Evidence showing that RBA is justified in considering an interest rate fall
At the beginning of the month of May, the Australian cash rate was said to be at 2.75%. This statistic was achieved shortly after the May’s bank rates were cut by the Reserve bank of Australia. This marked the lowest cut level achieved in the last 53 fiscal years in this country. The RBA’s board should consider cutting the cash rate because of the prevailing economic conditions in Australia today. The country’s financial markets are currently trading at a 14% chance of suffering a 25 basis points reduction; this sentiment was echoed by Credit Suisse while advocating for cash rates cuts that RBA reluctantly seem to avoid. The Australian Dollar currently trades at 92.23 cents to the US Dollar; which could be termed as considerably desirable . A was statement made by RBA’s board as to why cuts cannot be implemented to force the exchange rate to rise to 91.72 US cents per one Australian Dollar. The statement made by the board’s chair stipulated that in the current situation, the economy cannot permit cash rate cuts since it could be disadvantageous.
The board supports an argument that the current fall in exchange rate is not enough to warrant the cash rate cuts. Credible statistics indicate that since the last RBA cut, the Australian currency has fallen by a 10% margin against the United States’ currency. Most economies argue that unless the cuts are made, the Australian dollar may never return to its original position.
The current sluggish growth in the non-mining oriented growth is another issue of concern that could be settled through an RBA cut. According to De Garis, the RBA must, sooner than later, ease their stance with the cash rates; though this would depend more on the economic performance rather than the pressure from economic players. Garis argues that if the current trend continues, the unemployment rate would hit an all-time high of 6% by the end of the end of the year.
2 Phillips curve (AD/AS model) Relationship between rising and falling inflation
The aggregate demand/aggregate supply model could also be referred to as the Phillips curve. The Phillips curve attempts to explain the underlying relationship between unemployment and inflation. . The curve attempts to show how policy makers may kindle aggregate demand in times of recession or unemployment and how they could also restrain it in times of inflation. The model assumes that an economy can only be faced by either inflation or unemployment and never both at once. “For there to be zero unemployment, there has to be some level of inflation”. Phillips curve main argument is that; for one to have zero inflation there has to be some level of unemployment. According to the curve, Inflation and unemployment are inversely related such that as one increases, the other tends to decline and vice versa.
The curve proposes that the price inflation levels and the levels of unemployment have direct express effects on each other and that such effects are predictable
Inflation
(%)
6%
Phillips curve
2%
Unemployment (%)
3% 5%
Phillips inference that as the rate of unemployment increases, the labor market becomes tighter and, therefore, firms that have rapid responses, have to increase their wages in a bid to lure the scarce labor. When inflation rate goes up, the pressure tends to reduce. Phillips curve indicates the wage rate inflation in a particular level of unemployment. Developed economies develop Phillips curves for general price inflation. It would be important to note that the price a firm charges is usually related to amount of wages it offers.
3 money market model
The model helps indicate the possible short run market behavior that sheds light to the possible effects of interest rates and short run monetary policies. In this model, interest rates are considered and recognized as prices. The model assumes that money demands depend on the prevailing interest rates and transaction levels. When an economy is on the verge of recovery and when is entering the expansion stage, the authorities increases the supply of money in the economy. This is done by cutting down bank rates thus reducing the amount of interest charged on loans. When this happens people increase their borrowing and thus their investments. As a result of increased investments, there is a boost in the economy that causes it to grow.
Interest
Rate D
S
I
I1
M M1 money
On the other hand during recession, the RBA increases the cash rates. The effects of this would be higher interest rates thus reducing the supply of money in the market. People make lesser investments since they cannot afford loans due to the high rates of interest.
4 impacts lower interest rates have on Australia’s major Macroeconomic objectives
Inflation
6% Phillips curve
2%
Unemployment
3% 5
Lower interest rates by the RBA means that commercial banks in Australia would charge lower interest rates to their customers. The bank customers; who form the majority of the public, would result into demanding for more loans. This would happen due to the fact that the commercial bank can now offer term friendly loans to their customer that most of them can afford. This will trigger sporadic borrowing by the public. The public will result to extreme spending since they can easily access the money. This scenario would overwhelm the suppliers’ ability to supply enough goods to everyone leading to a rapid increase in prices and thus inflationary pressure.
The pressure would later turn into inflation. According Phillips a rise in inflation means a decline in the level of unemployment. . The model argues that for an economy to have zero unemployment there has to be some level of inflation. In this case the inflation will have been necessitated by the decrease in cash rates authorized by RBA and thus more jobs will be available.
Bibliography
Harford, T. (2013). The Phillips curve. Economic online .
Kohler, A. (2013). RBA sucked into an undeclared currency war. ABC.net .
Kwek, G. (2013). RBA holds fire on rates - for now. The Sidy Morning herlarld .
