The Asian Economic Crisis affected the ASEAN countries, where “a collapse in one country spread to its trading partners” (Source: Year 12 Economics 2001 – Tim Riley). The spreading of the collapse was due to the process of globalisation, where Australia and Japan were highly integrated (dominating 19.7% of Australia’s export markets), causing Australia to also collapse. Japan was and still is Australia’s major trading partner, and with an economic slowdown it caused less trade, therefore resulting in less demand for the Australian dollar causing depreciation.
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The third reason for Australia’s low exchange rate is the GST and the new tax reform. A fallacy, which based interest rates with exchange rates, stated that: “If the exchange rate was low, then interest rates should rise”. However, a different theory also states that the exchange rate depends on a country’s relative rate of economic growth/performance (Source: Sydney Morning Herald: Dollar’s descent is pushing economists to please explain - Ross Gittins 7/4/01).
When the GST was introduced on July 2000, it meant that every good and service would have a 10% tax on it. With goods and services at a higher price this would discourage consumers to spend causing less money to progress in the circular flow causing economic growth to decline. “Retail figures have recorded a 1.2% fall in February’s sales indicating a fall in consumer confidence” (Source: Sydney morning Herald: RBA to cut rates as indicators get worse - Jan Eakin 2/4/01). Debility in economic growth meant that there was a decline in real GDP. Lower GDP meant lower productivity leading to a depreciation in $A, which is similar to the reflection of productivity and share prices in a firm. Less productivity meant that there was less demand for trade, reducing the demand for the $A
- The last major reason for the weakening of the dollar is the high Current Account Deficit (CAD).
Australia’s Current Account Deficit 1993-1999
Source: ABS Catalogue 1350.0, May 1998 and Budget Statements 1999-2000 *(99-00 is up to March 2000)
The table above shows Australia’s CAD, increasing from $16, 254 million in 93-4 to $34, 765 million in 99-00(March), an increase of $18, 511 million in 7 years.
There is a directly proportional relationship between the Current Account and the Exchange Rate that is:
Current Account Surplus = Appreciation of Exchange Rate
Current Account Deficit = Depreciation of Exchange Rate
Australia has had a persistent current account deficit, where Australia is required to pay foreign borrowings (net income component on the balance of payments) back to its partners. As Australia repays for a high foreign debt, it increases the supply of the dollar, therefore depreciating the dollar and also resulting in an increase in CAD.
Effects of a low $A on the Australian Economy-
Inflation-
The low Australian dollar may have a detrimental effect on inflation. The Consumer Price Index (CPI) for All groups - March quarter 2001 recorded a 1.1% price rise in goods (Source: Sydney Morning Herald: CPI influenced by sharp increases in food prices: Costello – Jan Eakin 24/4/01). The CPI is a measurement of inflation, and with a price rise in all groups of 1.1%; this signifies that inflation is rising.
All Groups (Assorted Goods in the basket) - CPI
Source: ABS AusStats 6401.0 Consumer Price Index March 2001
These figures show the price increases in the past year in All groups of products from March 99 – March 00, to March 00 – March 01 there was a 1.1% rise in price of goods. This trend shows that there is an increase in inflation through all groups of goods, all due to the low Australian dollar. The decline in the exchange rate has increased the demand for the Australian dollar, because of increased exportation products. As the demand for goods increases, the price will follow therefore resulting in higher prices of goods, which reflects on the CPI.
Source: ABS AusStats 6401.0 Consumer Price Index March 2001
This graph shows the trend of the CPI increase, and further predictions show that inflation will keep rising. The low Australian dollar will keep the high inflation rate more persistent, which would result in prices of goods increasing and consumer confidence decreasing.
Economic Growth-
Australia domestically, due to a weak currency will have a low domestic economic growth with inflation increasing it will cause consumer confidence to reduce. Lower consumer confidence will lead to reduced money utilization, which will reflect on lower growth and performance in the long run. Australia’s economic growth dropped from 3.71%GDP in 2000 to 1.95%GDP in 2001(Source: IMF, The World Economic Outlook May 2001). The low Australian dollar has increased the price of imported goods and services.
Import Price Index – All groups
Source: ABS AusStats: Import Price Index, Australia
The table above shows the effect of the low Australian dollar on imported goods with prices rising, indicating that the Australian consumers will struggle through the turmoil of the low exchange rate. According to the laws of comparative advantage, Australia is an import-based country, which reflects on the consistency of the import price index.
However export goods from Australia have increased due to a low Australian dollar. The weak dollar has helped foreign expenditure to be much cheaper and more quantitative on Australian goods and services. This is an effect of globalisation, with increased integration with foreign countries - increased integration means increased diversity and trade.
Export Price Index – All groups
Source: ABS AusStats: Export Price Index, Australia
According to the Export Price Index, the low Australian dollar has meant that export goods have increased, causing macroeconomic growth to increase. There is an increase in the price index for exports, which indicates that there is an increased demand – demand and price for a good are directly proportional. However, the increase in macroeconomic growth in exports will not have a great significance in the exchange rate, with importation constantly higher, as shown by the terms of trade index:
Terms of Trade = Export Price Index/Import Price Index X 100
The terms of trade for year 1999-2000 was:
98/120.2 X100 = 81.5.
Showing deterioration and further deterioration in overseas trade by Australia.
External Debt/Current Account Deficit (CAD)-
Australia throughout history has always experienced a persistent CAD. The vulnerable dollar has increased and worsened the Current Account Deficit. With the dollar low, Australia is required to spend more to cover the costs of foreign debt from overseas loans and borrowings. This process of overseas repayments in the long run will consistently increase the CAD, causing the exchange rate to further depreciate according the relationship between the CAD and the exchange rate (refer to page 4).
Another factor contributing to the commotion of the dollar is that Australia usually necessitates the costs of overseas loans by seeking other loans from other partners, causing the debt to further increase. “The depreciation of the Australian dollar has lead to increased debt servicing costs since about 40% of Australia’s net foreign debt is denominated in foreign currency loans, increasing the risk exposure of borrowers to depreciations.” (Source: Year 12 Economics 2001 – Tim Riley) The table titled Australia’s Current Account Deficit 1993-99 (refer to page 3) shows the trend of increasing foreign debt.
Unemployment-
Unemployment will be greatly affected by the demotion of the dollar. It will affect businesses that require importing goods and services with the costs being so great, that job cuts are required to compensate for the high costs of importation and higher inflation.
“The number of job advertisements in major metropolitan newspapers fell 7.9% last month to the lowest level in four years according to ANZ’s monthly job ad survey. It is also predicted that future bill contracts would fall by 4.48% by June 2001.” A drop in the number of job advertisements has meant that there are less employment opportunities indicating that there is an increase in unemployment.
“Economists said the labour market would remain weak for much of the year and some tipped the unemployment rate to hit 8%. In February unemployment jumped to a 14-month high of 6.9%.”(Source: Sydney Morning Herald: Gloomy figures dollar’s rally – Matt Wade 10/4/01). Economists have different perspectives of the predicted unemployment rate, but most forecast increased unemployment.
The number of employment advertisements has fallen by 17% in February and March to be down almost 33% in year 2001 indicating less job opportunities and higher unemployment. “Claims for unemployment benefits were the highest in five years.”(Source: Sydney Morning Herald: Stronger dollar, gold up – David Potts 15/4/01) The effect of the low current exchange rate has caused unemployment to rise.
Unemployment in the past decade
Source: ABS AusStats: 6202.0 Labour Force, Australia, Preliminary
The trend estimate of unemployed persons peaked at 947,000 in September 1993, before falling rapidly to 752,300 in June 1995. The trend then rose slowly reaching 798,300 in March 1997, before falling to 619,500 in September 2000. The trend has since increased to stand at 667,200 in March 2001.
Unemployment %rate in the past decade
Source: ABS AusStats: 6202.0 Labour Force, Australia, Preliminary
After reaching 11.0% in August 1992, the trend unemployment rate remained steady for twelve months, before falling rapidly to 8.4% in July 1995. The trend then rose slowly until March 1997, before falling to 6.4% in September 2000. Since then the trend estimate has risen to stand at 6.8% in March 2001.
The low Australian dollar has been and is going to be catastrophe for employment, with unemployment rising by 0.2% in March 2001. The trend predicts that the unemployment rate will continue to increase further.
Source: Bureau of Statistics, Access Economics
According to the graph it shows that in 2000 GDP and the working age population had dropped significantly and as the dollar decays further, it is predicted that the working age population will continue to fall.
Implications to the Phillips Curve-
New Zealand economist A.W Phillips proposed a theory that stated that inflation and unemployment are inversely proportional, that is if:
Unemployment was high then inflation is low
Or
Unemployment was low then inflation was high
The Phillips Curve illustrates this:
Source: Year 12 Economics 2001 – Tim Riley
According to Phillips theory, Australia does obey the inverse proportional relationships, which predicts the ramifications of the Australian micro and macro economy to be possibly disastrous in the future. The low Australian dollar has implicated into a situation, where further predictions for inflation and unemployment for the Australian economy are not encouraging.
Note: Phillips Curve refers to the UNDERLYING inflation rate NOT the consumer price index.!
Bibliography
ABS AusStats –http://
RBA Reserve Bank of Australia – http://
Federation of Australia – http://
Egoli stockbrokers – http://
The Sydney Morning Herald – http://
Australian BRW – January 13th 2001 issue &
The International Monetary Fund IMF –
The Financial Review – 23/4/01
Year 12 Economics 2001 – Tim Riley © 2000 Tim Riley Publications
Australia’s Place in the Global Economy
Question-
“Explain the reasons for our current exchange rate level. Evaluate its impact on the Australian Economy.”
Introduction
- How do exchange rates work?
- Evaluation of the dollar
The weakening of the dollar
Causes of the low $A
- Interest Rates
- Asian Economic Crisis
- GST
- High CAD
Effects of the low $A on the Australian Economy
- Inflation
- Economic Growth/ Imports & Exports
- External Debt/ Current Account Deficit
- Unemployment
Implications to the Phillips Curve
Bibliography
Pages Contained: 9
Written by: Albert
