Effect of Global Crisis on Australian Economy - Case Study Example

Effect of Global Crisis on Australian Economy Name: Institution: Course: Lecturer: Date: Australian Economy The interconnection of the financial markets means that shock displayed by the global crisis was fast felt in Australia. There was a sharp decrease in prices of financial assets whereas access to international capital proved difficult. In broad terms, the confidence of businesses, consumers and external demand fell whilst domestic demand weakened. By the month of November 2008, equity prices in Australia had declined by 50 percent compared to prices during the previous year. The equity markets within Australia declined further than both United States as well as the global markets in the same period. The disintegration of international capital flow made access to funding extremely difficult. For instance, there was cessation of issuance of funds to RMBS, despite low-default-rate of Australian mortgages (Dyster & Meredith, 2012). The resultant effect of a weaker economy was reduction in demand of Australian exports. This subsequently resulted to fall in volumes as well as prices that led to decline of the country’s trade plus the exchange rate. Between December 2008 and April 2009, terms of trade declined by 10 percent, while more declines was felt in June 2009 reflecting movement of prices regarding key commodity exports. The dollar fell by 10 percent on trade-weighted basis within the two years period (Guillén, 2009). According to Dyster & Meredith (2012), a major transmission mechanism of global financial crisis was how it affected business confidence in Australia. By the close of 2008, the level of business confidence had declined sharply whilst investment decisions plummeted. According to survey conducted during the period, business conditions were hitting their lowest points since the 1991 recession. As a result of the global forces, Australian economy backtracked though the slowdown felt was moderate as compared to other developed nations. Despite these effects, business confidence recovered very quickly in Australia than other OECD nations. The main factor that resulted to such regain was announcement of Jobs Plan as well as the Nation Building. Consumer confidence resurfaced and rose sharply in 2009 with the announcement of 2009 GDP outcome. The economy recorded positive growth and thus avoiding multiple quarters of declining GDP. The unemployment rate was standing at 5.8 percent compared to the OECD standard rate of 8.8 percent. Comparatively, Australian economy was remarkably stronger in light of shock to the nominal incomes. The nominal GDP maintained a rate of 8.1 percent in the year 2008 but diminished by 2.5 percent within 2009 period. This was attributable to fall in terms of trade (Aloui, Aissa & Nguyen, 2011). Financial Policy Response Australian financial firms’ access to wholesale funding which could have overseen continuous lending was greatly impaired. Furthermore, global financial crisis was associated with sudden shortage of liquidity within key financial markets which included short-term debt securities as well as foreign exchange markets. The greater market volatility fronted risk even to the high-rated solvent institutions. In this regard, the measures that had been embraced to support financial institutions were vital for sustaining financial system stability plus overall growth of the economy. The Reserve Bank put appropriate measures ensuring continued liquidity within the banking system as well as in the foreign markets. Range of securities transacted by authorised deposit-taking firms as security for RBA exchange settlement was expanded (Cetorelli & Goldberg, 2011). RBA entered into an agreement with US Federal Reserve with an aim of addressing elevated pressures of US dollar funding markets within the Asian time zone. Moreover, the government undertook other measures in support of the financial sector which includes provision of government guarantees pertaining to deposits and whole debt securities as well as directing purchase of substantial package related to mortgage-backed securities by AOFM (Aloui, Aissa & Nguyen, 2011). This argues that the relative strength of Australian financial system played a significant role in inducing strong performance of the economy during period. Furthermore, the success related to monetary policy reaction would not have been realised had the Australian financial system responded to the crisis as the other economies did. Monetary Policy Reserve Bank of Australia was compelled to ease the monetary policy in response to global downturn. Cash rate declined from 7 percent to 3 percent in 2008 and 2009 respectively. Importantly, much of the easing in cash rate flowed to lending rates. Since a substantial number of households as well as business loans were variable, the policy was translated to a variation in household disposable returns. In contrast, the interest rates in the advanced economies were relatively low during the initial period of global downturn. This left monetary policy with less scope to respond (Cetorelli & Goldberg, 2011). In contrast to Australia, only Bank of England decreased official cash rate just as Australia, although England maintained lower rates at the inception period. On the other hand, New Zealand responded aggressively and reduced the rates more than Australia. Different countries shared the market pertaining to fixed and variable mortgages whereas Australia benefitted from a higher share (Obstfeld & Taylor, 2004). It is challenging to quantify the effects posed by monetary policy. This is because the policy works through variety of transfer channels which affects the overall economy with lasting variable lags. However, according to research, some impacts are felt immediately, while sometimes it can take considerable period of time to experience the effects related to monetary policy decisions (Cetorelli & Goldberg, 2011). The magnitude to which monetary policy was employed to support Australian economy was affected by the prevailing shock. The financial institutions exercised their caution in issuing credit while consumers exercised their caution in borrowing and spending. However, the most important factor that necessitated transmission of monetary policy was consumer confidence. In Australia, the shrunk in confidence of consumers as well as businesses was felt during the initial stages of the crisis. However, this confidence was recovered later-on at a stronger magnitude as compared to other countries. It is therefore rational to assume that the sharp decline in the rates of interest coupled with an early fiscal policy response led to the rebound which reinforced first-round effects (Aloui, Aissa & Nguyen, 2011). Movement in Dollar The effect of global shock was restructured by the sharp decline in Australian dollar. The fall in currency emerged from reduction in Australian interest rates. However, the impact was somehow muted by cut in the rate of interests in the other nations, which caused the interest to decline than the reduction in the official cash rates. Generally, the decline reflected a weaker global outlook as well as expectations of a reduction in the country’s terms of trade. By mid 2008, Australian dollar was operating close to its post-float peak. In October 2008, the currency had fallen tremendously hitting a low of 55 per TWI basis plus 65 cents trading against US dollar. The lower dollar strengthened the economy of the country, moderating the effect of Australian dollar against low international prices for the country’s exports. This improved competitiveness of the country’s manufacturers, service exports as well as import-competing industries. The moderate duration of exchange rate trough, subsequent volatility as well as the sharp reversal meant that overall contribution towards growth within the downturn period could have been modest (Rudd, 2009). Fiscal Policy The role played by fiscal policy during and after the downturn is worth discussion. The global crisis hit Australia when it had a very strong fiscal position. The country has a budget surplus as well as negative net debt compared to the most advanced economies. Thus, the emanating flexibility and credibility resulted to a strong fiscal response towards the crisis. The existing fiscal space provided a room for the government to mandate automatic stabilisers actions and organisation for an extensive discretionary stimulus, whilst maintaining strong fiscal position. Discretionary Fiscal Policy The government of Australia found it prudent to introduce significant discretionary fiscal packages during the downturn from October 2008 up-to February 2009. This was coupled by extensive structural initiatives in year 2009 budget. During this period, the government provided 10.4 billion dollars acting as fiscal stimulus package within her economic security strategy. The package comprised largely cash transfers directed to low as well as middle income earners. In November 2008, more funding amounting to 15.2 billion was announced by the government acting as COAG funding package where the funds were to be distributed in a 5 years period. More funding was announced in December 2008 (4.7 billion dollars) and was regarded as Nation Building package. Some 42 billion dollars directed to Nation Building and Jobs Plans was announced in the year 2009. These monies were directed to low as well as middle income earners. The monies were also to fund investments in different sectors of the economy including housing, community infrastructure, roads, business support and schools (Obstfeld & Taylor, 2004). Performance of Australia’s Trading Partners While the country’s main trading partners were equally impacted by global crisis, they illuminated their power and recovered quickly than the global economy. Particularly, the effect in China was largely felt. Despite the fact the China’s GDP was not reported, estimates from the treasury showed a 2 percent decline in GDP in September 2008 with a rebound achieved in the month of March 2009. Despite a sharp decline in demand for the country’s commodities in the global market, Australia was shielded by the moderate demand within the Chinese market. The early recovery illuminated by China was as a result of rapid monetary as well as fiscal stimulus. However, researchers argue that the strength depicted by Australian partners particularly China was competitive rather than complementary factor whilst fiscal stimulus played an important role in this respect (Obstfeld & Taylor, 2004). For over a decade, Australia had established key markets for her commodity products in Asia. This means the Asia was considered important destination for the country’s merchandise exports. The exposure and mutual collaboration with the Asian region is deemed as the biggest factor towards the country’s strong performance at the crisis period. Consequently, the early recovery of the country’s major partners contributed significantly towards stronger response of the crisis (Guillén, 2009). Traditionally, the Australian exporters had been largely price takers whereas volume of exports replicated productive capacity. The demand fluctuations were mainly reflected through changes in export prices. This means that the collapse in international demand in 2008 was adequate to impact significantly on trade volume and towards Australia’s commodity exports, especially the commodities with the largest share in the global arena. Structure of Economy The global downturn impacted volume of trade on products unevenly. The non-durable products were least affected while durable consumer products as well as capital products were largely affected. One of the main reasons why Australia had a strong resilience is that the country had somewhat small manufacturing sector coupled with large commodity sector as compared to OECD average. Since the global shock highly concentrated on the manufacturing sector, having moderate proportion of activity in the sector depicts strong performance of the country during the crisis (Guillén, 2009). Conclusion The disruption of the global market from 2007 to 2009 impacted significantly on Australian financial markets and the overall economy. While the local markets were disrupted, the magnitude of dislocation is considered minimal as compared to the other economies. One important reason to this resilience is the strong Australian policy response (fiscal policy stimulus), nature of the manufacturing sector, strong trading partners, competitive Australian market and introduction of strong regulatory framework in the economy (Guillén, 2009). The degree of the counterparty risk aversion was less in the Australian markets while the manufacturing sector in which significant effect of the downturn was felt, was small in size. However, restoration of business as well as public confidence regarding the economy played a major role towards recovery. References Dyster, B. and Meredith, D., 2012. Australia in the global economy: Continuity and change. Cambridge University Press. Guillén, M., 2009. The global economic & financial crisis: A timeline. The Lauder Institute, University of Pennsylvania, pp.1-91. Aloui, R., Aissa, M.S.B. and Nguyen, D.K., 2011. Global financial crisis, extreme interdependences, and contagion effects: The role of economic structure?. Journal of Banking & Finance, 35(1), pp.130-141. Rudd, K., 2009. The global financial crisis. Monthly, The, (Feb 2009), p.20. Obstfeld, M. and Taylor, A.M., 2004. Global capital markets: integration, crisis, and growth. Cambridge University Press. Cetorelli, N. and Goldberg, L.S., 2011. Global banks and international shock transmission: Evidence from the crisis. IMF Economic Review, 59(1), pp.41-76. Read More