GDP growth and net export is 0.23. The positive correlation implies a rise in net export is associated with a rise in GDP.

Australia has accounted a rising trade deficit for the last few years. The trade deficit resulted from an increase in the volume of import while export remains at the same level. The imports of consumption goods, intermediate goods, capital goods especially telecommunication equipment has increased. The service import also increases. As far as the export is concerned sales of non-rural goods, mineral fuels, metals, mineral ore and service export has increased (Salahuddin et al., 2015). The export of non-monetary gold has declined and the new export for merchandise remain unchanged.

The general relationship between inflation and unemployment is explained by Phillips curve. The theory of Phillips curve, developed by A.W. Phillips suggests an inverse and stable relation between inflation and unemployment. The simple explanation of Phillips relation is that economic growth generally come with a high inflation rate (Bishop and Cassidy, 2017). The high inflation encourages production by increasing profit margin. With expansion in production, more jobs are created and this likely to reduce unemployment rate.

Correlation between inflation and unemployment
	Unemployment rate	Inflation rate
Unemployment rate	1
Inflation rate	-0.23	1

The correlation between inflation and unemployment is estimated as -0.23. Therefore, the historical trend of inflation and unemployment supports the relation explained by the Phillips curve.

At the initial stage, the inverse relation between inflation and unemployment holds good. However, after 1990 recession the relationship has shifted. The Phillips curve becomes flatter. During this time, there was a fall in price level with unemployment level stuck following a shortage of aggregate demand (Lin and Cheng 2016). This is partly due to a decline in inflation expectation. The severe inflation in 1991 led to a steep decline in the rate of annual inflation. This reduces the inflation expectation. There was a persistent unemployment in the economy as firms shed full time employment and replaced with part time employment. In the middle of 1990s, the aim of RBA’s monetary policy was to achieve the twin objectives of an average inflation ranged between 2 and 3 percent and a desirable level of output and inflation (rba.gov.au 2018). For this, RBA first sets an inflation targeting and then adjust interest rate or cash rate.

Relationship between GDP growth rate and unemployment rate

A tight monetary policy is set to stabilize the price level from an unusually high level. During 1980s, RBA had undertaken a tight monetary policy to reduce inflationary pressure. The cash rate had reached to a very high level during this time (Bauer and Neely, 2014). In 1990, the targeted cash rate was 15.23%. The rate though reduced slightly in the next year but remained at a high level of 10.64%. However, the tight monetary policy in 1980s ended up with a severe recession in 1991. To rescue the economy from recessionary shocks monetary policy again eased with a declining nominal and real interest rate. However, in the middle of 2000s, RBA again resort to a tight monetary policy (smh.com.au, 2018). From 2004, onward RBA had gradually started raising the cash rate with the belief that a tight monetary policy might help the economy to slow the growth in domestic demand and control inflation. An increase in the home loan rate would tight the financial condition. This would help to reduce household debt.

The future outlook of the economy is based on the current and past performance trend. The forecasted growth rate is happened to be between 2.5 and 3.5 percent and is expected to achieve a rate of 3 to 4 percent in the coming quarters of 2018. A persistently low interest rate will stimulate economic activity and will boost household demand. Instead of a modest growth in average income demand is expected to gain necessary stimulus from the low interest rate. The growth outlook towards wage rate is relatively week depressing average household income (Mishkin, 2017). Despite a low saving ratio of household, investment will gain momentum from residential construction and investment. Following a low wage growth, the inflation expectation will continue to remain at a low level. The economic has reduced the risk of recession in the coming years through a percentage fall in housing price (abc.net.au, 2018). With increase in non-mining investment, different business gains risk mitigating chances of possible recession.

Conclusion 

The paper evaluates macroeconomic performance of Australia for a significantly long period. The economy being one of the developed nation in world has maintained stable growth rate averaging around 3.11 percent. The RBA by reducing the cash rate attempts to provide necessary support to the economy. The unemployment rate is declining with job growth in different sectors. Price level is also in a fairly stable state. The economy suffers from a trade deficit for the last few years as experienced from a currency appreciation. The monetary policy in Australia has passed through different phases. RBA takes expansionary or tight monetary policy depending on the economic state. The country with its strong growth rate and support received from central bank has minimized the risk of future recession.

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