Economics Macro IA

Quang Lam

MACROECONOMICS INTERNAL ASSESSMENT

IB Economics Internal Assessment School code

Name of school

United World World College Maastricht

Quang Lam

Candidate name Candidate number

1

Teacher

Louis Odendaal

Title of the article

Reserve Bank of Australia cuts official cash rate to record low 2% at May meeting

Source of the article

The Sydney Morning Herald  Mark Mulligan

Date the article was published

5 May 2015

Date the commentary was written

15 September 2015

Word count (750 words maximum

5! "ords

Section of the syllabus the article relates to

Section 2# Macroeconomics

Reserve Bank of Australia cuts official cash rate to recor lo! "# at Ma$ meeting Ma$ %& "'(% ) The S$ne$ Morning *eral ) Mark Mulligan The Reserve Bank of Australia on Tuesday cut the cash rate to a new record low of 2 !er cent" citing some ongoing economic weakness for its decision# The widelye$!ected uarter!oint reduction" the second in three months" takes lending rates to the lowest !oint since at least the late 1&'(s# The Australian dollar immediately reacted" !lunging more than )S(#*(+ to )S**#,,+# However" it uickly recovered to a new day-s high  of )S*&#('+  as details emerged on why the .oard voted to cut rates# RBA governor /lenn Stevens said the decision came des!ite some 0im!roved trends in household demand over the !ast si$ months and stronger growth in em!loyment0# However" he added 0ooking ahead" the key drag on !rivate demand is likely to .e weakness in .usiness ca!ital e$!enditure in .oth the mining and nonmining sectors over the coming year# 03u.lic s!ending is also scheduled to .e su.dued#

2

0The economy is therefore likely to .e o!erating with a degree of s!are ca!acity for  some time yet#0 The latest round of rate cuts" which .egan with 4e.ruary-s dro! to 2#2' !er cent" is aimed at s!urring .usiness investment outside mining and encouraging the socalled 0animal s!irits0 which create 5o.s and drive innovation# However" it could also further fan the flames of the hot Sydney !ro!erty market and run the risk of creating a .u..le#  According to Rate6ity#com" Tuesday-s cash rate cut will euate to home loan rates di!!ing .elow 7 !er cent this month" the lowest on record# 3eter Arnold" .anking analyst at Rate6ity#com" said ty!ical .orrowers would save around 812(( this year on their home loan re!ayments com!ared with what they !aid the !revious year# 4or a lot of !eo!le in the ca!ital cities it will .e around dou.le that# 09t-s not 5ust the RBA who-s .een cutting rates: the lenders have .een getting in on the action as well"0 he said#  A;< was the first of the ma5or .anks to announce its res!onse to the Reserve Bank-s cut" saying it would lower its standard varia.le home loan rate .y (#2' !ercentage !oints" effective this 4riday# Tuesday-s cut comes 5ust days ahead of the RBA-s uarterly statement on monetary !olicy" in which the .ank will detail !revailing weaknesses in the Australian economy such as low commodity !rices" the falloff in ca!ital investment" restraints on fiscal s!ending and relatively high unem!loyment# The central .ank-s language on Tuesday" however" a!!eared to suggest less of an easing .ias" meaning this might .e the last cut in the current cycle# Mr Stevens said 0the inflation outlook !rovided the o!!ortunity for monetary !olicy to .e eased further" so as to reinforce recent encouraging trends in household demand0# 0This is likely to .e inter!reted .y markets as a sign that the RBA .elieves it is near the end of the easing cycle"0 said Australia and ;ew ther commentators disagreed#

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Commentary The Reserve Bank of Australia cut the cash rate to a low record of 2 !ercent as a monetary !olicy with the e$!ectation to correct some ongoing economic weakness" es!ecially in .usiness ca!ital e$!enditure and !u.lic s!endings# Monetary !olicy is the !rocess .y which the government" central .ank" or monetary authority of a country controls the su!!ly of money" availa.ility of money" and cost of  money or rate of interest" in order to attain growth and sta.ility of the economy# Monetary !olicy generally refers to .e either e$!ansionary !olicy" which aims at increasing the money su!!ly or contractionary !olicy" which aims at decreasing the money su!!ly# 6ash rate is a term" used .y Australia and ;ew
/1# The effect of the decreasing of cash rates .y the Reserve Bank of Australia

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 As shown in the gra!h a.ove @/1" the increase of households consum!tion and firms investment shifts the aggregate demand from AC1 to AC 2# As a conseuence" the real out!ut shifts from D 1 to D 2" which demonstrates that the economy e$!anded# Therefore" if it worked" would increase consum!tion" ca!ital investment and decrease the rate of  unem!loyment" which Australian government recogniEed as !revailing weaknesses of  the economy# However" .eside these advantages" average !rice level also shifts from 31 to 32" which demonstrates an increase in the rate of inflation and if the Reserve Bank did not calculate the accurate num.er of cash rate" it might lead to high inflation rate which go against one of the main macroeconomic o.5ectives of every government to maintain a low and sta.le inflation# The decision of the Reserve Bank was risky and received mi$ed comments from the s!ecialists as some .elieved it would hel! the economy .ut others argued that it could cause high rate of inflation and affect negatively the economy" including less savings" social unrest and if it turned worse" the .ank needed to increase the cash rate" which .ackfired their own !olicy# Still" little or no inflation would ha!!en due to e$cess ca!acity of unem!loyed la.or and resources and inflation should not .e a high !riority in  Australia-s recessionary environment# >nly when consumer and investor confidence is restored" a condition that reuires low .orrowing costs" will the weaknesses of   Australian economy can .e resolved# Therefore" if the !olicy worked as the .ank e$!ected" in the shortrun" it would hel! the economy to increase out!ut and em!loyment# But as mentioned in the article" the cash rate had .een cut many times and these cuts only showed negligi.le im!act on real out!ut as the economy still faced its weaknesses# =hile it is acknowledged that in the long run the economy will revert .ack to its original level and will have e$!erienced increased inflation in the !rocess# 9n short" the cut would not hel! the Australian stagnant economy while it leaded to the increase of inflation" even though it was not significant .ut still had .ad im!acts on the economy which had suffered already# Therefore" instead of continuing this !olicy" to resolve the issues" the government of Australia could use other solutions such as fiscal !olicy  using government-s ta$es and e$!enditures to influence the economy more directly#

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