Gross Domestic Product (GDP) and Inflation

The assignment will enlighten a few key economic variables which can be held responsible for representing the economic condition of the Australian economy. These variables are examined and discussed with the help of the real time data available in the website of World Bank. On an added notion, the assignment will also examine if there is a relationship between these specific variables or not. Furthermore a conclusion will be drawn on the basis of the above analysis and it would predict whether the Australian economy will face an inflation or a recession in the upcoming years.

The GDP or gross domestic product is defined as the final monetary value of all the goods and services produced within the boundary of the nation for a stipulated time period. The gross domestic product amalgamates the private and public consumption expenditures, paid in construction costs, private inventories and the foreign balance of trade (Kuttner and Shim, 2016). Henceforth, it is quite evident that GDP can be regarded as the measure of overall economic activity of a nation. At the same point of the GDP effectively portrays the economic well-being and standard of living of the people of the country as well. Gross Domestic Product can also be divided into two categories which are namely nominal GDP and real GDP. Nominal GDP is simply the value of goods and services produced within the boundaries of the nation for a specific time period while on the other hand, the real GDP is the same value adjusted against the prevailing rate of inflation (Rees et al., 2016). In this context it is necessary to mention that the term inflation signifies a sustained rise in the general price level of the goods and services. Hence the rate of inflation can be characterized as the rate at which the level of inflation changes over the passage of time.

The figure above portrays the relationship between GDP growth rate and the rate of inflation in Australia during the time period of 1990 to 2016. From the figure above it can easily be pointed out that Australia has always experienced a stable and sustained rate of inflation over the time period taken into consideration and this is often regarded as good for the health of the economy (Behlul et al., 2017). However, the GDP growth rate has fluctuated significantly during the time period. The higher GDP growth rate signifies that the country is now producing more goods and services at the same price. This in turn reduces the rate of unemployment which again leads to higher demand for goods and services as the purchasing power of the people goes up. These altogether results in higher GDP and inflation.

Relationship between GDP Growth Rate and Unemployment Rate

There are certain factors which affect the growth of gross domestic product and unemployment rate of an economy. As per the empirical evidences available it can easily be stated that if there is an one percent decrease in the level of gross domestic product that would certainly lead to an increase in the rate of unemployment rate by not more than two per cent. This relationship was first pointed out by Koum and hence it is popularly known as the Koon’s Law. The figure above depicts the movement of GDP growth rate and the rate of unemployment during the time period of 1990 through 2016 (Summers, 2015). From the figure above it can be outlined that during the early stages of 1990 through 1991 GDP growth rate started to increase which at the same point of time the rate of unemployment also started to rise. However, after 1991 the GDP growth rate started to diminish however, the rate of inflation kept of rising. Although the GDP growth rate increased again during the time periods 2001 to 2004, 2006 to 2008 and again during 2009 to 2010. However, during these time points the unemployment rate remained almost the same although during the period of global financial crisis for the time period while the GDP growth rate started to decline the unemployment rate portrayed a slight increase (Manalo et al., 2015). Therefore, it can be stated that the movements of these two variables across the selected time period have depicted significant deviation from the historical evidences. Economists have argued that there will be a decrease in the rate of unemployment right after the recovery from the recession as the Okun’s law suggested that an increase in the GDP growth rate would lead to a decrease in the rate of unemployment (Downes et al., 2014). However, in reality this was not the scenario the GDP growth rate increased substantially but the unemployment rate remained almost the same.

The business cycle is characterized as the periodic and natural rise or fall of the economic growth rate of a nation. The business cycle is considered as one of the most important tool which is extensively used for analyzing and predictive purposes of an economy. In a standard business cycle there are mainly four distinct stages which are expansion, peak, contraction and trough. In relation to the current scenario it can be stated that there is clear evidence of the existence of business cycle (Rey, 2015). For instance during the time period 2001 through 2004 and 2006 through 2008 the GDP growth rate of the Australian economy depicted significant rise which can be regarded as the expansion phase of the business cycle. Although the emergence of global financial crisis the GDP growth rate started to decline from the peak of 2008 and this period after 2008 can be regarded as the phase of contraction. During the year 2009 the economy again started to recover from the trough (Goodman et al., 2017). In relation to the two diagrams as stated above it can be observed that the rate of unemployment and inflation also varied accordingly with the variations in the growth rate of GDP.

Business Cycle in Australia

The net exports of a country can be defined as the monetary value of the total exports of the country less than the monetary value of the total imports of the nation. The net exports is used for estimating the expenditure within the country or measuring the gross domestic product of an open economy. Author, have defined net exports as the extent to which the expenditure on the part of the goods and services of the home country supersedes the expenditure of the home country over the foreign goods and services of the foreign country.

On the other hand, the exchange rate is characterized as the price of currency of a nation in terms of the currency of the other nation (Hannaford and Allen, 2015). Therefore, it can be stated that the exchange rate possesses two distinct components which are domestic currency and foreign currency and it can either be quoted directly or indirectly. In the genre of direct quotation the unit price of the foreign currency is expressed in terms of the domestic currency. On the other hand, under indirect quotation regime the unit price of the domestic currency is expressed in terms of the foreign currency.

The diagram above represents the value of the exchange rate of Australian Dollar against the U.S. Dollar and the value of net exports for the time period of 1990 through 2016. It is expected that the relationship between these two variables can be traced out through this diagram.

As it can be observed from the figure above that the exchange rate of Australia remained almost the same during the selected time period and has not depicted any significant fluctuations as well (Waemustafa and Sukri, 2016). However, in relation to the net exports it can be observed that net exports of the Australian economy always remained on the negative side which signifies that Australia is a major importer of the foreign goods and services. It has been observed in the figure that the net export value of Australia only touched a positive value in the year 2011, although it again became negative in the consecutive year. Among the largest exporting countries in the world Australia has ranked 23 during the year 2016. During that very year the country exported goods and services worth of $159 billion while imported the foreign goods and services worth of $181 billion as a result of this there were a trade balance deficit of %22.1 billion. It has been observed that the top most exported goods of Australia are Petroleum Gas, Coal Briquettes, Gold and Iron Ore while the most imported products included cars, refined petroleum products and crude petroleum as well (Eichengreen, 2015).

Net Exports and Exchange Rate

Now in connection with the relationship between real exchange rate and the net export it is necessary to develop a proper understanding between the differences of nominal and real exchange rate. The nominal exchange rate is defined as the total amount of domestic currency that can be exchanged against one unit of the foreign currency (Mumtaz and Theodoridis, 2017). At the other end of the spectrum, real exchange rate is defined as the amount of goods and services that could be obtained in exchange of the goods and services of the foreign currency. Economists have pointed out a significant relationship between real exchange rate and net exports. For example when the real exchange rate increases it will signify that the relative prices of the goods and services in the home country is higher than that of the relative prices of the goods and services in the foreign country. In such a condition import is more likely to be favored as in real terms the goods and services of the foreign country is cheaper. Although in the context of Australia it can be stated that there were no such fluctuation in the real exchange rate and it remained more or less same though there were significant deviations in the net export (McCombie and Thirlwall, 2016). Henceforth it can be stated that there is no such relationship between the real exchange rate and net export in Australia at least for the given time period.

Cash rate is characterized as the interest rate which is charged by the central bank for the overnight borrowings of the commercial banks. The system of cash rate indirectly influences the prevailing interest rate in the economy. On the other hand, the cash arte target expresses the monetary policy decisions.

The Reserve Bank of Australia follows a strict approach for the implementation of monetary policies which is also known as the inflation targeting. This in turn signifies the fact that the country sets a numerical target of inflation and thereby develops a significant framework for achieving that target (Eichenbaum et al., 2017). The cash rate of Australia touched the lowest value of 1.5 per cent. This lowest value signifies that if there is a negative shock over the economy the government would merely get a chance to influence the cash rate anymore. It is also matter of fact that when the inflation rate is below the target level the reduction in the cash rate would in turn signify a reduction in the long term interest rate which allows the people to buy more of the goods and services. This increase in the demand also increases the price level and brings back the inflation to its previous level.

Real Exchange Rate and Net Exports

The federal government on the contrary uses forward guidance for controlling the cash rate. During 2008 the federal funds rate touched the lower bound zero and as a result of that the Federal Reserve lowered the federal funds rate for certain times. The figure above depicts the movement of the federal cash rate and the Australian cash rate. The Australian Cash Rate depicted significant fluctuations during the selected time period (Miller et al., 2015). It started declining from the high value since 1990 and reached the lowest value during 1995 the same value it has achieved during 2004 and 2014 as well. During the rest of the years it maintained a sustained value. On the other hand, the Federal Cash Rate has also fluctuated during 1990 to 2008 it depicted several rise and falls (Summers, 2014). However after 2008 it maintained a lower value almost equal to zero. In the context of the relationship between the Australian Cash Rate and Federal Cash Rate it can be stated that these two are the two different components of the monetary policy of two different countries. Hence it is quite natural that there would be no relationship between these two. However, if the federal cash rate can influence the exchange rate of the Australian economy then the Australian cash rate could be influenced by the changes in the federal Cash Rate.

On the basis of the empirical data analyzed throughout the study suggested the fact that the economy of Australia will continue to flourish in near future. The GDP growth rate of the country is depicting as steady growth rate the investments apart from the mining and housing industry will increase (Panizza and Presbitero, 2014). As the resource capacities of the country is increasing it will result in a rise in the level of exports as well. On an added notion, further strengthening of the labor market and the household incomes will help to sustain the private consumptions. This will give rise to an increase in the wage rate and the inflation rate as well (Fornero et al., 2016).

The GD growth rate, rate of inflation as well as the rate of unemployment strictly depicts that currently Australian economy is in a very good health and shape. The country managed to sustain a substantial GDP growth rate even after the emergence of the global financial crisis the country managed to recover quickly. On the other hand, Australian economy managed to maintain a substantially lower level of unemployment which signifies that the wage rate prevailing in the economy could attract substantially large number of workers to the industry. In the context of inflation it can be stated that the inflation rate has remained stable throughout the selected time period (Nakamura et al., 2016). Therefore, it can be forecasted that the country in near future may experience an inflation but chances are low that it will face any financial downfall. This is because the business cycle of the country depicts that during 2016 the country has achieved a trough and it is thereby now in a stage of recovery and it can easily be expected that it will continue to rise as the recovery phase will emerge. Henceforth, it can be expected that the country will face an inflation in near future.

Reference List

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