Impact of Interest Rates on Australian Economy

Commerce Assignment

Rising and lowering of interest rates

Interest rates, also known as cash flow influences many aspects of the economy, this aspect of the economy controls the worth of a currency. The interest rate of the Australian economy is controlled by the RBA (Reserve Bank of Australia), all decisions that are made follow the monetary policy which is a set of objectives that encourage healthy, stable and steady growth of the Australian economy.

When interest rates drop, money becomes cheaper to borrow. This encourages consumers to spend more money during this period. Low interest rate can also affect the price of housing as assets would be something worth to invest in and due to demand over supply causing the prices of property to sky

rocket. Low interest rates also discourage investments as low interest rates would yield small returns. Low interest rates would also be seen by businesses as a chance to expand, cheaper production rates would mean higher production and higher employment rates. This economic strategy could put the economy in a state of inflation raising the GDP.
As interest rates rise, money becomes more expensive to borrow. This discourages consumers to spend money and incentivize consumers to save more and to invest more as higher interest rate would yield higher return rates. High interest rates would also slow down the economy in negative ways putt it into deflation.
Interest rates correlate directly to the Australian economy, as seen in source 1 and source 3 years with higher interest rates yielded a lower GDP at 1142.26 billion USD, in the following years as the interest rates dropped the GDP went up by 200 billion USD. These result shows that lower interest rates encourage economic growth. Interest rates also have been on a decreasing trend since 2010 at 4.5% until current day at 1.5%, this significant change in interest rate is claimed to be caused by the need to create a housing boom before the next GFC so residential construction would fill in the gap for jobs created by the decline of project management construction.

Part 2
Explain how the economic issue impacts Australian Consumers
When the interest rate drops so will the cost of the money, making it cheaper for consumers to borrow money. The RBA has been consistently dropping the interest rates to ensure money is circulating around the system, as seen in source 1.
The lowering of interest rates can also affect those who invest in things such as government bonds, long term deposits and those who have a credit card loan.
In source 3 we can see that in 2010 the Australian GDP was extremely low, this was the cause of rising interest rates, as seen in source 1 at the time of the interest rise the GDP dropped, the rise in the interest made people save their money, investing it in Government bonds and long term investments. This rise in interest also incentivized people to not spend their money but to save up, this caused deflation which in turn causes economic stagnation, high periods of unemployment and recession.
To solve this issue the RBA decided to reduce the interest rate to kick start the economy again, this process can be found on the RBA’s official website (Link in bibliography). By lowering the interest rate money became cheaper to borrow, this impelled people spend more money as investing in long terms would yield little reward. With the lowering of interest rate also came the sky rocketing of the average house price, when money becomes cheaper an individual’s ability to purchase a residential property becomes greater. This large demand for property causes high rises in the pricing of properties. According to the 2016 Annual Housing Index Survey, Sydney and Melbourne are ranked in the top 4 most unaffordable cities in the world classifying it as “Severely Unaffordable”.
An example of this is clearly demonstrated in source 2, it shows the vast expansion of overpriced housing especially in Sydney and how it correlates with the interest rate over the same period as shown in source 1.

Explain how the economic issue impacts Australian businesses?

Interest rates can directly affect businesses as the increase of interest will discourage spending and more saving, whereas the decrease of interest will encourage more spending and less saving as money is cheaper to borrow.

Companies take advantage of this aspect of low interest rates to expand their business, hiring more people and generally paying higher salaries. The cost to of production will also become cheaper.

Low interest rates also impact lenders that are independent of the RBA, in times like these it usually means lenders have a lot of cash on hand and are anxious to lend it out forcing them to lower the interest rate. Low interest rates also encourage credit card users to pay back what they owe to the bank as it will save them money in the future.

Increasing interest rates will affect most businesses negatively, if businesses take loans prior to the increase of interest rates the business will most likely not be able to pay back and would have to cut back on their expenses. This would lead to high numbers of unemployment from businesses to recover.

High interest rates would also discourage the purchase of assets, businesses such as real estate would suffer as they rely on selling residential

properties.
In the case of Australia, a decrease in interest is seen, this has encouraged a growth in the economy. This is clearly demonstrated in source 3, within the first year of a decrease in interest the GDP for Australia rose by 18%. This trend did not only last one year but for the next 2 consecutive years.

Part 3 – Fiscal Policy
The fiscal policy is a tool used by the Government to control the fluctuations in the economy. When the economy is moving too slow the Government can then speed the economy up by changing government spending or taxes and when the economy is moving too fast the government can increase taxes.
When the economy falls into a deep recession government spending can be increased and taxes can be cut down, this is called expansionary fiscal policy. The idea of government spending is to increase the amount of jobs available for construction workers, teachers and other labourers. This is because government spending is essentially expenditure on things that directly satisfy the individual or collective need, this means new infrastructure needs to be built therefore creating more job opportunities. As the amount of jobs increase so does consumer spending, boosting the whole economy.
Cutting taxes follows the same principal, cutting taxes will allow more disposable income allowing more spending to occur in the market. This will also boost the economy.
When the economy is going through a phase of inflation the government can also raise taxes and cut spending, this is called contractionary fiscal policy. This method leaves consumers with less money to spend and lower government spending would mean fewer jobs available.
The 2012-13 Budget, which provides for an increase in taxes of $ 39 billion and a reduction in expenditures of $ 7 billion, is strongly contractionary, reducing aggregate demand by about 2 per cent. The government deserves praise for starting the process of fiscal consolidation in a possible election year. Still, given the low Australian government debt, there is no pressing need to restore an even budget within one year and a worsening of the economic crisis in Europe will make the budget unattainable.
Australia has been at the forefront of using fiscal policy to mitigate the macroeconomic effects of the Global Financial Crisis. It could well afford to do so as the Australian government debt is small by international standards. Even after several years of sizeable fiscal deficits, the net federal debt is still less than 10 per cent of GDP. This compares favourably with the debt ratio of the U.S. government of about 70 per cent - not to speak of Japan and some European countries.
Sustainable fiscal policy requires that the public debt does not increase relative to GDP in the long-run. An increase in the government debt ratio is permissible during an economic contraction but the debt ratio must be brought back to the old level when the economy recovers. The 2012-13 Budget reveals how the federal government intends to phase out the fiscal stimulus that has been applied during the Global Financial Crisis.

Bibliography
RBA interest rate debate - http://www.rba.gov.au/monetary-policy/int-rate-decisions/