Executive Summary International economy is going through tough conditions owing to different factors such as higher sovereign debt levels, low demandetc. Australian economy performed well during the troubling periods however, the recent performance of the economy is not so impressive. Inflation rate is increasing in the economy as well as the unemployment level however; interest rates have not been increased by the reserve bank of the country. Rising inflation level, contractionary fiscal policy as well as the increasing level of unemployment may reduce the aggregate demand in the economy thus forcing the interest rates to rise. Introduction Global Economy is experiencing one of its worst phases of history because of the widespread economic downturn.
What started with the subprime mortgage crisis has now created widespread economic panic which has even resulted into the downgrade of credit ratings of the largest economy of the world. The emerging sovereign debt crisis has exposed many governments’ ability to maintain a sustainable level of debt. The Euro Zone is actively looking for new ways and means to support economies like Greece, Spain, Portugal, Italy to avert their sovereign default.
Considering such situation, the overall growth prospects for the world economy are suggesting a stagnant growth rate of approximately 4.5% for current year and for the year 2012 and 2013. Australian Economy however, despite such downturn managed to achieve reasonable growth rates as well as better economic performance. Growth during 2010 and 2011 remained healthy despite the fact that country faced harsh weather conditions which slowed down economic growth. Real GDP increased by 2.7% as on Dec 2010 however, growth in household consumption remained low. It is important to note that there is a gradual increase in the inflation owing to rise in the food prices.
(BBC, 2011). Increasing inflation level therefore may erode the overall economic growth of the country if it is not able to control inflation levels. The recent statistics for the unemployment level also suggest that the overall level of unemployment is increasing in the country. Figures for July 2011 suggested an unemployment rate of 5.1% which seem to have surprised many. (Zappone, 2011). Current Economic Situation in Australia As discussed above that economy of Australia posted improved performance when world was witnessing economic and financial turmoil.
However, the recent data suggests that the overall economic situation may not sustain for long as there is a gradual increase in the level of inflation as well as the unemployment level. The overall cash rate i. e. the rate offered by Reserve Bank of Australia is held at 4.75% however, there are indications that the overall rate may further be increased due to rising inflation level. (RBA, 2011). Higher interest rates prevailing in the economy may be due to the fact that the Australia may be looking for to ensure that the inflation remain within control. The recent monetary policy issued by the central bank of the country suggests that the increase in the level of unemployment has slowed down however; it is still increasing thus causing important repercussions for the Australian economy.
It is also important to understand that the overall industrial wages are also increasing in the economy thus increasing the overall burden on the firms in terms of their overall variable costs. It has also been suggested that the overall fiscal policy is being exercised in contractionary mode thus creating an environment where the demand for government purchase of goods and service may decline.
Such contraction therefore may result into the reduction in the overall aggregate demand in the economy and thus reduce the overall growth rates. The current performance of the economy therefore may witness further decline in the future. Important Factors One of the key challenges faced by reserve bank is the declining consumer activity within the economy. The lack of domestic demand therefore may be one of the key economic variables which may be forcing the bank to keep the interest rates at the current level.
Due to lack of domestic demand, higher interest rates may further discourage the consumption activity since consumer credit will be expensive therefore overall household consumption may decline. Further, the increasing inflation within the economy may further influence the reserve bank to increase the interest rates. (Murdoch, 2011). This may therefore a delicate situation for the reserve bank as at on one hand it has to ensure that economy registers a health growth rate while at the same time ensuring that the overall inflation rate remain within control.
The growth of Australian exports has also seen a decline and as such Australian currency is appreciating against US Dollar. Such situation may not be favorable for the exporters as the Australian exports will be more costly as compared to exports from other countries. In order to ensure that the exchange rate remains at an acceptable level, reserve bank may have to keep the interest rates at the current level. The overall depressive conditions in the international market may also be another important factor forcing Australian Central Bank to keep the interest rates at the current level.
(RBA, 2011). Increasing current interest rates may increase the borrowing costs of the firms and may hurt the exports of the country. Explanation of the situation As per IS-LM framework, if interest rates are increased, there will be an upward shift in the aggregate demand curve. An upward shift in the aggregate demand curve will therefore reduce the national income level and hence the growth of the economy will decrease. (Gordon, 2009). As discussed above that the Australian economy is also experiencing a contactionary fiscal policy therefore a reduction in the government purchases will also result into the reduction in the national income level.
Y = C + I +G+NX It is also important to understand that due to the reduction in the national income, the overall reduction in the national income may shift the LM curve upwards also.
Since the inflation rate is increasing therefore the existing stock of money will lose its value therefore in order to reduce the inflation rates, interest rate may further go up. Conclusion The above discussion suggests that Australian economy may experience a decline in the economic activity in the recent past. The increasing inflation as well as the increasing in the unemployment level may force Reserve Bank to increase the interest rates. As such this may result into the decline in the exports of the country due to depressed international market conditions. References 1.
BBC (2011). Australias inflation accelerates on rising food prices [online]. [Accessed 16 August 2011]. Available from: . 2. Murdoch, S (2011). Reserve Bank puts interest rates on hold despite price-inflation risks [online]. [Accessed 16 August 2011]. Available from: . 3. RBA (2011). Economic Outlook [online]. [Accessed 16 August 2011]. Available from: . 4. RBA (2011). Minutes of the Monetary Policy Meeting of the Reserve Bank Board [online]. [Accessed 16 August 2011]. Available from: . 5. Gordon, R (2009). Macroeconomics. 11th Edition.
ed. New York: Little Brown. 6. Zappone, C (2011). Jobs figures loom as critical gauge of the economy Read more: http: //www. smh. com. au/business/jobs-figures-loom-as-critical-gauge-of-the-economy-20110811-1ino3.html#ixzz1VJ7YVmTf [online]. [Accessed 16 August 2011]. Available from: http: //www. smh. com. au/business/jobs-figures-loom-as-critical-gauge-of-the-economy-20110811-1ino3.html